SES Corporate Governance Research - Maruti Suzuki - 11 February

STAKEHOLDERS EMPOWERMENT SERVICES
PUBLICATION DATE: 11 FEBRUARY, 2014
CORPORATE GOVERNANCE RESEARCH MARUTI SUZUKI

Stakeholders Empowerment Services (SES) is a not-for-profit Corporate Governance research and advisory firm. For more information about us, please contact us at +91 22 4022 0322 or connect with us via email at: info@sesgovernance.com Corporate Governance Research | Corporate Governance Score | Proxy Advisory | Stakeholders Education
Maruti Suzuki Gujarat Expansion 2013
Table of Contents
Executive Summary...................................................................................................................... 3 Overview of the Deal ................................................................................................................... 4 SES Analysis ................................................................................................................................. 5 The Proposal .............................................................................................................................. 5 Analysis of the press release ...................................................................................................... 5 The expansion of facilities was kept on hold due to market conditions ...................... 5 The Suzuki subsidiary would always remain a 100% Suzuki owned Company............. 6 Expansion through a 100% Suzuki subsidiary ............................................................... 6 Production contract ...................................................................................................... 6 Transfer price between SMC subsidiary and MSIL ....................................................... 7 Leasing of Land by MSIL ................................................................................................ 8 Risk for MSIL in the structure ....................................................................................... 8 Assistance by MSIL in implementing the project .......................................................... 8 Marketing...................................................................................................................... 8 Financial benefits to MSIL ............................................................................................. 9 Royalty issue at MSIL ............................................................................................................... 10 What is there in it for SMC? ..................................................................................................... 11 Does the deal require shareholders approval? ...................................................................... 12 Evaluating alternative structure .............................................................................................. 12 Conclusions ............................................................................................................................... 14 Disclaimers ................................................................................................................................ 15
2013 - 2014 Stakeholders Empowerment Services Pvt Ltd | All Rights Reserved
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CORPORATE GOVERNANCE RESEARCH

