maruti open letter letter 24nov2015

7/21/2019 Maruti Open Letter Letter 24Nov2015

http://slidepdf.com/reader/full/maruti-open-letter-letter-24nov2015 1/14

Institutional Investor Advisory Services India Limited15th Floor, West Wing, Dalal Street, Fort, Mumbai – 400 001

Phone +91 22 22721570 - 3 Fax: +91 22 2272 1574 www.iias.in CIN: U74990MH2010PLC204788

An open letter to the shareholders of Maruti Suzuki Indi

Limited

Al lowin g Suzuki to own th e Gujarat plant and i ts manufactur ing h as impl icat ions thextend beyond commercial arrangements. Suzuki is cu rrent ly dependent on Marut i , b

al lowing Suzuki to own the Gujarat plant wi l l shi f t the balance of pow er in favour of Su zuk

If the transaction is approved, Maruti will lose all control over its own destiny, and Maruti

shareholders will always remain subservient to the interest of Suzuki’s shareholder

Equal ly important are the impl icat ions of suc h transact ions on other fami ly-run and MNC

in India – they too may begin manufactur ing in un l isted com panies and al low the l iste

com pany to merely trade.

24 November 20

Dear Shareholder:

For a company with as strong a manufacturing track record as Maruti has, to willingly cede groun

to another manufacturer should be anathema - yet this is just what your company is proposing,

allowing Suzuki to own the Gujarat plant. Make no mistake, this vote is about the shifting pow

equation and whether shareholders will allow a manufacturer to continue to ‘manufacture and se

or let it shift gears, and ‘buy to sell.’ To put it simply, you - the shareholders of Maruti - need

decide whether Maruti will continue to remain a manufacturer of cars or will it become a glorifie

distributor.

Equally important are the implications of this vote on family run firms and on other MNC’s. shareholders agree to Suzuki doing owning the Gujarat plant, why should they not agree to th

Tata’s, Munjal’s, Mahindra’s or the Bajaj families proposing the same? Will Glaxo or Nestlé

Holcim now set up fully owned subsidiaries and have their Indian arm only market the products

If so, it will spell doom for the Indian equity markets.

About Maruti and this vote

Your company, Maruti currently has two facilities - in Gurgaon and in Manesar - which have

combined capacity to manufacture 1.55 mn cars. Your company planned to expand its capacitie

by setting up a third plant in Gujarat (1,500,000 cars annually – to be set up in a phased manne

However, in early 2014, Maruti took us all by surprise when it announced that, Suzuki (and n

Maruti) will set up and own the Gujarat plant. Suzuki will manufacture the cars in Gujarat that w

be purchased by Maruti at cost and be sold under the Maruti product portfolio.

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An open letter to the shareholders of Maruti

Suzuki India Limited

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In order to execute this arrangement, your company now proposes to enter into two related par

transaction contracts with Suzuki Motor Gujarat Private Limited (SMGPL), a wholly-owne

subsidiary of Suzuki Motor Corporation (Suzuki), and as required by the Companies Act, 2013,

seeking your approval for the following transactions:

i. Contract Manufacturing Agreement for manufacture and supply of vehicles for an init

period of 15 years. All goods will be sold at cost by SMGPL to Maruti with no profit or loss f

SMGPL.

ii.Lease Deed for developing the plant on land owned by Maruti. As per the deed, SMGPL w

pay Maruti an annual aggregate rental of Rs.49.9 mn for the land an initial period of 15 years

IiAS recommends that you vote AGAINST the resolution. Voting AGAINST this resolutio

means that Maruti will own the Gujarat plant and not Suzuki – it will not result in any stoppage

capacity creation at the Gujarat plant.

IiAS has had reservations about this deal since it was first announced in January 2014 an

continues to believe that the deal is not in Maruti’s long term interest. Our main contentions are

Suzuki is squarely dependent upon Maruti for sales volumes and profits; owning th

Gujarat plant will limit Maruti’s growing criticality to the group

Suzuki is largely an automobile maker 1; automobiles contributed to 89.5% of consolidate

revenues and 95.5% of (segment) profits in 2014-15. Suzuki’s automobile growth, and effective

the company’s entire growth, over the past 15 years has emanated largely from Maruti’s growt

Japan volumes have been almost flat and volumes in ex-India ex-Japan markets have als

reported limited growth. Maruti’s sales (including exports) accounted for 45% of Suzuki’s glob

volumes and Maruti’s production accounted for 43% of Suzuki’s total automobile productio

volumes in 2014-15. India, which is catered to solely by Maruti, has grown almost three time

faster than Suzuki’s sales volumes in Japan and the rest of the world (ex -India ex-Japan).

