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Why BAT should not be allowed to take over ITC

BAT -British American Tobacco - is a UK-based multinational corporation. ITC used to be called India Tobacco Company and before that, Imperial Tobacco Company.

It is India's largest manufacturer of cigarettes with a whopping market share. It also owns and runs hotels, manufactures paperboard and exports handicrafts and agricultural commodities.

For over a decade now, BAT has been lasciviously eyeing the management of ITC, a company in which it holds 32.5 per cent of the share capital.

In recent weeks, the cash-strapped, government-controlled Unit Trust of India has been toying with the idea of selling its 12.3 per cent stake in ITC to BAT for a huge controlling premium.

With the government announcing a bailout package for UTI, the pressure on India's largest mutual funds organisation to sell its blue-chip holdings has eased somewhat.

Nevertheless, if BAT acquires UTI's 12.3 per cent stake in ITC, it would have to offer to purchase an additional 20 per cent of the company's shares from the general public that, in turn, would take BAT's holding in ITC to nearly 65 per cent or well above the majority mark.

Should the government allow this to happen? The answer, at the risk of sounding like an incorrigible jingoist, is categorically in the negative. But before I explain why, a personal explanation is in order.

For almost three decades, I was a chain-smoker. I learnt the hard way about the damage that smoking does to the body and mind of an individual. I am also aware of the fact that nicotine is among the most addictive - if not the most addictive -substances known to humankind.

As a professional journalist, I have written a number of articles against ITC - about how the company was accused of evading excise duties and how senior executives were hand-in-glove with leading cigarette wholesalers and dealers to allegedly cheat the exchequer.

I have met and interviewed at least three former chairmen of ITC and listened to one of them explain in great detail the complexities of the country's excise tax structure.

I have reported how a former chief executive of ITC, K L Chugh, compared his company to the Taj Mahal when confronted by a takeover attempt by BAT. Will the Indian government allow the Taj to be sold for a billion dollars if a foreigner offered the money, he rhetorically asked.

The same individual later had to face the ignominy of being placed behind bars, together with some of his colleagues after they were accused of financial bungling and violating foreign exchange rules. I have no sympathy for such people.

ITC claims it is helping hundreds of thousands of poor tribals in states like Andhra Pradesh by participating in social forestry programmes. The company provides farmers high-yielding, disease-resistant varieties of cloned saplings of trees that provided pulp.

But I, for one, am hardly impressed by these claims. The company needs wood pulp to manufacture paperboard. The paperboard, in turn, is used in cigarette packets. So what's the big deal if a company acts in its own interest?

If these are my views, why indeed would I be opposed to the UTI selling its holdings in ITC to BAT? There are many reasons and let me enumerate them.

Dhirendra Kumar, Managing Director, Value Research, says UTI (and other financial institutions) have so far been passive investors in blue-chip companies like ITC and provided such companies cheap equity capital and managerial stability.

The time has now come, he argues, for UTI to "derive the maximum value for its crown jewels, including ITC, even if it amounts to getting militant and creating upheavals in corporate boardrooms" (The Economic Times, September 4, 2002).

My view is quite different. Even if the UTI sells its shares in ITC to BAT for a large controlling premium of, say, 100 per cent, it would still make a one-off windfall gain.

If UTI holds on to its shares and ITC prospers and grows, the chances are bright that UTI would earn much more in the medium term.

ITC claims that over the last six years, it has created incremental shareholder value in excess of Rs 12,000 crore (Rs 120 billion) that has directly benefited not just ordinary shareholders but large all-India financial institutions like the UTI.

Four multinational corporations dominate the world market for cigarettes. These are BAT, Philip Morris, R J Reynolds (in the US) and Japan Tobacco Company (outside the US) and Imperial Tobacco Company.

India is perhaps the only country in the world that has an independent cigarette manufacturing industry that is relatively free of the influence of multinational companies.

International cigarette companies are experiencing a sharp fall in demand in developed countries. Consequently, unutilised manufacturing capacity has gone up sharply and these MNCs are looking at the markets of developing nations to sell their cigarettes.

Over the years, giant tobacco corporations have been deploying complex methods to abet and encourage illegal trade in cigarettes in developing countries, including India.

MNCs legally sell consignments of cigarettes to so-called traders in a port in the country of manufacture without paying local excise taxes as the consignments are shown as if they are solely meant for export.

While these traders claim they are 'independent,' they actually act in collusion with the cigarette MNC. The trader then ships the goods to a duty-free port like Dubai from where the consignments of cigarettes are smuggled in boats (dhows), which land along India's west coast.