Summary
The proposed arrangement is a related party transaction (RPT). SES recommends that a Company should not resort to related party transactions unless they are unavoidable and are in the larger interest of the Company. RPTs should only be partaken if they bring in some definitive advantage to the company and their Impact can be measured in a holistic manner. Present laws/regulations do not require shareholders approval for RPTs. However, Companies Act, 2013 interalia provides for approval of RPTs by majority of non-interested shareholders. Therefore, it is desirable that as a good governance practice, the Company should seek shareholders approval for this RPT notwithstanding legal position as on date. If the Company proceeds with the transaction without seeking shareholders approval, it may indicate that the transaction has certain issues which the company or its promoter SMC does not wish to bring to the notice of shareholders. Additionally, in case the Company does not take approval for the RPT at this stage, there is a possibility that shareholders might block this RPT in future, when relevant provisions of the Companies Act, 2013 become applicable. Prima-facie, SES does not find any adverse issue for minority shareholders of MSIL, provided that all statements made by the Company in its press release announcing the transaction are correct. However, a lot would depend on the provisions in fine print of the deal and future actions that will determine whether statements made were for real or only a ploy to circumvent investor approvals/ scrutiny. In order to ensure that the RPT is at arms length and that there are no hidden anti minority-investor issues, SES recommends that comments/commitments made by SMC in its press release should be a part of agreement(s) between MSIL, SMC and the subsidiary company. If safeguards are not built to protect minority investors interests, then it would be a clear case of enticing shareholders with high sounding statements and putting wool over their eyes and hiding real intentions. In such a case, investors should exercise all their powers to block the transaction. In view of savings envisaged for investors on account of interest savings (amounting to EPS of `8/share), SES would advise shareholders not to reject the transaction off-hand but to constructively engage with the company and discuss each and every related party issue. If the management comes out clean on the issues highlighted in the report and addresses all concerns in a positive manner, shareholders would benefit from the proposed transaction. SES believes that governance can only be improved by constructive engagement of all stakeholders with the company. An outright rejection might not be in the interest of either party. Stakeholders exercising their rights and ensuring that all their issues are addressed would ensure that any positive opportunity is not frittered away.
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Overview of the Deal
On 28th January, Board of Maruti Suzuki India Ltd. (MSIL) issued following Press Release to announce the decision of Suzuki Motor Corporation (SMC) setting up a Greenfield project for manufacture of cars in Mehsana District of Gujarat on the land that was bought by MSIL for setting up a plant for expansion. SES has examined the deal from governance and minority (non-controlling) shareholders point of view. SES has not analysed financial implications of the deal except where it is necessary to highlight issues of governance. Press Release: Maruti Suzuki Board Decision on Gujarat Project dated 28 Jan 2014
Maruti Suzuki Board Decision on Gujarat Project New Delhi, October 29, 2011: The Board of Maruti Suzuki India Limited (MSIL) had, on 29 October 2011, approved the purchase of land in Mehsana District of Gujarat for further expansion of manufacturing facilities. Following this decision, approximately 640 acres of land in Becharaji and approximately 550 acres in Vithalapur was acquired. The expansion of facilities was kept on hold due to market conditions. Recently, the Board received an attractive proposal from Suzuki Motor Corporation (SMC) for implementing the expansion project through a 100% Suzuki subsidiary. The Suzuki subsidiary would always remain a 100% Suzuki owned Company. The Board, today, decided that the time was now appropriate to expand production facilities in Gujarat. It approved implementing the expansion through a 100% Suzuki subsidiary because it would result in substantial financial benefits to MSIL, and its minority shareholders. MSIL would enter into a contract with this subsidiary company under which all production in the subsidiary company would be in accordance with the requirements of MSIL, and the vehicles would be sold to MSIL. The Suzuki subsidiary would not sell vehicles to anybody else. The price of the vehicles to MSIL would include only the cost of production actually incurred by the subsidiary plus just adequate cash (net of all tax) to cover incremental capital expenditure requirements. The return on this investment for SMC would be realized only through the growth and expansion of MSILs business. MSIL would financially benefit from the interest earnings resulting from not investing its money in this project. It would also benefit because the vehicles would be sold to MSIL by the Suzuki subsidiary without any return on capital employed. MSIL would be able to avoid all risk inherent in this investment. MSIL would also retain the option of investing its own funds for strengthening its marketing network, product development, R&D or in any other opportunity for growth or building strength for market leadership of the company MSIL would render all required assistance to the subsidiary company for implementing this project on an arms length basis. The land for the project would be leased by MSIL to the subsidiary company to establish the production and related facilities. The rent would be determined on an arms length basis.
th
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SES Analysis
In absence of adequate details, SES has analysed the contents of press release of Maruti and to some extent the interview of Mr R C Bhargava, Chairman of the Company.
THE PROPOSAL
Suzuki Motor Corporation SMC
SMC owns 56.21% in MSIL 100% Initial Investment to setup plant Vehicles @ Cost Price
Dividends + Royalty
Gujarat subsidiary to be 100% owned by SMC
Maruti Suzuki India Limited MSIL
Gujarat Subsidiary
1. Land 2. Cost of Production 3. Incremental Capital Expenditure
ANALYSIS OF THE PRESS RELEASE

The expansion of facilities was kept on hold due to market conditions The Company acquired land at Mehsana District in Gujarat at two locations measuring 640 acres and 550 acres for expansion, but kept the expansion on hold due to (adverse) market conditions. Now that the company has announced the proposed plan, it is inferred that the market conditions are now conducive for expansion. The decision of the board, especially the timing coupled with proposed structure, indicates that the board must have mulled over and decided that the time was ripe for setting up the plant. However, the Company has not substantiated this statement with any figures. MSIL itself reported lower sales both in volume and money terms for third quarter and reported a 10% dip in sales in month of January 2014.
Further, SES has also noted certain inconsistencies in the statements made by the Company.
Work on the Gujarat site has commenced and we expect to start production by the end of 2015-16. - Chairmans statement, Annual report 2012-13 During the year, the Company signed an agreement with the Gujarat government and acquired 700 acres of land near Mehsana for future capacity expansion. Work is likely to start there shortly. Management Discussion and Analysis, Annual report 2012-13 The Board, today, decided that the time was now appropriate to expand production facilities in Gujarat. Press release, October 29, 2011
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SES recognises that the decision to expand or not is a long-term issue and is not impacted by decline of sales in a month or quarter. However, a change of decision must be made based on certain information, data and predictions. As a good Corporate Governance practice, the company should have disclosed the information that impacted its decision-making to its shareholders. SES finds that the company has been rather conservative on disclosures.