1 Other products include motorcycles, and marine and power products





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Chart 1: Volume growth in Indian markets (and Maruti) drive Suzuki’s automobile sale

growth

Source: Company Annual Reports, IiAS Research

Chart 2: India is Suzuki’s single largest market, larger than Japan

Maruti’s profit level was over 50% of Suzuki’s (pre-minority interest) in 2014-15 (See Table

below). Moreover, Maruti’s margins have been consistently higher than those reported by Suzuk

On a consolidated basis, in 2014-15, Suzuki reported net margins (after minority interest) of 3.2

against Maruti’s 7.7%.

India41%

Japan26%

OtherMarkets

33%

based on 2014-15 automobile sales volumes

Maruti domestic sales volumes

Suzuki's automobile sales in Japan

Suzuki's automobile sales in ex-India ex-Japan markets





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Chart 3: Maruti's EBITDA margins are higher than those of Suzuki


Table 1: Maruti’s profit levels drives Suzuki’s global size

2010-11 2011-12 2012-13 2013-14 2014-15

Suzuki Motor Company, Japan (Consolidated) Net sales $ Bn 31.37 16.83 27.41 28.55 25.09Net income before minority interest(A) $ Bn

0.78 0.78 0.97 1.24 1.06

Net income before minority interestmargin %

2.5% 4.6% 3.5% 4.3% 4.2%

Maruti Suzuki India Limited, India (Consolidated) Net sales Rs. Bn. 366.11 351.97 432.16 432.72 492.95Profit after tax, but before minorityinterest (B) Rs. Bn.

23.07 16.34 24.49 28.32 37.91

Profit after tax, but before minorityinterest margin %

6.3% 4.6% 5.7% 6.5% 7.7%

Exchange Rate on 31-Mar ( Source: RBI ) 44.65 51.16 54.39 60.10 62.59Profit after tax (C) $ Bn 0.52 0.32 0.45 0.47 0.61

Maruti's profit level compared to Suzuki's(C/A)

65.9% 40.9% 46.5% 38.0% 57.0%


Your company, Maruti has had an enviable track record, from when the government took contr

of a moribund company that Sanjay Gandhi was tinkering with. It has been a trailblazer in i

partner selection, the unique ownership structure while remaining a PSU giving it the desire

flexibility, in completing the factory within cost and on time, in launching a high quality car at a

affordable price, in building the dealer network, to setting up ancillaries, and much more. R

Bhargava’s book, The Maruti Story, captures how management responded to the variou

obstacles and challenges, as it journeyed to become an iconic company. While the Suzu

10.0%8.9% 9.3%

10.9% 11.2%11.5%9.6%

11.8%

13.9%15.5%

2010-11 2011-12 2012-13 2013-14 2014-15

Suzuki's EBITDA margin Maruti's EBITDA margin

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management was supportive, as was the government, it was the Indian management that ensure

that Maruti became the company it did, and in the process put India on the global auto map.

Suzuki has not seen this degree of success in any other market, not even in Japan, its hom

market. With Maruti’s phenomenal success, it became critical to the group. Therefore, establishingreater control over Maruti became equally critical. Suzuki first attempted to control Maruti b

wanting to own the Manesar plant. This decision was opposed by many Maruti executive

including Mr. R C Bhargava – it was, in fact, Mr. R C Bhargava who convinced Osama Suzuki

revise this decision. The decision to set up the Gujarat plant under Suzuki rather than Maru

continues to reflect Suzuki’s need to establish greater ownership over Maruti. IiAS continues

ask – what has changed now?

Going forward, Maruti’s one-sided dependence on Suzuki’s technical support will reduce

Maruti has benefited from Suzuki’s technical support in the past, but this will no longer be a on

sided relationship. Over the past three years, your company has invested an average of ov

Rs.3000 per car (produced) in R&D efforts: capital expenditure aggregating Rs.10.14 bn an

another Rs.8.14bn in revenue expenditure. Maruti’s R&D efforts have supported the launch of ne

models and variants, new feature developments and fuel efficiency improvement efforts in th

recent past.

