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Markets were shocked by the sudden change in manufacturing structure announced by Maruti Suzuki, where the parent company, Suzuki Motor Company (SMC) will set up a wholly owned subsidiary in Gujarat. This unit will be selling its entire production to the listed entity, Maruti Suzuki. While the stock fell when the news hit the market, it recovered the next day as the company in a conference call convinced most analysts that the move would mean more profits in the hand of Maruti. However, the deal still lacks complete clarity.
The most important point in why announce such a deal now? Though the company's management has spoken of no impact on its profitability, there is definitely no altruistic motive behind Suzuki's move. A look at what Suzuki will gain from such an investment over the long run can give us an idea of what Maruti Suzuki will lose.
Being present in India for over three decades, the country is now the second most important market for the parent company. Over the next three years, Suzuki is planning to launch 16 new vehicles in Japan; India will see 14 new vehicle from the Suzuki stable while Europe and China will see only seven each. Maruti Suzuki was expected to play an important role in the company's expansion plan in West Asia and Africa. But this was before the present deal was announced.
There were expectations earlier that the parent company would increase its stake in Maruti Suzuki from the existing levels of around 56 per cent. But with the setting up of a 100 per cent subsidiary for manufacturing, it is unlikely that Suzuki would be keen in increasing its stake. This is a negative for those who were trading the stock for such an eventuality.
As a business decision it boils down to the return the parent company will get by investing in a greenfield project as compared to increasing its stake in the listed entity. Maruti Suzuki currently trades near its all-time high level and is giving a dividend yield of less than 0.5 per cent. For Suzuki capital appreciation is not a choice as it will not be selling or reducing its stake. Thus investment in the listed entity is barely giving any returns to the parent at current valuations. The only other choice is to create a parallel manufacturing set-up.
Maruti Suzuki's Chairman RC Bhargava argues than the greenfield project is beneficial for the company as it would not have to sacrifice returns during the gestation period of five years. According to him, return on capital from the Gujarat car unit will be around 17 per cent, which is what the company is enjoying at present.
The Gujarat plant would need a capital expenditure of around Rs 3,000 crore, which Maruti Suzuki could have easily managed given its Rs 7,500 crore cash level. According to Bhargava, Maruti will be free to use the Rs 3,000 crore to expand its marketing set-up. But the company has invested close to Rs 5,300 crore in mutual funds, which no one is stopping it to invest in marketing. Also, the long term steady return of 17 per cent that Maruti could have received if it would have set up the project is any day better than the uncertain returns on its mutual funds investment, even if we take the gestation period into account.
In late 1990s, multinational pharmaceutical companies wanted to set up 100 per cent subsidiaries in order to take advantage of changes in patent laws in India. But vociferous shareholders and investor protection group throttled their move. However, later they were allowed to set up 100 per cent subsidiaries, but the activity was largely restricted to research. What the pharmaceutical multinationals were trying to exploit was the huge market potential in India where they could sell their high cost patented products. They did not want their Indian listed entity and minority shareholders to benefit from the huge potential that existed. Suzuki's move to set up a 100 per cent subsidiary also smells of similar opportunism.
Maruti Suzuki has demonstrated that it can manage high volume of production and sales. Though the current scenario in India is not conducive for growth in the automobile sector, this is a temporary phenomenon. Maruti, because of its pricing policy, has always been the first choice of a car for a price conscious youth. With increasing youth population and rural push, Maruti with a lion’s share of the market is ideally positioned to capitalise on a turnaround in the fortunes of the sector.
Further, Maruti is likely to be the manufacturing hub of West Asia and Africa, two of the fastest growing automobile market in the world. Though Suzuki has said that all exports would also be through Maruti, not many analysts are convinced. UBS in its report has said that most of the future exports could be pursued through this plant and Maruti would only make marketing margin. What it means is that though Maruti will be exporting cars made in Gujarat, it will be doing so to another Suzuki unit which would enjoy the mark-up in price. In short there are doubts over the entire exercise.
Due to its size of operation Maruti has been able to aggressively price its cars, and in turn it has proven to be a low-cost producer. Suzuki seeks to exploit this advantage as well as the proximity of the manufacturing unit to the port, which it could not when the unit was in Haryana. The Gujarat unit makes it an ideal manufacturing hub for Suzuki to tap West Asian and African markets.
Clearly, Maruti has not only sacrificed its right to produce its own cars, but also sacrificed transparency in its dealing with Suzuki. The question of where most of the profit will be captured will linger in the minds of its shareholders.
