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BW Businessworld

The Indian Cash Cow

If it were a murder, it would have been the perfect murder. It was quick and quiet. In February, while India’s corporate governance vigilantes obsessed over Maruti and its deal with Japanese parent Suzuki, Alstom Transport India, a wholly owned subsidiary of French engineering major Alstom, bought out the transportation division of Alstom India, another arm of Alstom. The division was sold for Rs 176.9 crore, a figure far lower than the division’s sales for the previous 12 months, leaving minority shareholders of the Indian arm high and dry.

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Predictably, the institutions invested in the company registered their protest — by voting against the deal. The resolution was opposed by 94 per cent of the institutional investors. Yet, the deal went through as the promoter holding of 68.5 per cent outweighed theirs. As for the others, they had probably paid scant attention to the transaction to raise an objection. The whole process took under two months.

Alstom, on its part, defended the valuation, saying it was certified fair by two independent valuers — EY and Axis Capital. The company says it also went beyond what was mandated to get shareholders’ consent — by way of a special resolution —for the transaction.

Meanwhile, Maruti retreated from its decision to allow Suzuki to set up a wholly owned plant in Gujarat to supply Maruti, following protests from minority shareholders. According to the deal, Suzuki was to invest around $500 million on the plant, originally intended for investment by Maruti, and sell the cars produced therein to Maruti. Prima facie, the deal looked innocuous. In fact, an efficient allocation of capital considering Maruti could earn interest on the capital that was set aside for investing in the plant.  But the investors were not happy.

They wondered if the deal would turn Maruti into a mere distribution company. Questions like whether Suzuki would turn the screws on Maruti after setting up the plant and whether it would emerge as a competitor to Maruti unsettled investors. After all, Maruti is the ‘least multinational’ of all the multinational companies (MNC) operating in India. Conceptualised and founded in India in the early 70s, the carmaker formed a joint venture with Japan's Suzuki Motor in in 1981.
Proposals like the one floated by Suzuki are, however, not unprecedented. They are symptomatic of everything that has been going wrong with MNCs invested in India through listed subsidiaries.

Chirag Talati, lead analyst at Espirito Santos Securities, puts it in perspective. Compared to MNCs operating in India, purely Indian companies are doing better in terms of governance, he says. “Given the fact that it (governance concerns) crops up often, you could possibly say that there is a pattern,” suggests Amit Tandon, former MD of Fitch India, who now runs Indian Institutional Advisory Services that advises investors on how to vote on company resolutions.

The concern is not unwarranted. Traditionally, MNCs have enjoyed a hallowed status among investors for the best global practices that they bring to Indian boardrooms. But if one takes a closer look, one will be left wondering if the corporate standards claimed by these global titans actually work against the interests of Indian investors. Their list of sins is long. There are too many of such instances for them to be dismissed as isolated events.

Proctor and Gamble (P&G), for example, sells its products in India through three companies — P&G Home Products (PGHP), P&G Hygiene and Healthcare (PGHH) and Gillette India. The first, P&G Home Products, is unlisted. According to a research by Ambit Capital, the revenues of the unlisted entity (fully owned by the parent) as a percentage of PGHH, a listed company, have been steadily growing in the past 10 years. They now stand at around three times those of PGHH. The growth in revenues has been at twice the rate at which those of the listed subsidiary grew. So, the question is: Do shareholders of P&G in India not have the right to the profits of the company’s businesses in India?

While there’s merit in the question, P&G argues that having two entities is not illegal. In response to a query from BW | Businessworld regarding the company’s decision to sell some of its products in India through an unlisted subsidiary, P&G said it was committed to winning consumers, customers and shareholders across all three verticals in India. It added: “We continue to record sustained growth across our entities and our listed entity PGHH is testament to this, having delivered consistent double-digit growth and shareholder value over the past decade.”

Cummins is another example. Back in 2012, the company made an announcement saying that the new products for which its listed subsidiary, Cummins India, did not have the technological know-how would be manufactured by an unlisted subsidiary which would also have the rights to the export markets. The decision incensed investors as it prevented Cummins India from entering export markets. Cummins, at that time, countered this contention with the argument that the listed company would still have the export market for its existing products, as well as the mark-up on all Indian sales — quite similar to Maruti’s argument that company would still be entitled to all the profits from sales of its cars.

“MNCs probably never intended to share profits with Indian shareholders,” argues Gaurav Mehta, lead analyst at Ambit Capital. In the 70s, when most MNCs began to look at India as an investment destination, the foreign exchange rules did not allow them to have a majority stake in their Indian subsidiaries. “The companies had to, therefore, list their Indian subsidiaries to operate in India,” he says. Today, even as the rules have eased, MNCs face two choices: they can either delist or stay listed with at least 25 per cent of public shareholding. Considering delisting is a difficult and often expensive process, several MNCs have chosen to stay listed, but are constantly looking for ways to channel a bigger share of profits to the global parent.

Scheming MNCs
Restructuring has routinely come under fire from corporate governance watchdogs. A recent example was Switzerland-based global building materials company Holcim which, in a scheme purportedly aimed at eliminating cross-holdings in its two Indian cement companies — Ambuja Cements and ACC — transferred its stake in ACC to Ambuja for a cash payment of Rs 3,500 crore as well as a bigger stake in the company. The furore from Indian proxy advisors who believed the transaction was detrimental to minority stakeholders of Ambuja was unprecedented, but that did not affect the deal. Even many minority shareholders voted in favour of the proposal.

