Suzuki Motor Corporation (SMC) parent company of Maruti Suzuki India (MSIL) is going ahead with setting up of a car manufacturing plant in Gujarat with 1.5 million units per annum through its 100% subsidiary, Suzuki Motor Gujarat (SMG).
During an investor presentation, SMC informed that SMC/SMG intends to fund the investment of Rs 18,500 crores in the plant with own equity and accumulated depreciation. It will make cars on a strictly no-profit, no-loss basis.
SMG will enter in to a contract manufacturing agreement (CMA) with MSIL for an initial period of 15 years for supply of entire production to the latter. The CMA could be extended by mutual consent. In case, it is not extended, the “assets would be transferred to MSIL at a fair value to be determined by independent valuation”
As per an initial plan, MSIL was to set up this factory. Gujarat government had given the land and also agreed to grant tax benefits to MSIL. However, the plan was changed midstream.
In January, 2014 MSIL (SMC holds 56% in MSIL) informed that plant would be owned and built by SMG with an investment of Rs 3000 crores for an initial capacity of 250,000 cars per annum. Eventually, capacity would be increased to 1.5 million per annum.
This caused consternation among minority shareholders who hold around 14% in MSIL. What raised their hackles even more was SMC’s intent to fund entire investment beyond Rs 3000 crores through ‘incremental capex cost’ or a mark-up, to be over and above cost of production of vehicles. And, this was to be borne by MSIL.
They not only saw an opportunity to be a partner in major expansion slipping out of their hands, but also, MSIL being forced to contribute to financing of Gujarat plant to the extent of 84% (15500/18500) without the benefit of actually owning it.
Following representations made by institutional investors to regulatory authorities viz., SEBI etc, SMC has now tweaked plan to say that entire investment of Rs 18,500 crores will be funded by SMC with ‘accumulated depreciation and equity infusion from SMC, to the extent necessary’.
It has also added that in case CMA is not extended by mutual consent “assets would be transferred to MSIL at a fair value to be determined by independent valuation”. In the initial proposal, plant was to remain under SMG all through.
A closer look would show what is being put on table now is nothing but old wine in a new bottle; perhaps even worse. The commitment of equity infusion by SMC has been changed from Rs 3000 crores to ‘to the extent necessary’ which could even be nil.
So, funds would have to come entirely from accumulated depreciation. This is an accounting jargon for an amount generated as net surplus from car pricing. You can’t get this unless amortization of capexp is specifically built-in.
Now, look at statements from SMC elaborating on no-profit, no-loss principle (NP, NL):-
‘SMG would not generate any profit or loss at end of a financial year. If, it does generate profit or any interest thereon, it will be utilized in reducing prices of products to be supplied to MSIL during immediately following financial year.’
‘Similarly, if there is a loss at SMG, it will be compensated by an increase in sale price to MSIL during the immediately following financial year.’
The statements are anomalous. Given absolute control of SMC over pricing, there is no room whatsoever for either profit or loss. These are only meant to camouflage real intent which is to make MSIL foot bill for entire capital expenditure on setting up the factory.
The pricing process by subsidiaries of MNCs is generally opaque devoid of transparency. Since, SMG is 100% owned by SMC, MSIL cannot have access to full costing details and ask questions. The latter will have to accept whatever numbers are fretted out.
Together with assured market for entire production (via CMA) and tax concessions from state (Gujarat govt has already agreed to transfer/endorse these to SMG), it will be a win-win all the way for SMC. MSIL will be reduced to a ‘shell’ company doing only marketing and distribution.
SMC argues that arrangement will be beneficial to MSIL who will earn about Rs 10,500 crores during initial 15 years ‘by not investing in the plant’ (@ 8.5% post-tax return). The earnings would continue during the extended period of CMA. This is perverted logic.
What makes SMC feel that investment in Gujarat factory would yield lower return than if money were to be invested elsewhere? Why would MSIL’s investment in plant not yield even 8.5%, a rate used for computing earnings elsewhere? The facts speak otherwise.
On deployment of its cash thus far, MSIL has not earned return any where near mentioned figure. SMC’s claim for future returns is presumptuous. In contrast, if MSIL were to invest in Gujarat plant, it can earn 16% plus in line with earnings from existing plants.
Clearly, SMC’s game plan is to push MSIL out of its core territory where there is substantial scope for consolidation and expansion. If allowed to succeed, MSIL could even run risk of a deleterious impact on its existing operations.
The capacity of Gujarat plant is 1.5 million cars per annum. With an obligation to sell these as per CMA, MSIL may not be able fully utilize its capacity (at Manesar & Gurgaon) in a competitive market place. In economic down-turn, it could end up in disaster.
The purported sweetener of ‘transferring Gujarat plant to MSIL at a fair value’ is predicated on too many ifs and buts. In any case, in a world of technological advances and rapid obsolescence, such a proposal will have little commercial value.
Given serious implications and considering that minority shareholders have a significant stake, MSIL needs to take a re-look at its decision and take forward the original plan for housing Gujarat factory within its fold. SEBI and Gujarat government should lend requisite support to efforts of institutional investors in this endeavour.
With majority stake (56%) in MSIL, SMC too will stand to gain from this arrangement. However, it would do well not to push its desire to a point where it wants to appropriate entire benefits from Gujarat plant causing irreparable loss to minority shareholders.