An alternative technique is for the trader to 'legally' export the goods to countries like Nepal or Bangladesh with India being used as a transit point.

While the goods leave the port under a bond, the consignments never reach their destination. Instead, the containers are unloaded within India and sold.

Another technique is that consignments of cigarettes are legally imported from Dubai or any other duty-free port and stored in a bonded warehouse in India.

Thereafter, the goods are clandestinely removed from the bonded warehouse and sold within the country. Officials are bribed and fraudulent documents created to show that the goods have been 're-exported' out of India.

Then, cigarette MNCs directly organise large sales to duty-free shops in the country. Deals are then struck with employees of duty-free shops to sell the goods to agents of the MNC who pose as passengers bringing in cigarettes as part of their hand baggage.

Customs officials are bribed to allow substantial quantities of cigarettes as hand baggage. This technique is particularly prevalent at Chennai airport where couriers - called kuruvis or sparrows - bring in cigarettes almost every day from duty-free shops in Colombo.

In countries other than India, MNCs have been known to invest directly in an organisation that legally imports relatively small quantities of cigarettes.

However, the MNCs spend disproportionately large sums on advertising to build up demand for legal as well as smuggled cigarettes.

Governments all over the world are extremely concerned about the high incidence and fast growth of the contraband trade in cigarettes.

It has been estimated that the total revenue loss incurred by all governments put together is currently in the region of almost $20 billion (Rs 97,000 crore).

What is particularly alarming is the fact that the contraband trade in tobacco products has jumped nearly five-fold during the decade of the 1990s. In order to curb this menace, certain governments have initiated legal action against cigarette companies.

The European Union has filed a lawsuit in the US against Philip Morris and R J Reynolds under the provisions of the Racketeer Influenced Corrupt Organisation Act to recover revenues lost on account of smuggling of cigarettes.

The government of Columbia has also sued Philip Morris and its subsidiaries for allegedly defrauding it of tax revenues running into billions of US dollars over a ten-year period.

Twenty-six regional governments of Columbia have also sued BAT, UK, under the provisions of the RICO Act in the Federal Court at Brooklyn, New York, for allegedly carrying on smuggling operations since the 1970s.

At present, BAT is also being investigated by the Department of Trade and Industry of the government of United Kingdom to establish allegations that some senior employees of the company were actively and systematically involved in global smuggling operations.

Three executives of BAT - two from Canada and one from Hong Kong - have either been convicted or have pleaded guilty to charges of smuggling of tobacco and cigarettes.

The Web site of the UK-based non-government organisation called Action on Smoking and Health - www.ash.org.uk - contains meticulously-researched data on how multinational cigarette companies have organised an intricate network for contraband trade in cigarettes.

The ASH Web site has highlighted a vast body of documentary evidence that purports to establish the involvement of top managerial personnel of some tobacco MNCs in international smuggling operations.

The evidence is in the form of thousands of pages of internal documents from these companies that have been obtained by ASH from a depository at Guildford. These documents had been archived in the depository by BAT in response to discovery requirements in a suit filed against the company.

The suit, filed in a Minnesota court in 1998, seeks to recover costs of healthcare from BAT.

Besides ASH, another NGO called Campaign for Tobacco Free Kids has published a study entitled Illegal Pathways to Illegal Profits.

This publication has drawn extensively on BAT's internal documents and, among other allegations, claimed that BAT employees were involved in large consignments of cigarettes to Bangladesh finding their way to India.

Details of the allegations can be found on the NGO's website, www.tobaccofreekids.org.

It has been calculated that nearly 120 brands of cigarettes are regularly smuggled into India. Among the smuggled brands that are freely available in markets are Marlboro Lights, Benson & Hedges, State Express 555, Dunhill, Rothmans, Win, Classic, Aziz Gold, and Good Leaf.

Retailers in this country find it highly profitable to sell smuggled cigarette brands - their profit margins are usually three or four times higher than the margins earned from selling duty-paid cigarette brands or domestically manufactured cigarettes.

Every packet of smuggled cigarettes sold in India violates the following laws of the land: the Cigarettes Act (stipulating that every packet of cigarettes sold in the country must carry the prescribed statutory health warning), the Weights and Measures Act read with the Packaged Commodities Rules (which stipulates that each cigarette packet offered for sale must have printed on it the maximum retail price in Indian rupees), the Excise Act, the Customs Act and the Foreign Exchange Management Act.

Smuggled cigarettes currently account for around 6 per cent of the total cigarette market in India. This proportion is low when compared to countries where cigarette production and sales are controlled by MNCs.