Table 2: Maruti’s R&D spends have increased over the past five years

Year Production

Volumes

R&D Revenue

expenses

R&D Capex R&D Capex

Amortization

R&D spend per

car producedNos Rs. Mn. Rs. Mn. Rs. Mn. Rs. A B C D E=(B+D)/A

2005-06 572,127 396 692.22006-07 667,048 536 803.52007-08 777,017 379 259 24 518.12008-09 774,738 666 244 46 918.72009-10 1,027,879 1,110 623 102 1,179.52010.11 1,273,361 1,847 2,316 313 1,696.22011-12 1,134,607 2,226 1,491 448 2,357.22012-13 1,168,917 2,533 2,613 686 2,753.82013-14 1,153,645 2,265 4,311 1,078 2,897.72014-15 1,308,446 3,340 3,220 1,371 3,600.2

Note: R&D capex amortization has been assumed at 11-year straight line method. Maruti depreciates its plant andmachinery on a straight line basis using an estimated life of 8-11 years.Source: Company Annual Reports

The Rohtak R&D facility (Suzuki Group’s first R&D centre outside Japan) is expected to be ful

functional by the end of the current fiscal. Among other facilities, the Rohtak R&D facility

expected to aid in testing and validating products to meet new regulations regarding safety an

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environment. Most of Suzuki’s incremental investment in R&D facilities is largely being made

India through Maruti. This is also why the company has publicly stated that royalty payouts f

newer models will be lower than the average 6% of sales that is being paid out currently .

IiAS believes that going forward, Suzuki will require Maruti’s R&D facilities and talent as much aMaruti will require Suzuki’s product technology. With the relationship on product developme

becoming less dependent and more co-dependent, Maruti must stand its ground and own th

Gujarat plant, rather than let Suzuki dictate terms.

It’s not about the money – debunking the savings argument

Maruti contends that Suzuki is making the investment in the Gujarat plant because it has a low

cost of capital than Maruti, implying that Maruti would generate better returns investing its cas

surplus in India. Maintaining the excess liquidity in the form of an investment portfolio is detriment

to shareholder interest as Maruti’s investment portfolio has generated returns significantly lowthan the company’s return on capital employed (RoCE).

Maruti estimates earnings from not investing in the Gujarat plant at Rs.105 bn over a 15-ye

period, assuming a post-tax return of 8.5% p.a. But, in the recent past, Marut i’s yield on

investment book has been around 8% at pre-tax levels. Further, Maruti’s RoCE has increase

since 2012 – ROCE was between 15-16% in 2014-15 compared to 10-11% in 2011-12. It is wor

mentioning that in 2014-15, Maruti outperformed its benchmark, BSE Sensex, which registered

median ROCE2 between 8-10% in 2014-15.

Chart 4: Maruti RoCE is higher than the median RoCE of BSE Sensex companies

Source: CMIE Prowess, Company Annual Reports, IiAS Research

2 Source: CMIE

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

2010-11 2011-12 2012-13 2013-14 2014-15

Maruti RoCE (Consolidated) BSE Sensex Median RoCE (Consolidated)

Maruti's average yeild on investments

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Maruti argues that the return on capital employed will increase as the profits from the cars sold

Gujarat will be recorded in Maruti’s books, while there will not be any incremental capit

investment. Further, the savings from the surplus funds will further boost revenues and profit

That is a truism. Our contention relates to whether the money is more efficiently utilized in investin

in the business, or in parking the money in surplus funds, or in beginning a real-estate businessThe excess liquidity is pushing Maruti in all directions and it may well lose focus of its co

business. Since Maruti has the money, and can easily invest in setting up the Gujarat plant, it mu

– and remain focused on what it does best.

Maruti’s investment portfolio of surplus funds increased from Rs. 71.2 bn in 2010-11 to Rs. 126

bn in 2014-15. It is clear that Maruti has more than enough funds to meet the initial capit

investment.

In 2014-15, Maruti increased dividend payouts in an effort to please investors. Their contentio

was that because it was not investing in the Gujarat plant, it could pay larger dividends. This is

smokescreen, for two reasons. First, even after the increased dividend payout Maruti is still sittin

on a large cash pool. Second, releasing the cash will increase the company’s ROCE; but, Marut

ROCE is higher than BSE Sensex ROCE, therefore, investors are better placed in letting Maru

invest in the Gujarat plant rather than distributing it or keeping it invested in safe securities.

Chart 5: Despite the increase in dividends, Maruti continues to hold a large investib

surplus

Source: Maruti’s Annual Reports

71.2

79.7

84.4

105.1

126.4

2.5

2.5

2.8

4.2

9.1

2010-11

2011-12

2012-13

2013-14

2014-15

Dividend paid (including dividend tax; Rs. Bn) Surplus funds (Rs. Bn)





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New dealerships and service network expansion is a weak rationale to not invest in Gujar

Maruti already has one of the largest and strongest dealership and service centre network in th

country (more than 1,600 outlets across over 950 cities, and more than 3,000 service outlets

more than 1,470 cities), which not only imparts high visibility to the brand but also helps

garnering new clients. Maruti proposes to significantly expand its dealership network (to abo5,000 dealer workshops) to accommodate increased capacities. While this expansion will requi

some investment, it is unlikely that the entire investment will be made in one year. Maruti ha

taken over 30 years to set up its current level of dealership and service network – and wh

incremental expansion may be significantly faster, it is unlikely to occur in just a span of one

two years. Therefore, as the dealership network expands, Maruti will have also generate

incremental cash flows to accommodate the increasing investment.

