Suzuki's 100 percent Gujarat subsidiary is a win-win for all

Suzuki Motor Corporation’s decision to run its Gujarat plant as a 100 percent owned subsidiary rather than as a unit of its majority-owned (56 percent) listed entity, Maruti Suzuki Ltd, has jolted the markets. The share prices headed straight south yesterday (28 January) when it was announced that Suzuki would make the cars in Gujarat under a new company, Suzuki Motors Gujarat Pvt Ltd. The idea is to sell the cars at cost price plus royalty to the listed company to market. The listed company will thus make only marketing margins. Several questions loom. Is this good news or bad news for Maruti shareholders? Why did Suzuki do this when it could have instead chosen to take Maruti Suzuki private by making it a 100 percent subsidiary after making an open offer? Is this good strategy even for Suzuki, since it will now come under the taxman’s scrutiny on transfer pricing? Is Suzuki going the multinational way, where almost all of them have now set up 100 percent subsidiaries (P&G, Pfizer, et al) in addition to majority-owned listed entities to launch new products? Are the analysts who have raised corporate governance issues about this gambit right? Here are some key points that will provide some, but not all, of the answers. [caption id=“attachment_136459” align=“alignleft” width=“380”]  More than mere shareholder issues, Suzuki’s decision to run its Gujarat plant as a 100 percent subsidiary brings larger benefits for both Maruti, Suzuki and India[/caption] Improving returns: An Economic Times report says Suzuki was sitting on cash surpluses of Rs 25,000 crore on which it was earning measly interest at Japanese rates. In the new subsidiary, it would make money from exporting sub-assemblies from Japan apart from royalties on sales to Maruti Suzuki. Also, given the high market valuation of Maruti (Rs 50,000 crore plus currently) on which Suzuki earns only dividends, the returns would have been equally low (current dividend yields: less than 0.5 percent). From Suzuki’s point of view, the move makes sense. Why not an open offer? An open offer for the remaining 44 percent outstanding shares of Maruti Suzuki would cost Suzuki all its cash – around Rs 25,000 crore, at a small premium to current market prices. So that clearly does not make commercial sense. Does Maruti gain? The listed company gains in two ways. One is that the investment cost of the Gujarat plant (around Rs 3,000 crore) will not be on its books, depressing short-term returns on capital. Plus, if Suzuki offers the cars at cost to Maruti, its marketing margins remain intact. Even though Maruti does not lack for cash, the fact is the new plant would de-risk its business. However, it is also true that Suzuki may keep more of the gains in its 100 percent subsidiary, depending on how it defines costs of production. And there is the issue of which company would launch new products, and whether a part of the production at its Gurgaon and Manesar plants will cannibalised by Gujarat. Are there other calculations behind Suzuki move? From Suzuki’s perspective, the problem is that Maruti has all its eggs in the Haryana basket. Despite its Japanese DNA, Maruti has faced lots of labour trouble at its six plants – three each in Gurgaon and three in Manesar, especially the latter - with 2012 even witnessing violence in which one manager was killed. The Manesar belt has become a problem for many auto companies, and this is one reason why the additional plant in Gujarat – with its better labour climate – made sense. However, there may be a hidden reason behind Suzuki’s move to separate the Gujarat operations from Haryana’s: to begin afresh with 100 percent Suzuki DNA. The Haryana plants have not been able to imbibe the Suzuki pattern of close labour-management ties despite over 30 years of existence. By insulating the Gujarat plant from the Indo-Japanese hybrid management in Haryana, Suzuki may be hoping to start on a completely new slate of work ethic and labour relations. In separating the two ops, Suzuki will be courting issues about transfer pricing and taxes, but this is not insurmountable. The larger point missed by those who raise standard corporate governance issues is this: while shareholders have a right to be concerned about what they may lose or gain from the launch of a new subsidiary, one cannot negate the interests of other stakeholders in this – including Suzuki, employees, government, and society at large. What matters to India are the following: will Suzuki bring in the best practices from Japan? The answer should be yes. Will the project create jobs in India? Again the answer is yes. Will it reduce Suzuki’s vulnerabilities? Yes, since it will now have an alternative production unit in Gujarat. Should a foreign company be allowed to create another subsidiary like this to compete with its old one? This is a tricky question, but the evidence from other foreign companies with two companies in India, it that shareholders have not lost out. Moreover, should one differentiate between a listed Indian company an an unlisted one? Having spent 30 years building and developing cars for India, is Suzuki not an Indian company? Gujarat is the originating and terminating point for the Delhi-Mumbai Industrial Corridor (DMIC) that is expected to change the face of western and northern India. Over the next decade, there will be new cities, world class infrastructure, strong road and rail links, and good port infrastructure for exports and imports along the DMIC. DMIC will be financed substantially by Japanese capital, and geopolitically, it will give muscle to the India-Japan political partnership, which is seen as a counter-weight to China. It will be the defining Asian strategic alliance of the first half of the 21st century. Having Suzuki run its Gujarat plant should thus be seen as a win-win in the ultimate analysis. It will benefit both companies, and India. Beyond xenophobia, we have nothing to lose.