Troubles for listed MNCs to increase in India

The recent fracas between Maruti Suzuki and its minority shareholders has blown the lid off the tension that has been steadily building between minority shareholders and listed multinational corporations in India.  

This is despite the fact that many of the listed multinationals have delivered better financial performance as well as stock returns to shareholders.  

Compared to their Indian peers, multinationals have higher return ratios (return on capital and return on equity) because of their superior allocation of capital, management skills and higher dividend pay-outs.  

This is visible in the shareholder returns too. Listed multinationals in India have generated CAGR (compounded annual growth rate) of nearly 19 per cent over the last decade while the BSE 500 has returned about 13 per cent.  

In contrast, many Indian companies tend to hoard cash, which is either parked in low-yielding bank deposits (or fixed return instruments) or used for unrelated diversification, leading to lower return ratios and stock returns.  

But, over the last few years, Indian subsidiaries of multinationals have also begun to contribute significantly to their parents' earnings.  

It is the rising size and scale of Indian operations (in their global portfolio), and partly the fact that parents' global operations are slowing down, that have led to a conflict of interest and simmering tensions between the promoters (the parent of the multinational) and the minority shareholders in India.  

In a bid to get a larger share of the profits, experts say, parents of Indian multinationals are resorting to questionable tactics.  

Maruti Suzuki is a case in point. As it expanded its business, Maruti's contribution to its Japanese parent, Suzuki, grew significantly.  

By setting up a parallel manufacturing plant in Gujarat, partly utilising Maruti's post-tax profits, Suzuki would have not only reduced the Indian arm to a marketing company but would have also eroded its profitability.  

There are several other examples of the multinational parent's growing dependence on its Indian subsidiary. Emerging markets contribute 55 per cent of Unilever's profit and by 2020 this will increase to 75 per cent.  

Last year, Unilever guided for lower profits due to the slowdown in key emerging markets like India.  

Hindustan Unilever on 22 January 2013 announced its decision to increase royalty from 1.4 per cent of sales to 3.15 per cent in a phased manner between 2013 and 2018.  

Over two days the stock was down over 7 per cent, and remained under pressure till end-April when Unilever announced an open offer. On April 30, Unilever announced the offer at Rs 600 per share, which though 21 per cent higher than the then prevailing price, was only 14 per cent higher than the two-month average price before the royalty increase was announced. The market viewed this as controversial.  

Brokerages too are taking note of the investor sentiment. Espirito Santo recently red-flagged the top five royalty payers-Maruti (which paid the highest royalty as a percentage of sales at 5.8 per cent in FY13) along with Hindustan Unilever, Nestle, Bosch and ABB.  

While the increase in royalty is one of the many ways to benefit the parent, larger institutional shareholders claim that multinationals also resort to merging unlisted subsidiaries, into listed ones, usually enabling the parent to raise its stake.  

Conversely, there are instances of transferring (profitable) divisions to the parent firm, and that too at low valuations.  

Siemens is one such example, say experts. The German parent bought a company owned by its listed Indian subsidiary at valuations that were way lower than valuations a few years back.  

Holcim's complex proposal involving two of its listed subsidiaries was also questioned by shareholders. The proposal was to sell Holcim's stake in ACC to Ambuja Cements for cash consideration of Rs 3,500 crore plus higher stake in Ambuja. By doing so, it would have got the cash as well as retained indirect control in ACC.  

Mismatched interest  

Most of these restructuring exercise by companies are driven by the intention to enrich the parent company, say experts.  

London-based Nick Paulson, co-head (emerging market equities), Espirito Santo Investment Bank, says: "The problem is inherent - the interest of multinational and minority shareholders aren't fully aligned. Some companies operate with global standards of transparency and accountability, but others suffer serious incentive misalignments."  

Investors today are watchful of red flags like royalty increases, merger of wholly-owned subsidiaries into parent-owned entities to increase shareholding, poor disclosures and weak boards. 

Ambit Capital says, "With the increasingly hostile behaviour of several prominent multinationals vis-à-vis minority shareholders, and given the business strengths and superior capital allocation of multinationals in general, investors face a dilemma today." The brokerage has red-flagged some of these multinationals which have been accused of short-changing minority investors.  

Fund managers and equity strategists believe that multinationals command higher valuations because they pay dividends, but it does not mean that their corporate governance standards are world-class. 

Amit Tandon, founder & managing director, Institutional Investor Advisory Services (IiAS), says, "As the Indian business has grown, it has attracted more attention. So the parent looks at how to benefit more tangibly from it by either taking cash or increasing stake at artificially low valuations. These last few years have also been difficult globally - hence, the tendency to move cash from the Indian balance sheet to global balance sheet to shore up the global P&L."  

It is for this reason that Ambit Capital says that while many multinationals are great companies, they might not be great stocks given the misalignment in their interests and that of minority shareholders. 

This behaviour is unique to India in many ways as these entities are listed in India not out of commercial compulsions but because Indian laws mandate them to do so.  

Tandon says India might be one of the few markets where large multinationals have a listed entity outside of their home markets.  

It is for this reason that they behave differently and the minority shareholder is an unnecessary irritant.  

There are about 100 listed multinationals in India, either due to historical reasons or because of acquisitions they have made.  

So far, most decisions taken by the boards of these listed multinationals have sailed through, despite opposition from the minority shareholders.

But the new Companies Act 2013, introduced recently, has been a big step forward for the minority shareholders. Under this Act, all related party transactions will need to be passed through a special resolution, which requires 75 per cent consent from the minority shareholders.

Any decision on mergers, royalty and other similar transactions will also need to be passed through a special resolution where the multinational parent will not be allowed to vote.  