Further, Maruti’s volume growth in recent times has emanated from its increasing rural mark

focus. In 2014-15, Maruti’s domestic sales volumes (total) grew by 11%, but rural market volum

grew by 23%. Maruti expanded its reach to nearly 125,000 villages in 2014-15, against 93,00

villages in 2013-14 by increasing its smaller format outlets. It has created a fleet of 1,250 vehicle

that provide mobile service in rural India (Maruti Mobile Service; MMS) to improve servic

penetration.

Chart 6: Maruti has grown its rural sales and service network over the past 5 years

Source: Maruti’s annual reports

Maruti plans to invest in expanding its dealership network especially in the premium car segme

where it has negligible presence – it plans to set up 150 Nexa outlets by 31 March 2016. Th

comes on the back of Maruti trying to establish a name for itself in the premium segment aft

weak response from customers for their premium luxury cars in the past couple of years.

483 509 541 564 568 574

319424

559640 742

1,045

2009-10 2010-11 2011-12 2012-13 2013-14 2014-15

Full Sales Outlets Smaller Format Outlets





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Given this, how much investment does the Maruti expect to make in increasing its sales an

service outlets? IiAS believes that Maruti has sufficient funds to meet the requirements

expanding and upscaling its sales and service network, and continue to invest in the Gujarat plan

Suzuki has been taking Maruti and its shareholder for granted

Maruti has been operating on its own in the past. Suzuki’s poor attendance of board meetings

prior to 2013 – is testimony to that. In 2012-13, Maruti signed an agreement with the Gujarat Sta

Government (GoG) to acquire 700 acres of land. Following this, Suzuki’s interest in Maruti seem

to have spiked - and in early 2014, Maruti announced that Suzuki would own and set up the Gujar

plant.

Table 3: Attendance of Suzuki’s non-executive directors on Maruti’s board

2009-10 2010-11 2011-12 2012-13 2013-14 2014-15

Osamu Suzuki 0 0 0 2 5 6

Kenichi Ayukawa + 1 0 1 2 6 5

Kinji Saito N.A. N.A. N.A. 1 5 5

Toshihiro Suzuki N.A. N.A. N.A. N.A. 3/3 4

Number of board meetings held 5 6 5 6 6 6

N.A.: Not applicable + held an executive position from 2013-14

Even when Maruti made the announcement in 2014, it seemed hurried – the company did n

have enough answers to your questions and eventually modified the original deal structu

following the strong push back you gave them. For Japanese companies that think through th

minutest of details, having come out with this announcement was clearly rushed, and perhaptimed to avoid a shareholder vote under the soon-to-be implemented Companies Act 2013.

Having been accused of timing the announcement, the company promised to take your approv

for the offer . It then waited for another 18 months, possibly for the Act to the amended, and th

threshold for related party transactions to be watered down, before approaching you. To say th

the company needed this time to ensure that the agreement met with the feedback from investo

is naïve: a parent is unlikely to have spent 20 months after the announcement, negotiating with

56% subsidiary.

Suzuki’s actions betray its true intention: it is only looking out for itself.

Maruti must not cower, but push for a role reversal

In simply pr esenting the resolution, Maruti’s board has agreed to cower to Suzuki. Suzuk

shareholding can only give it that much power. Maruti must have the integrity to accept that it ha

built its own business, which grows faster and is far more profitable than Suzuki’s. Therefore, yo

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must insist that Suzuki have representation from Maruti on its board as well. In fact, given th

Maruti has demonstrated a stronger manufacturing capability that Suzuki, it must begin to own a

new plants that Suzuki sets up, rather than the other way around.

Shareholders must see through the razzle dazzle and ask – why do all of this at all?

The discussion on the Gujarat plant has been focused squarely towards the details of th

arrangement, including pricing structures and royalty payment. But the larger question remain

unanswered: why have this structure in the first place? IiAS believes that you, as Maruti’s minor

shareholders, must cut through the noise, and focus on the more material decision: Why shou

you allow Maruti cede more control to Suzuki? Will Maruti generate better shareholder returns b

investing in the Gujarat plant, or by earning ‘higher -than-Japanese’ returns by leaving the mone

in bank deposits or even in rolling out a dealership network? The answer is obvious.

