Where Suzuki goofed: You can't spring a nasty surprise on investors

Not unexpectedly, Suzuki’s decision to build its new plant in Gujarat all by itself and not through its Maruti Suzuki subsidiary has got the market’s goat. While the share has been marked down, last week seven mutual funds, holding around 12 percent of Maruti Suzuki’s free float, weighed in with their concerns. Their worry: by doing this, Suzuki will be shifting a profitable project out of the listed entity, leaving the latter as a shell marketing company after a few years. This is against the interests of minority shareholders.

Let’s be clear. Only the future will tell whether this decision is right or wrong, since a lot would depend on how car demand pans out and how the profits from cars produced in Gujarat are shared with the listed company. If Maruti’s sales grow at 15 percent annually, as the mutual funds assumed, the Gujarat plant will take over a larger share of the production than planned; if it doesn’t, the fears of minority shareholders will have been disproved - at least in the medium term. RC Bhargava, Maruti Suzuki Chairman, clearly does not believe sales are going to boom 15 percent annually over the next five years.

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We can discuss the arguments and counter-arguments for and against Suzuki till the cows come home, but we should not forget one simple fact: a foreign investor who has shown such commitment to the Indian market has a right to decide how to route his future investments. While minority shareholders may or may not like this, the rights of the majority shareholder to do what he wants with his money cannot be lightly dismissed either.

This has been the case all through wherever multinational companies - from Pfizer to Procter & Gamble to Honda Motorcycle - have sought to create 100 percent owned subsidiaries whenever they felt the market was ripe for going solo. Not only that, most MNCs have also been raising royalty payments despite owning a majority stake in their Indian entities. Once again, this does not seem fair to minority shareholders, but they have had no option but to grin and bear it.

Now why would MNCs do this? Three reasons why.

First, the cost of going private. With a 56 percent stakeholding, Suzuki would need around Rs 25,000 crore or more to take the company private and buy out minority shareholders at current market prices. This makes the option of investing in a new fully-owned new outfit attractive.

Second, a 100 percent subsidiary makes technology transfer easier in Suzuki’s all-important market.

Third, a 100 percent subsidiary also makes it far easier to transact business - in terms of internal culture, executing plans with minimum loss of information between headquarters and Indian subsidiary, etc.

On the other hand, setting up your own fully-owned company also exposes you to greater risks - since they are now all your own. So when a Suzuki decides it will dip its toes directly in Indian waters and not through Maruti Suzuki, one has to presume that it believes the rewards are greater than the higher risk it is now undertaking.

The fundamental reason for doing business one way and not another is surely for promoters to judge. They are putting in the money, so they get to decide.

That said, the problem is MNCs are no different when it comes to dealing with minority shareholders, despite their overall higher standards of corporate governance.

In Maruti’s case, Suzuki could easily have done the following:

#1: Explain the rationale of investing in the Gujarat plant on its own to the board, indicating the pros and cons to the independent directors, and letting them take a final call. The promoters could have abstained while the independent directors discussed this issue and made their recommendations.

#2: Suzuki could have sought shareholder approval at an EGM before making the announcement. It would have been even better if they let minority shareholders take the decision without promoters participating in it. The chances are they would have won their backing.

#3: Suzuki could have offered carrot-and-stick: the option of paying higher royalties against the option of saving on capital costs and risks, which is what the Gujarat gambit really amounts to. Suzuki’s failure is one of springing a decision suddenly on investors instead of taking them through the loop of good argument.

In the ultimately analysis, this is where MNCs flunk the test: of not seeming to consider minority interests when taking decisions to set up wholly-owned subsidiaries. In most cases, were minority interests consulted before decisions are taken, there may have been few protests.

The experience with other foreign companies suggests that this would have been the case with Suzuki too. Long after P&G and Pfizer set up their own wholly-owned subsidiaries, their listed entities continue to remain investor darlings. The same goes for Hero Motor, which saw Honda exit into a wholly-owned subsidiary.