Hero Honda: Parting ways

The proposed split gets interesting as investor activism rears its head

By buying out Honda, Hero plans to spread its wings and export to other emerging markets, replicating the success formula of Bajaj Auto. On the surface, it may look like a sensible move, given the intense competition in the domestic market, even as growth starts to taper off, but the actual outcome will depend on execution sans the Honda brand.

Reports indicate promoters are buying Honda’s 26 per cent stake for $1.2 billion (about Rs 5,400 crore), at more than 40 per cent discount to the current market value. They are then placing 20 per cent of this with private equity firms at a slight premium to the price paid. However, reports of existing investor angst indicate minority (read institutional) shareholders will join hands to negate such a move. An added dampener comes with reports of a possible rise in royalty payments to Honda on new variants.

At eight per cent, the royalty payments in 2011-12 will increase to nearly Rs 1,000 crore (Rs 810 crore after tax) from the current Rs 600 crore (around three per cent of net revenues), according to Man Financial estimates. The impact on 2011-12 earnings per share estimates can be to be tune of Rs 40 on the current equity.

Moreover, the loss of the Honda tag may also affect the company’s domestic market share, reckon analysts. Sales growth has clearly lagged peers in the key festival season (ending October), dipping 150 basis points year-on-year to 48 per cent.

The other risk is on the research and development (R&D) front, but that is allayed with the technical support agreement with Honda, in place till 2014, for product development and production. This, even if not renewed, allows some buffer for Hero to get its R&D act together.

As the markets await further formal announcements, the stock has slid nearly nine per cent in the last one week. It ended at Rs 1,787.4 on Tuesday, up 0.76 per cent over its previous close.