These statements indicate that although work had started earlier and project was being executed under MSIL, a change has been made now. However, the press release does not give the same impression. SES recommends that the Board should explain what led to change of decision especially the parameters which led to the change. The Suzuki subsidiary would always remain a 100% Suzuki owned Company The statement gives an impression that the subsidiary will remain 100% SMC owned unconditionally and perpetually. SES recommends that both MSIL and SMC should state conditions, if any, under which this decision might change. Else SMC will be able to exit the business only through liquidation of the subsidiary, as it can neither be sold wholly or partly to MSIL or any third party. Even merger with MSIL or any other company is not allowed; therefore effectively risk of future dilution is ruled out if the statement is taken at face value. Expansion through a 100% Suzuki subsidiary The Company has stated that expansion through a 100% Suzuki subsidiary will result in substantial financial benefits to MSIL, and its minority shareholders. Major assertions in the Press Release are as under 1. 2. 3. 4. The subsidiary will always remain 100% Suzuki subsidiary. All sales will be made to MSIL. All sales will be at cost plus just adequate cash to cover incremental capital expenditure requirements. No return on investment will be realised.
SES is of the opinion that with the stringent conditions self-imposed by SMC, it can be inferred that there will be no dividend transfer from subsidiary to SMC, and only initial capital brought in by SMC will be repatriated. To give comfort to MSIL and its shareholders against any other interpretation, the contract between MSIL/SMC and subsidiary should not only confirm above observations but may also include an option for MSIL to buy out subsidiary at book value at any point of time in future. Production contract Press Release has further emphasised on following points: 1. 2. 3. 4. MSIL would enter into a contract with SMC subsidiary All production in the subsidiary would be in accordance with the requirements of MSIL All Vehicles would be sold to MSIL Suzuki subsidiary would sell vehicles to MSIL at the cost price plus just adequate cash to cover incremental capital expenditure requirements.
Plain reading of the above statements suggest that the subsidiary would be a captive unit and its 100% revenue will come from MSIL. Production programme will also be in accordance with MSIL requirements. Understanding the impact and meaning of these statements is very important. Concerns have been raised by various analysts that it may happen that capacity utilisation of MSIL may drop, and that of the subsidiary will go up. SMC may be in drivers seat at MSIL being the major and c ontrolling shareholder. SES is of the opinion that if the decision to expand production facility is commercially correct, then it will be immaterial which unit produces, operates at what capacity utilisation, subject to following being true. 1. The entire output will be sold to MSIL.
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2. SMC, through its subsidiary, will not earn any return on its capital employed/invested. As discussed previously, this statement means that there will be no dividend from subsidiary to SMC at any point of time in future and at the most it will be repatriation of original investment. It may be argued that the subsidiary will dump its production to MSIL and will continue to produce more vehicles and put MSIL to disadvantage. More so, as SMC is controlling MSIL it may do favours to subsidiary being 100% owned. SES does not agree to this view because subsidiary or SMC may resort to this, only if the subsidiary could earn and give any return to SMC. In the absence of any returns to SMC from subsidiary, there is no reason for subsidiary to do anything that will hurt SMC and MSIL as well. Factually, if the subsidiary does not operate at full capacity or, hypothetically produces only a single car in a year, even then the entire cost of subsidiary will have to be absorbed by MSIL. At the end of the year, the subsidiary will have revenue equal to its cost returning NIL profit and loss. It may appear that this structure brings a big risk for MSIL as lack of demand may result lower operation level at subsidiary. SES is of the opinion that risks for this transaction should be the same as that of any expansion project, and should not be seen as additional risk from the structure proposed. If the decision to expand is sound and prudent, then profitability of MSIL on account of change in demand and supply position would be agnostic to structure chosen for expansion as in all the cases entire costs would be absorbed by MSIL in its consolidated account. Post the subsidiary becoming operational, MSILs financials will be akin to consolidating financials of the SMC subsidiary with MSIL. For purpose of Profit and loss, the entire cost will be borne by MSIL. Therefore, individual capacity utilisation will be immaterial. It will be the aggregate capacity utilisation that will matter due to nature of contract. The above analysis would be incorrect if there is no control on the costs at subsidiary and SMC is able to derive benefit through supply of spares, parts, technology etc. to subsidiary. As, such a situation is practically possible, proper safeguards need to be built into the deal to ensure that import content at subsidiary is at similar levels to that at MSIL at any given point of time. If the subsidiary sources all its inputs through MSIL and direct import, if any, are equal to or less than MSIL and are at the same rates, there is no issue with the structure.
3.
4.
5.
6.
Transfer price between SMC subsidiary and MSIL SES is of the view that any transaction / agreement between proposed 100% subsidiary of SMC and MSIL will be a related party transaction and would also be subject to applicable transfer pricing rules. The Press Release mentions the following, about price of vehicles produced by proposed subsidiary: 1. 2. The price of vehicles to MSIL would include the cost of production actually incurred plus just adequate cash (net of all tax) to cover incremental capital expenditure requirements
Cost of production includes cash and non-cash cost. Depreciation and writing off of the preliminary expenses are the only non-cash expenses. While rate of depreciation will impact the cost year by year, however it will be immaterial in the long run as total cost recovered will be only the capital cost and if the agreement between MSIL and SMC will provide for an option to MSIL to take over the proposed subsidiary at book value, rate of depreciation at best will impact cash flow timing and nothing beyond that. The potential issue could be with Incremental Capital Expenditure being adjusted and included as part of cost of production. At this stage, there is no clarity about what could be this incremental capital expenditure. By definition, incremental can mean only a small amount vis a vis the original investment. Initially, the plant is being set up with a capacity of 100,000 vehicles (this is as per newspaper report and not confirmed hence SES is not placing any reliance on this data). In case the incremental capex is beyond normal repair and 2013 - 2014 Stakeholders Empowerment Services Pvt Ltd | All Rights Reserved PAGE 7 OF 15

