5 reasons why Maruti's move is a strategic mis-step

A a knee-jerk reaction to the news that the proposed investment ($500 million) in the planned Gujarat plant will occur via a 100% subsidiary of Suzuki, and Maruti will only distribute and sell the vehicles saw the stock skid nearly 8% on the bourses on Tuesday. However, it has erased most of its previous day’s loss in trade today.

Under the terms of the contract, Suzuki will make the first round of capital investment in the subsidiary for the initial period of three to four years. Overall investment in the plant would be close to Rs 30bn (JPY 50 bn).

Suzuki Gujarat (SMG) will sell vehicles to Maruti on an arm’s length basis, and 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 MSIL’s business.

Analysts at Barclays believe that the move will result in a structural shift in the company’s earnings profile (incremental shift to a distribution based model) in the longer term. Additionally, it will create an overhang with respect to the use of cash generated. As a result, they expect investors to apply a discount to Maruti’s target valuation multiples going forward.

Corporate governance issues

Analysts have raised questions on “corporate governance" issues and said minority shareholders should challenge the deal, as their interests would be adversely affected.

“A very pliable Board of Maruti Suzuki India Limited (MSIL) has done grave injustice to minority shareholders of MSIL. The Board has agreed to enter into contractual arrangements for expansion with a 100% subsidiary of Suzuki Motor Corporation, the dominant shareholder of MSIL,” says a note from InGovern Research Services, a corporate governance research and analysis firm.



“This is not a simple contract manufacturing arrangement as the dominant shareholder of MSIL is the contract manufacturer and can dictate the terms of any contractual arrangement,” it adds.

Here are 5 reasons why analysts think the latest development is a significant strategic mis-step:

1) Maruti has enough cash to adequately fund the Gujarat requirements on its own;

2) A higher share of earnings from distribution is a structural shift of the earnings profile;

3) Maruti's lack of control over the cost of production is a worry although Maruti claims that Suzuki Gujarat (SMG) will not make a profit;

4) SMG eventually is expected to scale up to 1.5mn units (as large as Maruti is today), essentially satisfying 5-6 years of requirements; and

5) This could set a precedent for other similar steps

On the other hand, the company sees this as a step in the right direction. Maruti suggests:


1) By investing the money through Suzuki, its cash is conserved for future requirements;

2) It is enhancing shareholder value based on the interest income from unused funds;

3) SMG will sell goods to Maruti on an arms-length basis, as SMG's costs will include cost plus cash requirements for future capex requirements;

4) Profitability will be unchanged