It has been a downhill ride in the last one month for car industry leader and stock market darling Maruti Suzuki which is embroiled in a controversy of its own making. Investors, analysts and the stock market are up in arms over the proposal by Suzuki Motor Corporation (SMC), which owns 56 per cent of Maruti Suzuki, to set up a new plant in Gujarat as a wholly-owned subsidiary. They sent Maruti’s stock plunging by 8.12 per cent on January 28, the day the decision was announced. On Friday, the company sent a clarification to the stock exchanges but it raises more questions than it answers. Not surprising then that the market voted with its feet again sending Maruti’s shares tumbling down by 4.53 per cent.
If the original announcement was patronising to Maruti’s shareholders and flawed in its financial logic, the clarification put out on Friday raises concerns over transfer pricing strategies. SMC’s wholly-owned Gujarat subsidiary will operate on the basis that it will neither make a loss nor a cash surplus. If you thought this means that the subsidiary will supply to Maruti at cost, you are wrong.
Cars manufactured on contract basis for Maruti by the Gujarat subsidiary of SMC would be priced in a manner that will generate a “surplus” to fund the subsidiary’s capital expenditure, says the clarification. Of course, the company has also very kindly clarified that such price would be lower than what Maruti charges its dealers so that it can build in its margin. But how much lower? And why should the capital expenditure of the SMC subsidiary be funded by Maruti when it has no stake? Investors are agitated over the basic question of why SMC should branch out on its own when Maruti has the financial resources and management bandwidth to implement the project as its third plant. The land for the Gujarat plant has already been paid for by Maruti and it is obvious to assume that its managers, contractors and vendors will play a key role in implementing the project for SMC.
The existence of a fully-owned subsidiary of SMC and a partially-owned one, both dealing in the same business, raises obvious questions of conflict of interests. Will SMC’s new products and technology be channelled through Maruti or the new wholly-owned subsidiary? SMC has defended its decision saying that Maruti will benefit from interest earnings on its huge cash resources of over Rs.7,000 crore by not investing in the project. But where is the money now invested? In unquoted units. And what did it earn? All of Rs. 313.40 crore as interest in 2012-13, which is a piffling 4.5 per cent rate.
In comparison, Maruti’s return on capital employed, which is a rough estimate of what the cash might earn if invested in a project, was a little over 15 per cent in the same year. How does SMC then say that Maruti will benefit by not investing? If that was bad logic, this takes the cake: Maruti can apparently “avoid all risk inherent in any investment” by not investing in the new plant, according to the statement. If it is not the karma of a corporate manufacturing enterprise to invest in growth, what is?
The bottomline is this: SMC’s strategy is not favourable to Maruti and it is shocking that the Japanese multinational can do this to its Indian subsidiary which earns more than what the parent earns in Japan. The strategy is hostile to minority shareholders, and institutional investors, who are already miffed, should carry their protests to the logical conclusion. SMC is trying to have the cake and eat it too; it should not be allowed to get away with it.