For example, in countries like Argentina, Brazil, Uruguay, Paraguay, Poland, Philippines and Russia, contraband cigarette sales comprise between 35 per cent and 60 per cent of the total market for cigarettes in these countries.

If the Indian government allows foreign direct investment in this industry, it could result in a sharp fall in revenue collections on account of a spurt in smuggling, ITC sources apprehend.

What is more, unlike ITC, cigarette MNCs would prefer to import much of their requirements of tobacco, they add.

The sources point towards the most populous country in the world, China, which accounts for roughly one-third of the total international market for cigarettes and which has so far refused to allow FDI in its government-owned cigarette industry.

The Indian government currently disallows proposals for foreign investment for the manufacture of cigarettes and tobacco products unless the particular proposal receives the formal approval of the Foreign Investment Promotion Board.

The FIPB, in turn, insists on an enabling resolution from the board of directors of the concerned company before allowing foreign investment.

BAT has so far not been successful in acquiring a majority stake in ITC because the UK-based company is aware that the ITC board would not approve a proposal of this nature.

The present board of directors of ITC comprises four executive directors and ten non-executive directors, seven of whom are independent. BAT has a minority representation on the ITC board through two of its nominees.

ITC has somewhere in the region of 200,000 shareholders and the company's board of directors is answerable only to these shareholders.

Former union industries minister Sikander Bakht had sought to allow foreign direct investment in the cigarette manufacturing industry. He had argued that the entry of foreign capital into cigarette manufacturing would help tobacco farmers in states like Andhra Pradesh, but the move raised a big hue and cry.

Bakht's successor, Minister for Commerce and Industry Murasoli Maran, subsequently stated categorically on a number of occasions that he was not in favour of allowing FDI in companies manufacturing cigarettes and tobacco products.

Maran has assured Parliament no less than three times in the recent past that FDI would not be allowed in this industry. In fact, over the last five years, the government and the FIPB have rejected various applications from MNCs for investment in the tobacco sector (including those from BAT).

ITC is not merely a manufacturer of cigarettes; it is a diversified corporate entity with interests in fast-moving consumer goods, hotels and tourism, agriculture, paper, paperboards and packaging.

While the total capital employed by the company has increased two-and-a-half times over the last six years, nearly 70 per cent of its investments are currently not in the tobacco business.

During the financial year ended March 2002, the company paid Rs 5,600 crore (Rs 56 billion) to the exchequer as excise duties - this amount equalled 6 per cent of the government of India's total collection of excise taxes during the year and roughly 3.5 per cent of the government's total collections of indirect taxes (excise and customs duties).

ITC is also the single largest payer of income tax in the country's private corporate sector. It also ranks among India's top three companies in the private sector during 2001-02 in terms of gross income (Rs 9,840 crore or Rs 98.40 billion) and operating profits (Rs 1,847 crore or Rs 18.47 billion).

Between 1996 and 2002, the company's gross turnover has grown each year by 11.5 per cent while profit before interest and tax has increased by nearly 23 per cent.

Post-tax profits have witnessed an average annual compound rate of growth of 28.8 per cent while market capitalisation has increased by nearly 21 per cent.

The company is also among the largest foreign exchange earners in the country - ITC has earned nearly $2 billion in hard currency over the last decade, of which $1.5 billion has come from exports of agricultural commodities such as rice, coffee, soya and various marine products.

During 2001-02, the company's exports grew 28 per cent in US dollar terms at a time when the world economy was depressed and India's exports grew at a niggardly pace.

At a time when private sector investments in India are well below expected levels, ITC has plans of investing substantial sums in its different businesses, including in hotels, paperboards, food processing, agricultural commodities, branded apparel and for developing the rural infrastructure for information technology.

ITC already employs around 13,000 persons directly and over one million retailers are engaged in trading and distributing the company's products.

ITC recently set up more than 1,000 'e-choupals,' an Internet-based initiative to provide farmers access to the latest information in their local languages on farm practices, domestic and international prices of various agricultural commodities and weather data.

This initiative has been widely appreciated and is currently being studied by academics from reputed universities and educational institutions, including the Kellogg Business School and Harvard in the US.

Finally, unlike ITC, BAT's business interests are confined to cigarettes and its sole aim is to maximise profits - it is not in the least bothered about anything else, leave alone India's national interests.

The author is Director, School of Convergence @ International Management Institute, New Delhi and a journalist with 25 years of experience in various media - print, Internet, radio and television.

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