This opens up the possibility of more litigation. As IiAS points out in a report, Have multinationals found a way around the delisting norms?, "Given the complexity of regulations and increased cost of compliance across various jurisdictions, multinationals generally prefer to remain listed only in their home markets. This is especially true in the Indian context where the Companies Act 2013 and SEBI corporate governance code (to be implemented soon) not only requires a larger set of disclosures and approvals, but also raise the risk of litigation through class action suits."  

But, even as the tensions are rising between the two sets of shareholders, there is perhaps more waiting to unfold. Because of regulatory tightening, many companies may look at delisting their Indian arms. But even that will have its own set of challenges with questions being raised on the manner of arriving at the delisting price.  

Royalty pay-outs: What the Companies Act says

While the Companies Act makes it difficult for related party transactions to go through without the approval of minority shareholders, experts await clarity on whether royalty pay-outs fall in the normal course of business or are a related party transaction. 

Listed multinationals may have gotten away with some controversial decisions in the past, but the Companies Act (2013) gives more muscle to the minority shareholder.

Section 188 of the Companies Act has made it mandatory for all related party transactions, other than those in the ordinary course of business, to be passed through a special resolution, requiring 75 per cent votes of the minority shareholder. All transactions between the company and a related party (be it royalty payment to the parent or M&A with other related parties) would have to be passed through a special resolution.

In this special resolution the related party (which would be the promoter) will not be allowed to vote.  

Historically, promoters or majority shareholders have often pushed through regulations to benefit themselves, at times even at the expense of the minority shareholder.

The new Companies Act has now changed the regulatory landscape. While more clarity on royalty pay-outs is awaited, even if the payments are assumed to be in the normal course of business, they would have to be justified to the audit committee.

Yogesh Sharma, partner (assurance), Grant Thornton (an assurance, tax and advisory firm), says: "Section 188 gives additional protection to minority shareholders. Any transaction which is outside the course of regular business, like brand fees or management fees payments to majority shareholders (or to related parties), would require going through a special resolution.

Further, all related party approvals will now be scrutinised by the audit committee, which comprises of a majority of independent directors."

Nick Paulson of Espirito Santo says the bill provides the enabling architecture for better corporate governance. "There are tighter restrictions on related party transactions, but the restrictions will not apply to those entered into in the 'ordinary course of business'. The definition of this needs clarifying, as it creates uncertainty on issues such as royalties."

Questionable decision by MNCs

Transfer of profitable division at Throwaway valuations

Siemens India in January 2009 approved divestment of its subsidiary Siemens Information Systems Ltd (SISL) to Siemens Corporate Finance, wholly-owned by Siemens AG, in a deal valued at Rs 490 crore.

The subsidiary SISL had revenues of over Rs 990 crore and a net worth (book value) of Rs 360 crore, implying a valuation of 1.25 times of book value. In contrast, in May 2003, the parent company had picked up 25.2 per cent stake in the Indian subsidiary for about Rs 80 crore ( Rs 800 million) (SISL's networth stood at Rs 120 crore (Rs 1.20 billion) as on September 2003) or valuation of 2.75 times of book value even as the profitability of the subsidiary had deteriorated in the year preceding the divestment in 2003

Royalties rise despite slowing sales  

The top 25 listed MNCs in India paid Rs 4,950 crore (Rs 49.50 billion) in FY13, a 23.8 per cent jump over the previous year, well in excess of both sales and profit growth. Maruti Suzuki continues to pay the highest royalty at 5.8 per cent of net sales. Others in the list are HUL, Nestle, Bosch and ABB

Buyback announcement soon after royalty increase

Hindustan Unilever on January 22, 2013 announced its decision to increase royalty from 1.4 per cent of sales to 3.15 per cent in a phased manner between 2013 and 2018.

On 30 April, Unilever announced the open offer at Rs 600 per share, which was 21 per cent higher than the then prevailing price, but only 14 per cent higher than the two month average price before the royalty increase was announced. The market viewed this as controversial

Cash repatriation from subsidiary to parent 

Last year, Holcim announced a deal involving sales of its controlling stake in ACC to its other listed subsidiary, Ambuja Cements. While Holcim would have got Rs 3,500 crore (Rs 35 billion) in cash (and a higher stake of 61 per cent in Ambuja versus 50.6 per cent prior to the deal) besides retaining its control (indirectly through Ambuja) over ACC, Ambuja would have seen significant cash outflow and equity dilution.

Although Ambuja was getting majority stake in ACC (hence, ACC's financials would reflect in its consolidated numbers), the combined stake of its minority shareholders would have fallen 20 per cent. Analysts say, a better way would have been to merge ACC and Ambuja, which would have helped retain cash within the listed companies as well as made the structure simpler

Seeking to de-list  

This month, AstraZeneca Pharmaceuticals AB of Sweden announced plans to delist its Indian arm, AstraZeneca Pharma India (AstraZeneca), a move minority shareholders are opposing. IiAS, a proxy advisory firm, while examining the issue, said one of the patterns emerging is oddly enough, the 'Offer for Sale (OFS)' route.

To comply with the minimum 25 per cent public holding rule, last year many promoters did so through the OFS or IIP (institutional placement) route. AstraZeneca's parent held 90 per cent stake which it brought down through the OFS route.

In less than a year, the parent has come out with delisting offer. Given the current rules, the delisting is easier if AstraZeneca's parent manages to get the shares held by institutional investors.

IiAS says that retail investors have alleged that entities which participated in the OFS were acting in concert with the promoters and would sell the shares purchased through the OFS to the promoters. This would impact true price discovery while de-listing.

(Source: Espirito Santo, Ambit Capital and IiAS)