»5 Minute Wrap Up by Equitymaster

On This Day - 21 OCTOBER 2015
Are Big MNCs Giving You a 'Royal' Ignore?

In this issue:
» What's making private equity investors restless
»  Does slowdown in China mean gain for India?
»  ...and more!


00:00
Maruti Suzuki India Ltd is in the news. Once again for the wrong reasons. The company has received flak for paying high royalties to its parent company Suzuki. As per a report by proxy advisory firm IiAS, over last 15 years, royalty payments per car sold have gone up six times. In comparison, realization per car has increased just 1.6 times. Ironically, this is the same company that was ready to shut down a production plant to avoid higher compensation to workers.

A royalty is an annual charge that the Indian arm of an MNC pays to use the MNC's product technology or brand. Now, brand and technical know-how are some of the key moats for a business. So it's not a question of whether compensation should be made. It's a question of how much.

And companies like Maruti Suzuki India are likely to struggle with answers. Consider this: While royalties in FY15 for Maruti accounts for 5.2% of sales, the R&D expense is barely .01%. Compared to a 15% compound growth rate (CAGR) in operating profits over last decade, the royalties have grown at a CAGR of 30%.

While the spotlight is on Maruti now, the overall trend is disturbing. Companies like Nestle, HUL, and ACC are treading a similar path.

Since royalties are rising at a much higher rate than sales growth, parent companies are clearly getting more than their due.

This growing divergence between profits and royalties is at the expense of minority shareholders. The growth in the royalty payments exceeds that of dividends. One must note that royalties are paid as a percentage of sales. On the other hand, dividends correlate to profits. Unlike dividends, which are offered to all stakeholders including the parent company, minority shareholders do not share in the royalties, and they have no say in royalty payments.

By linking royalties to sales and keeping percentage flexible, the foreign companies have capped their risk and are positioned to make the most of good times. There have been cases when Indian arms have continued to pay royalties despite bottomlines in the red. In other cases, while royalties continue, no dividends have been offered.

There was a time when these royalty payments were regulated. But they were removed to make India friendlier to foreign investment. In the process, the corporates have become indifferent, hostile even, to the interests of domestic stakeholders. And now, unreasonably high royalty payments instead are leading to capital flight.

MNCs are perceived to be the torch bearers for corporate governance standards. However, there seems to be a huge hypocrisy here with parent stakeholders being treated as more equal than others. It's time minority shareholders take offence and be more vocal about being unfairly treated.

Do royalties by Indian arms to MNC parents suggest unfair treatment of minority shareholders? Let us know your comments or share your views in the Equitymaster Club.

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02:15
 Chart of the day
The last couple of years had seen a dry spell in the IPO market. However, the current year so far has turned out to be good in this regard. Some statistics give an idea of the overall picture. According to Prime Database, there have been 16 new issues so far this year. This is much higher than the number of IPOs that had come during the years 2013 and 2014. A total of 8 companies raised money through IPOs in these two years...

While there is surge in the IPO activity, some private equity investors seem to be a dissatisfied lot.

As per an article in Economic Times, UK-based private equity (PE) fund Actis has entered into agreement with New Quest Capital, to sell its seven year old investment in NSE. The former had bought stake at Rs 1.78 bn and will be selling at around the same valuations at which it had acquired. Actis's decision to exit its holding came as a result of delay in the IPO listing. Private investors are of the view that regulatory and bureaucratic delays have been one of the reasons for PE funds exiting even without making profits.

The Indian regulator - Security Exchange Board of India (SEBI) - has been facing pressure regarding the IPO bottleneck since some time now. In most of the cases, it is PE funds and companies that benefit while retail investors end up burning their fingers.

In order to tighten the scrutiny of the IPOs, and protect the interest of the shareholders, the regulator has been taking longer time to approve the IPOs. While delay because of SEBI regulations may not go well with some PE firms, we believe it is a necessary check to protect the interest of retail investors to some extent.

IPO activity gaining momentum

03:30
The bad news for China's economy continues. The latest one is regarding recently released quarterly economic growth data. China's GDP growth stood at 6.9% YoY for July-September 2015 quarter. This is the weakest reading since the 2009, when growth slipped to 6.2% during the April-June quarter. The slowdown in China's economy is mainly due to sharp decline in its manufacturing and investing activity.

But does a slowdown in China bode well for India?

As per an article in Business Standard, the Chinese economy is in a transition phase from being a manufacturing and investment heavy economy to a consumption and service oriented one. These structural changes, along with the fact that its export infrastructure and technology support is much better than ours, cannot be neglected. Hence, it could be naive and too early to write off China.

04:15
After trading on a firm note in the early hours of the day, the Indian share markets lost their momentum and slipped into the red in the post-noon trading session. Sectoral indices were trading mixed with banking, capital goods and pharma sectors bearing the maximum burnt.

BSE-Sensex was down 44 points (0.2%) and NSE-Nifty was trading 25 points down (0.3%). S&P BSE Midcap and S&P BSE Smallcap index were both trading on a negative note, down by 0.3% and 0.6% respectively.

04:30
 Today's investing mantra
"It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently." - Warren Buffett

Editor's note: There will be no issue of The 5 Minute Wrapup on 22nd October 2015.

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