replacement, for any contribution towards incremental capital expenditure by MSIL, the Company (MSIL) should either get equity in the subsidiary or that portion of expenditure should not be a part of cost of production. However, if MSIL gets the option of buying out the subsidiary at any point of time in future by paying initial cost fewer amounts repatriated to SMC, then even contribution for capex would not be an issue except for taxation purposes. In case incremental capex is provided by MSIL and the capex becomes part of the subsidiary with right to SMC to take it back, it will be against the statement made by SMC that The return on this investment for SMC would be realized only through the growth and expansion of MSILs business because SMC would be getting returns from subsidiary in the form of increased assets. Leasing of Land by MSIL As per Press Release, land will be leased by MSIL to the subsidiary and the rent payable by the subsidiary will be determined at arms length. While it may be argued that MSIL, as owner of land, would be at a disadvantage because SMC/ Subsidiary may not pay appropriate rent, SES is of the opinion that amount of rent will not affect MSIL adversely in any manner. The amount of rent will be just a book entry. The revenue on account of rent will be offset by equal amount that will be recovered by subsidiary as cost. Therefore, MSIL needs to determine rent at fair value according to tax law in order to avoid transfer pricing issue. The other important issue is that, one has to view the provision of land as capital contribution by MSIL; the term lease is only for the purpose of accounting. The terms of the Lease deed should be stipulated in such a manner that SMC cannot operate the plant if MSIL is not a willing partner. Further, it is not clear from the Press Release whether both the parcels of land will be leased or only one of them will be leased. Risk for MSIL in the structure The Company has stated that MSIL would be able to avoid all risk inherent in any investment. SES is not in agreement with the statement. In the opinion of SES, MSIL is placed in the same risk as it would have been if it had undertaken expansion on its own. At best, it could be a matter of timing of cash flow and conserving its cash. MSIL is exposed to operational risks e.g. in case of a slowdown and lower capacity utilisation, all the costs of subsidiary will get reflected in MSIL books. Therefore, MSIL has all the risks inherent in this structure due to commitment to buy entire production at cost. Assistance by MSIL in implementing the project The Press Release states that MSIL would extend all help in implementation of the project at arms length basis. The issue arises as to how MSIL will price its services. Although, in the long run it may not matter as ultimately MSIL will have to reimburse the same to SMC subsidiary in form of cost of vehicles. Yet as the two entities are separate legal entities it will be desirable to keep transaction at arms length basis and to disclose the same to shareholders. Once again in view of nature of agreement the amount will be immaterial as ultimately it will be recovered in cost over a period, indicating at best an issue of cash flow only. Marketing MSIL will continue its marketing activities as it is. All the production of subsidiary of SMC will be sold through MSIL and all the profits would be parked in MSIL. The Company in its Annual Report of 2012-13 had provided following information related to exports.
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Suzuki Japan has decided that India will now be responsible for the export markets of Africa, the Middle East and our neighbouring countries. We have to ensure adequate sales and marketing arrangements in these countries, with the help of Japan. We also have to determine the products to be manufactured for these markets and, if necessary, establish assembly plants overseas. This decision will greatly help the growth of our exports.
At face value, this appears to be a positive statement for MSIL and its shareholders since MSIL will become an export hub for the territories. However, at this stage, the efforts and expenses required to develop the market are not known. It is also not clear what will be the pricing policies for sales in the territories assigned. Will MSIL be required to subsidize sales? It may happen that after spending time and money, SMC might decide to export the vehicles directly, thus jeopardising MSIL interests and future potential gains. Therefore SMC and MSIL should spell out the minimum period for which these export territories would be exclusive domain of MSIL .What would be the parameters that will determine further extension? Will it be at the option of MSIL or SMC or mutual? Financial benefits to MSIL The Company has stated that MSIL would financially benefit from the interest earnings resulting from not investing its money in this project. It would also benefit because the vehicles would be sold to MSIL by the Suzuki subsidiary without any return on capital employed. SES is of the opinion that as long as vehicles are sold by the proposed subsidiary to MSIL at actual cost, MSIL would stand to gain interest on the funds that MSIL otherwise would have invested in expansion. However, the Company has not given amount that would be invested by SMC in the new subsidiary. In absence of this information, the expected financial benefits on this amount cannot be calculated. However given tax free rate of 8.5% available in tax free bonds, for every `100 Cr invested by SMC, MSIL would save `8.5 Cr tax free (interest saved by not investing MSILs own funds), which will belong to shareholders of MSIL including SMC. There is an indication that SMC would invest close to `3,000 Cr in the subsidiary, which would result in savings of nearly `255 cr for MSIL. With approximately 30 crore shares outstanding, the savings works out to over `8 per share. Therefore, MSIL would avoid dilution of EPS to the extent of `8 per share on the amount perpetually or till the arrangement continues.
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ROYALTY ISSUE AT MSIL
Over the last 5 years, royalty payments by MSIL to SMC have increased and presently account for more than what SMC gets from its share Total Payments to SMC of profits.
8.7% 8.3% 6.3% 4.9% 3.5% 5.2% 3.5% 2.5% 4.5% 5.0% 5.5% 5.5% 3.1% 8.7% 7.5% 6.0% 6.7% 3.3% 3.3% 8.6%
Royalty Payments increased 3.61 times from `680 Cr in 2007-08 to `2,454 Cr in 201213. During the same period, sales rose by 2.15 times and profit by approximately 2 times. This indicates faster growth of royalty as compared to sales and profits. It is presumed that the proposed structure will also involve payment of royalty to SMC by MSIL on vehicles produced by subsidiary.
2009 NPM
2010
2011 2012 2013 SMC's share in Profit as % of Sales SMC Total Pay as % of Sales
SMC Royalty Payments as % of Sales
Royalty Payment to SMC