MNCs have resorted to even more outrageous schemes earlier. The two most popular examples are Siemens and Akzo Nobel. In January 2009, Siemens India announced the divestment of a ‘low-margin business’ and sold the business unit to its parent — Siemens AG of Germany. Analysts were quick to point out that Siemens India was paid just Rs 450 crore for the business that was generating revenues of Rs 990 crore annually. Siemens, at that time, justified the proposal saying the valuation was independently arrived at. 

The company still carries a reputation for such transactions. An analyst, when asked about the transaction, said he couldn’t remember the particular instance, but every year Siemens carries out a few of these. In a report titled House of Cards, Bangalore-based InGovern outlined how in 2012-13, Siemens India did four restructurings involving buying and selling of businesses with its parent. When quizzed about the spate of transactions, a Siemens official explained that it was part of an ongoing process of merging companies that came into their fold through global acquisitions by Siemens AG.

The other example is the case of Akzo Nobel. In 2011, the company decided to merge three of its wholly owned subsidiaries in India with Akzo Nobel India, which was listed. This would take care of the issue of the unlisted companies competing with the listed entity. But the valuation at which Akzo Nobel India was poised to buy the companies left everybody outraged. In a note to Akzo Nobel, the financial institutions (FI) that were invested in the company wrote: “As a result of the overvaluation, the parent company’s holdings are increasing at the expense of the non-promoter and public shareholders.”

In spite of all the opposition, the merger went through as two large FIs abstained from voting. The dissenters could generate only 23.15 per cent votes, when 25 per cent was required to effectively abort the merger.

While such restructuring poses a serious threat to minority shareholders, the biggest issue that Indian investors have to contend with is royalty payments. In 2012-13, five companies collectively paid a whopping Rs 3,979 crore to their parents in royalty, with Maruti alone contributing Rs 2,453 crore. The amount was 24 per cent higher than what was paid the previous year. This, however, wouldn’t have been much of a problem if the companies were raking in revenues — after all, royalties are linked to a boost in a company’s sales through the use of a well-known brand. But revenues and profits lagged, growing just 15 per cent and 13 per cent, respectively, in 2012-13.

Till 2010, companies required the government’s approval to repatriate royalties. MNCs began demanding higher royalty payments only after the stipulation was removed. In 2013, Unilever, Nestlé and Holcim came under attack for huge increases in their royalty rates. Hindustan Unilever agreed to raise royalty from 1.4 per cent to 3.15 per cent over a period of five years, while at Nestlé, the rates went up from 4.1 per cent to 4.2 per cent. Holcim increased royalty rates from 0.6 per cent to 1 per cent, but sneaked in other new fees that took the additional outgo to 2 per cent.

The payments look particularly egregious when compared to profits their Indian arms are making. ABB India paid out a royalty that was twice the profit that remained in the company after the payment. Maruti would have had twice the amount of profit if it had not paid 5.8 per cent royalty (up from 2.8 per cent in 2008-09). While it could be argued that royalty payments shouldn’t be compared with profits left behind in the business on the ground that they are a cost of carrying on the business and not an apportionment of profits, the sheer scale of the payments warrants the comparison.

Royalty payments do not require shareholders’ approval. But after Holcim drew a lot of flak last year for its Ambuja deal, it went to its shareholders to have its royalty payments approved. The shareholders voted vehemently against it, with 88.6 per cent negative votes. However, the proposal was passed with the promoter shareholding of over 50 per cent in each of the companies.
The new Companies Act has taken steps to check promoters from abusing their shareholding in companies to the detriment of minority investors. Starting this fiscal, many of the transactions that were run of the mill earlier will find it difficult to go through. Under the new law, any related party transaction will have to be considered by the independent audit committee of the company. If it finds the transaction to be a routine transaction done at arm’s length, the deal can go through. If not, the transaction will have to be considered by the board and, if material, by the shareholders of the company. The safeguard is that in such a meeting, the promoter will not be allowed to vote. So, effectively, a majority of the minority shareholders should approve the decision to have a transaction with a related party at an abnormal rate. It is easy to see how it can only be an embarrassment to the company, acting as an effective deterrent. The new liability provisions will ensure that audit committees (headed by an independent director) do not turn a blind eye to promoters’ excesses.

Analysts were particularly miffed with Hindustan Unilever last year. The company announced that it was increasing its royalty payouts by around 2 per cent, triggering an immediate 7 per cent fall in its share price. Three months later, the company announced a buyback of its shares from the market. Many analysts wondered if the fall in share price after the royalty announcement helped the company announce a buyback at a price lower than it would have otherwise had to pay. 

Shareholders’ Say
Most MNCs have a better reporting framework than the average Indian firm. “You can, thus, have more trust in the sanctity of their accounts as well as the veracity of their communication with shareholders,” says Mehta of Ambit, explaining why multinationals get a premium in the Indian market. That said, international parent companies are keener to protect their interests even if it is at the cost of minority shareholders, he adds.

Many of the key decisions at Indian arms of MNCs are taken without considering minority shareholders’ say, despite their money being at stake. This is, however, about to change, with the Companies Act 2013 mandating that all non-routine transactions with promoters be approved by non-promoter shareholders.

In fact, the prominent view is that MNCs hurriedly carried out a spate of transactions and board decisions before the new Companies Act took effect. This, to avoid the risk of rejection of deals by overzealous minority investors. If that is indeed so, it reflects poorly on the priorities of global majors looking to be a part of the India growth story. And, that is a pity. 

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(This story was published in BW | Businessworld Issue Dated 30-06-2014)

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.

Abraham C Mathews

The author is an Advocate, practicing in Delhi, and a Chartered Accountant

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