CG Alert: Maruti Suzuki

Maruti Suzuki India Limited (MSIL) made an announcement to the stock exchanges on January 28th 2014 regarding an arrangement with the promoter – Suzuki Motor Corporation (SMC).

As per the press release, the company had purchased 640 acres of land in Becharaji and 550 acres in Vithalapur in Mehsana district of Gujarat in 2011 for expansion of manufacturing facilities. However, after the purchase of land, expansion plans were kept on hold due to market conditions.

Now, acting on a proposal sent by SMC, the Board of MSIL has agreed to an arrangement as per which expansion and production in Gujarat will be undertaken by a 100% subsidiary of SMC. The subsidiary will produce vehicles in accordance with requirements of MSIL and the vehicles will be sold only to MSIL. The price of the vehicles to MSIL would include cost of production by the 100% subsidiary and adequate cash to cover incremental capital expenditure requirements. The return on this investment for SMC would be realized only through the growth and expansion of MSIL’s business. The subsidiary will always remain a 100% subsidiary of SMC.

A very pliable Board of Maruti Suzuki India Limited (MSIL) has done grave injustice to minority shareholders of MSIL. The Board has agreed to enter into contractual arrangements for expansion with a 100% subsidiary of Suzuki Motor Corporation, the dominant shareholder of MSIL. This is not a simple contract manufacturing arrangement as the dominant shareholder of MSIL is “the contract manufacturer” and can dictate the terms of any contractual arrangement. Various contractual arrangements that give scope for conflicts of interest are:

(a)               Transfer pricing of vehicles from 100% subsidiary to MSIL. The cost of production and adequate cash to recover the capital expenditure would be returned to the 100% subsidiary.

(b)               Lease rental on land, as land continues to be on the books of MSIL.

(c)                All assistance in executing the project to be provided by MSIL.

(d)              Ownership and development of newer products and brands.

(e)               Vehicular offtake.

The positives stated by the company that MSIL benefits from the interest expense of not investing is not tenable as MSIL is a net cashflow positive company, and incremental cash generated would be better utilized for capital investment for this expansion. There is no compelling business logic for such an arrangement when MSIL has the necessary capital raising ability to make investments. It looks like the SMC subsidiary will enjoy the benefits of no business risk with assured vehicle offtake by MSIL and assured return on investments, while MSIL will bear the business risk of cyclical vehicle sales, competitive pressures, pricing and cost pressures. Inventory levels, car pricing and discounts, cost increases, dealer network management, post-sale servicing, brand management would all be risks that will continue to be borne by MSIL, while the 100% SMC subsidiary enjoys an assured vehicular offtake at pre-determined prices.

Read the full report here: CG Alert – Maruti Suzuki