10.0% 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 200.0% 180.0% 160.0% 146.4% 140.0% 136.4% 120.0% 100.0% 4.1% 3.5% 80.0% 2.7% 60.0% 40.0% 20.0% 0.0% 2011 2012 2013 Royalty as % of PAT from Operations 185.4%
NPM = Total Profit as percentage of Sales NPM from Operations = Profit from Operations as a percentage of sales
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However, MSIL should ensure 128.0% 6.2% that the royalty is not doubly paid i.e. included in the cost of the subsidiary and again in sales 2.6% of vehicles to MSIL. SES maintains 55.7% that present royalty payments by MSIL to SMC are unfair and nontransparent and are enriching 2009 2010 SMC at the cost of minority NPM from Operations shareholders of MSIL. One of the main reasons for this is that the shareholders do not have any say in the matter. Shareholders may note that this will change soon when provisions of Companies Act, 2013 in respect of related party transactions are made effective and SEBI decides to implement new Corporate Governance Code based on its Consultative paper issued in Jan, 2013.

WHAT IS THERE IN IT FOR SMC?
If we take the Press Release at face value, the questions that come to mind are that whats in it for SMC? Why should SMC shareholders consent to investing money on such terms? This analysis can be done with principally two approaches: 1. 2. Indirect gains to SMC from Interest earning of MSIL that would be protected. To calculate extra profit that will be generated for SMC along with extra royalty.
Analysis 1 Benefit to SMC on account of interest earning of MSIL is explained in following diagrams, broken into two steps for clarity. Step 1 depicts use of own cash by MSIL and the Step 2 creates proposed structure Step 1 Use of own cash by MSIL
Increased Royalty and Dividends
Step 2 Proposed structure

Increased Royalty and Dividends
MSIL (Minus Cash) Capital investment
SMC
MSIL (Cash neutral)
SMC (Minus Cash)
Sale of production at cost
Cash Refund
Sale of production at cost
Gujarat Expansion Project Subsidiary of MSIL
Gujarat Expansion Project
SMC pays cost for this by foregoing 44% of interest earnings to minority shareholders of MSIL. If Tax Free Rate of 8.5% available on PSU bonds is taken, then tax free earnings of SMC will be 4.76% per annum (56% of 8.5%) less dividend tax. However, the return earned by SMC in this case may still be more than the Interest earned on its Yen balances. In nutshell SMC is effectively deploying its surplus cash at 4.76% interest rate per annum against 0% available in Japan and probably taking - ` exposure risk. (Details of which will only be known after details of funding of the subsidiary can be revealed) Analysis 2 For working out extra profit, few assumptions need to be made. Assumptions: Investment made is Rs 1,000 Million Net profit margin remains the same as at MSIL, Royalty remains same. Returns have been calculated at three different Assets turnover ratio. SES expects Assets Turnover Ratio to be less than MSIL in subsidiary as it will be a new plant. (In Rs Million unless otherwise mentioned) Investment Made Fixed Assets Turnover Ratio (assumed) Net Profit Margin Case 1 1,000 4 3% Case 2 1,000 3 3% Case 3 1,000 2 3%
A B C
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(In Rs Million unless otherwise mentioned) Sales (A x B) PAT (C x D) Royalty % Royalty Amount (D x F) Total to SMC (G + 56% x E) Return to SMC as % of Investment Made (H / A) Case 1 4,000 120 5% 200 267 27% Case 2 3,000 90 5% 150 200 20% Case 3 2,000 60 5% 100 134 13%
D E F G H I
The above calculations show that SMC is going to earn a moderate to high return on its investments. However, this return would have been there for SMC even if the expansion was done by MSIL at its cost. Whats SMC gaining? As discussed above, by undertaking this project, SMC would be able to redeploy its cash which may have been earning low interest rate and bears the Yen-Rupee currency risk. Additionally, the holding company would gain from the increased sales and royalty payments by MSIL.
DOES THE DEAL REQUIR E SHAREHOLDERS APPR OVAL?