On the Gujarat plant vote, our reservations stem from the fact that the proposal unnecessari

complicates Maruti’s business model. Following the Gujarat transaction, the control over a larg

part of its operations and cash flows would move significantly to Suzuki Japan. The balance

power, already in favor of Suzuki, will tilt completely towards them. Over time, Suzuki cou

undermine the criticality of Maruti and significantly increase the importance of SMGPL, bringing

newer technologies, and expanding capacities: Maruti will, over time, cease to have any contr

over its own destiny.

The Indian operation is the jewel in Suzuki’s portfolio. However, given that it is held as a 56.2

subsidiary, implies Suzuki’s own share price does not reflect the full value of its Indian businesBy setting up a facility in Gujarat and manufacturing cars and then selling these to Maruti t

distribute, Suzuki hopes to directly capture a greater portion of the Indian businesses valuation

its share price rather. We believe what Suzuki shareholders will gain – and make no mistake

they will, you will lose.

Your vote is twice as valuable, exercise it

The dates of Maruti’s postal ballot are given below:

Outcome Date: 17 December 2015Receipt Deadline: 15 December 2015, 5:00 PM

Notice Date: 27 October 2015

E-Voting Site: www.evoting.karvy.com

E-voting Period: 16 November 2015, 9:00 AM to 15 December 2015, 5:00 PM

Postal Ballot Notice Available on the BSE website

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Your company has given its rationale for this structure in its explanatory note and details on

website. Our perspective, of course, is different.

You should be aware that e-voting is possible, so unlike the traditional show of hands, each vo

will count. So, it is important that you vote. But that’s not all. This is a related party transactioWhat it means is that Suzuki does not get to vote, but you do. Given Suzuki’s ~56.2% ownersh

only the remaining ~43.8% votes can be cast implying your one share equals 2.2 votes. In othe

words as a shareholder , you can now punc h wel l above your weight.

We hope you will take the above into account the above and exercise your vote.

Yours sincerely,

Please also read IiAS’ previous research on Maruti Royalty flows in Suzuki’s blood 19-Oct-2015

Why should it be any different now? 11-Sep-2014

Maruti launches the razzmatazz 09-Jun-2014

Minority shareholders get their say 15-Mar-2014

Legal Recourse for Maruti Investors 14-Mar-2014

Has Maruti timed its announcement? 07-Mar-2014Maruti must invest in the Gujarat plant, not Suzuki 04-Mar-2014

Has Suzuki short-changed Maruti? 04-Feb-2014

Gujarat announcement weighs against Maruti's minority shareholders 28-Jan-2014

Royalty Payments and minority shareholders 24-Sep-2013

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conflict of interest at the time of publication of this report.

As a proxy advisory firm, IiAS provides subscription, databased and other related services to various Indian and

international customers (which could include the subject company). IiAS generally receives between INR 10,000 and INR25,00,000 for such services from its customers. Other than compensation that it may have received for providing such

services to the subject company in the ordinary course, none of IiAS, the research analyst(s) responsible for this report,

and their associates or relatives, has received any compensation from the subject company or any third party for this

report.

None of IiAS, the research analyst(s) responsible for this report, and their associates or relatives, has received any

compensation from the subject company or any third party in the past 12 months in connection with the provision of

services of products (including investment banking or merchant banking or brokerage services or any other products and

services), or managed or co-managed public offering of securities of the subject company.

The research analyst(s) responsible for this report has not served as an officer, director or employee of the subject

company.

None of IiAS or the research analyst(s) responsible for this report has been engaged in market making activity for the

subject company.

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About IiAS

Institutional Investor Advisory Services India Limited (IIAS) is a proxyadvisory firm, dedicated to providing participants in the Indian market withindependent opinion, research and data on corporate governance issuesas well as voting recommendations on shareholder resolutions for over600 companies.

To know more about IIAS visit www.iias.in

OfficeInstitutional Investor Advisory Services15th Floor, West Wing,P J Tower, Dalal Street,Fort, Mumbai - 400 001India

[email protected]: +91 22 2272 1570-3

F: +91 22 2272 1574

http://www.iias.in/

http://www.iias.in/

http://www.iias.in/

https://twitter.com/IiASAdvisory

https://www.facebook.com/iias.iias.9?fref=ts

http://in.linkedin.com/pub/iias-proxy-voting-advisory/4a/237/bb1

http://www.iias.in/

maruti open letter letter 24nov2015

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