MNCs' royalty pangs

Small shareholders can feel left out

Minority shareholders of many of the Indian subsidiaries of multinational companies have reasons to feel left out, with an increasing number of parent firms of Indian MNCs opting to earn more from royalty than equity dividends, hurting minority shareholders. For, the gains for non-promoter shareholders are entirely tied to companies' profitability and dividends, and royalty payments for using their parent firms' brand and technology are a cost for the Indian subsidiaries and lower their profitability. This clearly points to a negative correlation between higher royalty payment and profitability for MNCs. As a report in this newspaper showed last week, there has been a consistent decline in MNCs' profit margins in India as they have raised royalty payments. Both net profits and dividends grew much slower than the top line.

An over-reliance on royalty against dividends to earn returns also reduces the parent company's incentive to maximise profits in India. Royalty is tied to revenues, while dividend is dependent on firms' profits. The fact that royalty payments are taxed at lower levels than profits pushes MNCs to maximise revenues rather than profits in India. For example, a whopping 94 per cent of Suzuki's returns from Maruti Suzuki in 2012-13 came in the form of royalty. The corresponding ratio was 78 per cent in the case of ABB, 59.4 per cent for GlaxoSmithkline Consumer and 92 per cent for Cadbury India.Things could get worse as competition increases in India, making it tough for companies to raise prices to compensate for royalty payments. In the automobile sector, the entry of global car majors - coupled with aggressive growth push by home-grown car makers - has triggered a price war and margins have been under pressure. This will increasingly make it tough for companies to keep both their principal and minority shareholders happy.

In the past, MNCs were criticised for dividend-stripping from their Indian subsidiaries compared to their Indian-owned peers. It wasn't uncommon for MNCs to distribute over two-thirds of their net profit as dividends, more than double the payout ratio for an average listed company in India. Some shareholders liked it and MNCs were the preferred choice for shareholders looking for safe bets during volatile times. The pressure to maintain high dividend payout ratio, however, limited MNCs' risk-taking ability and constrained their growth potential in a rapidly evolving economy like India, where new categories and markets are always emerging. Contrast the growth divergence between Hindustan Unilever and ITC. While the former remained stuck in personal care products, beverages and ready-to-eat foods and distributed most of its profits as dividends, ITC leveraged its cash flows from the tobacco business to become a consumer conglomerate with a strong presence in a large and varied set of sectors. ITC, which was once smaller than HUL, is now India's largest consumer goods company on all financial parameters. One can see a similar divergence between HUL and second-tier fast-moving consumer goods (FMCG) companies such as Dabur, Godrej Consumer and Marico, among others. While MNCs are justified in charging a royalty for their brands and technology, it should not be so steep that only crumbs are left for minority shareholders.