Taking into account laws and regulations existing presently in India, the deal does not require any approval from the shareholders of MSIL. The deal can be viewed as two major related party transactions (RPTs) for MSIL (i) Proposed lease of land and (ii) purchase agreement for vehicles produced by the subsidiary. These decisions are ordinary business decisions and the board is empowered to take such decisions on behalf of the Company in the ordinary course of business. Since the transactions are with a related party, the Board and the Auditors need to confirm that the transactions will be at arms length basis. This statement should also be disclosed by MSIL in the Annual Report to its shareholders. The current provisions, especially relating to related party transactions, are likely to change once the Companies Act, 2013 is implemented. As a good governance practice, MSIL should obtain shareholders approval. The shareholders may note that once the provisions of the Companies Act, 2013 are implemented, all related party transactions will have to be approved by majority of minority shareholders.
EVALUATING ALTERNATIVE STRUCTURE
Ownership of by SMC Ownership by Minority Shareholders of MSIL Business Risk for MSIL Profit for SMC Marketing Rights for MSIL Interest Income of MSIL Benefit of Increased Exports/ Domestic Growth Royalty for SMC Growth of MSIL business
MSIL - division 56% 44% Yes 56% Directly Neutral Reduction Neutral Neutral Neutral
MSIL subsidiary 56% 44% Yes 56% Directly Neutral Reduction Neutral Neutral Neutral
SMC subsidiary 100% 0% Yes 56% Indirectly Neutral Unchanged Neutral Neutral Neutral
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If MSIL intended to go for expansion, it could have gone for two alternative ways to implement it i.e. 1) Within MSIL as a separate division or 2) as a 100% subsidiary of MSIL. However, the Company has gone for 100% subsidiary of SMC, its promoter. SES has evaluated the three options in table below on various parameters of evaluation.

Related Party Issue Investment Risk of SMC Currency Exposure Risk of SMC Strong Strong Shared Shared Same as at present Same as at present Strongest 100% Increased
From the table above, we can see that there are minor differences between all three options and other than loss of interest income to MSIL, in case expansion is by using its reserves, the only significant concern is the related-party issue. The loss of income to MSIL in cases can be easily compensated by SMC, as discussed in approach 1 above. Therefore, shareholders should be specifically concerned about the related party issues that arise from current scenario and should urge the board/ management to implement strongest measures to minimize any future risks.
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Conclusions
Although not strictly required by present laws and regulations in India, the Company (MSIL) should get the approval of the transaction from its shareholders as a good corporate governance practice. If the statements made by the Company are taken at face value, there is no negative issue for minority shareholders of MSIL. However, a lot would depend on the fine prints. In order to ensure that there are no hidden issues that may surface in future, the Company should ensure and confirm to shareholders that agreement(s) between SMC/MSIL and subsidiary would have the following safeguards: o o o There would be no dividend from subsidiary to SMC and subsidiary will at the most repatriate to SMC only amount equal to its contribution. MSIL will have option to buy back the subsidiary at book value or initial investment of SMC less repatriation made by subsidiary to SMC. Incremental capital expenditure shall be treated as capital contribution of MSIL or as a loan from MSIL. It shall not become part of subsidiary. However, this will not matter if MSIL gets the right to buy back the subsidiary at cost. Incremental capital expenditure if any contributed by MSIL shall not be counted as cost for pricing vehicle sales/ cost from subsidiary to MSIL. Sourcing of components for subsidiary will be done either jointly by subsidiary and MSIL or by MSIL. Supplies from SMC to subsidiary shall be at arms length and in no case import percentage will be more than what is at MSIL at any point in time. There should be an agreement between MSIL and SMC spelling out duration for which export territories are exclusively assigned to MSIL. This agreement shall specify role of MSIL and SMC including support to be provided by SMC. The land will always remain in the ownership of MSIL. Subsidiary should voluntarily adopt disclosure norms as applicable to public listed company in India MSIL should have authority to get cost-audit of subsidiary done at any point of time and board of MSIL shall certify to shareholders of MSIL that cost audit was done and board is satisfied.
o o o
o o o
MSIL is exposed to same operational risks it would have had, had it gone for in-house expansion because of 100% sales, at cost, from subsidiary to MSIL. SMC will be exposed to Yen-Rupee exchange-rate risk on its investment in subsidiary. No details are available as to what will be the nature of SMCs investment in subsidiary. In case it is part loan and part equity, and loan is denominated in Yen, then risk will be limited to equity portion only. MSIL will save interest cost on the amount brought by SMC to invest in subsidiary. In a nut shell, SMC will gain only interest on its investment through MSIL conserving the cash and that too after sacrificing 44% in favour of minority shareholders. It sounds reasonable return for SMC if seen in backdrop of 0% rate of interest in Japan and with no visibility of improvement of these rates in near term. SES would recommend the deal, if all the protection as suggested are built in and the management can assert that the decision for expansion was in-house and not dictated by SMC. If the protections suggested are not built in in the agreement(s), then shareholders may conclude that it was an attempt to put wool over the eyes of investors/shareholders by making grand sacrificial statements.
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Disclaimers
Sources Only publicly available data has been used while making the report. Our data sources include: BSE, NSE, SEBI, Capitaline, Moneycontrol, Businessweek, Reuters, Annual Reports, IPO Documents and Company Website. Analyst Certification The analysts involved in development of this report certify that no part of any of the research analysts compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report. Disclaimer While SES has made every effort and has exercised due skill, care and diligence in compiling this report based on publicly available information, it neither guarantees its accuracy, completeness or usefulness, nor assumes any liability whatsoever for any consequence from its use. This report does not have any approval, express or implied, from any authority, nor is it required to have such approval. The users are strongly advised to exercise due diligence while using this report. This report in no manner constitutes an offer, solicitation or advice to buy or sell securities, nor solicits votes or proxies on behalf of any party. SES, which is a not-for-profit Initiative or its staff, has no financial interest in the companies covered in this report except what is disclosed on its website. The report is released in India and SES has ensured that it is in accordance with Indian laws. Person resident outside India shall ensure that laws in their country are not violated while using this report; SES shall not be responsible for any such violation. All disputes subject to jurisdiction of High Court of Bombay, Mumbai Copyright 2012 - 2013 Stakeholders Empowerment Services Pvt Ltd. All Rights Reserved. This report or any portion hereof may not be reprinted, sold, reproduced or redistributed without the written consent of Stakeholders Empowerment Services Pvt. Ltd. Contact Information research@sesgovernance.com +91 22 4022 0322
Company Information Stakeholders Empowerment Services A 202, Muktangan, Upper Govind Nagar, Malad East, Mumbai, 400097 Tel +91 22 4022 0322 www.sesgovernance.com
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SES Corporate Governance Research - Maruti Suzuki - 11 February

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STAKEHOLDERS EMPOWERMENT SERVICES

PUBLICATION DATE: 11 FEBRUARY, 2014

CORPORATE GOVERNANCE RESEARCH MARUTI SUZUKI

Maruti Suzuki Gujarat Expansion 2013

CORPORATE GOVERNANCE RESEARCH

Maruti Suzuki Gujarat Expansion 2013

CORPORATE GOVERNANCE RESEARCH

Maruti Suzuki Gujarat Expansion 2013

CORPORATE GOVERNANCE RESEARCH

Maruti Suzuki Gujarat Expansion 2013

Gujarat subsidiary to be 100% owned by SMC

Maruti Suzuki India Limited MSIL

1. Land 2. Cost of Production 3. Incremental Capital Expenditure

ANALYSIS OF THE PRESS RELEASE

CORPORATE GOVERNANCE RESEARCH

Maruti Suzuki Gujarat Expansion 2013

CORPORATE GOVERNANCE RESEARCH

Maruti Suzuki Gujarat Expansion 2013

CORPORATE GOVERNANCE RESEARCH

Maruti Suzuki Gujarat Expansion 2013

CORPORATE GOVERNANCE RESEARCH

Maruti Suzuki Gujarat Expansion 2013

CORPORATE GOVERNANCE RESEARCH

Maruti Suzuki Gujarat Expansion 2013

SMC Royalty Payments as % of Sales

Royalty Payment to SMC

CORPORATE GOVERNANCE RESEARCH

Maruti Suzuki Gujarat Expansion 2013

Step 2 Proposed structure

MSIL (Minus Cash) Capital investment

MSIL (Cash neutral)

SMC (Minus Cash)

Sale of production at cost

Sale of production at cost

Gujarat Expansion Project Subsidiary of MSIL

Gujarat Expansion Project

CORPORATE GOVERNANCE RESEARCH

Maruti Suzuki Gujarat Expansion 2013

DOES THE DEAL REQUIR E SHAREHOLDERS APPR OVAL?

EVALUATING ALTERNATIVE STRUCTURE

CORPORATE GOVERNANCE RESEARCH

Maruti Suzuki Gujarat Expansion 2013

CORPORATE GOVERNANCE RESEARCH

Maruti Suzuki Gujarat Expansion 2013

CORPORATE GOVERNANCE RESEARCH

Maruti Suzuki Gujarat Expansion 2013

CORPORATE GOVERNANCE RESEARCH

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