Will this move stop MNCs milking their subsidiaries? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Will this move stop MNCs milking their subsidiaries? 

A  A  A
In this issue:
» Not too many people are working in Europe
» What will the Holcim-Lafarge merger mean in India?
» China is taking its reform process seriously
» Why has unemployment in the US declined?
» ...and more!

When Maruti Suzuki announced an unusual mode of arrangement with its parent company Suzuki with respect to setting up a plant in Gujarat, the investing community was miffed. The major bone of contention was that the deal benefitted Suzuki and was detrimental to the interest of minority shareholders. Little wonder then, that this sparked off a debate about MNCs in general and their murky standards of corporate governance.

The other gripe that came to the fore was the matter of royalty payments. These are payments that the Indian subsidiary makes to the parent company for the use of the latter's technology, brand name etc. Because this forms part of the company cost structure, it has a direct bearing on margins and profitability.

The reason why royalty payments have become an issue is because these seem to have risen significantly ever since the restrictions on them were lifted in December 2009. As reported in the Business Standard, royalty payments rose from 13% of foreign direct investment (FDI) in 2009-10 to 18% in 2012-13. Overall, in four years, these payouts have increased 57%. So much so that the royalty payments that the parents are receiving from their subsidiaries exceeds the dividends received from them.

Plus, there seems to be not much evidence to support the fact that the use of technology has significantly contributed to overall performance. Thus, in the last 5 years while royalty payments made by the Indian subsidiaries have grown at a compounded annual rate of 31%, net sales and profits have grown at a much lower rate of 15% and 10% respectively during the said period.

What is the solution to this? The article suggests that a cap on royalty payments needs to be introduced. We are not sure if this is the only solution that will work out. We believe that there needs to be greater transparency between dealings of the parent MNCs with their subsidiaries. At least as far as royalty payments are concerned there needs to be better communication to shareholders as to the rationale for these payments as well as the method by which the percentage has been derived at. Because royalty payments impact profits and thereby eat into the share of minority shareholders, they have a right to expect a greater voice in this regard.

Do you think that a cap needs to be introduced on royalty payments made by Indian subsidiaries to MNCs? Let us know in the Equitymaster Club or share your comments below.

Editors Note: There's more to getting wealthy than investing in stocks... to learn American wealth coach & Daily Reckoning contributor Mark Ford's wealth building strategies check out his 11 Secrets to Building Wealth (free access).

--- Advertisement ---
Inside: 5 "Safe Stocks" For 2020...

The recent market boom has left many investors wary about which way will it turn in near future.

Will we continue to see new record highs being set?

Or could we see a correction in near future?

Now, we both know that none amongst us can predict that with certainty.

However, what we can do is to not get tempted by these short term trends and invest in "Safe Stocks" which could deliver big returns over long term.

And to get you started, we have Equitymaster's Top 5 Blue Chip Stock Picks for 2020.

Click here to find out more about the 5 "Safe Stocks"...

01:36  Chart of the day
The developed world seems to have found no solution to tackle the persistent rate of high unemployment in their respective economies. The situation is particularly dire in Europe where the latest unemployment rate for the region stands at around 11.9%. This is largely on account of the economies of Greece and Spain where unemployment has breached the 25% mark. While the US in that sense fares much better, many attribute it largely to a sizeable chunk of the unemployed giving up looking for work altogether. Obviously, the central banks' unimaginative monetary policies are not working. And the sooner they realise this, the better off these economies would be.

Unemployment in Europe is way too high
*Data for Feb/Mar 2014

It won't be unfair to call cement a commodity. However, try telling this to investors in India. The word commodity used to describe cement may not quite register on them. Simply because some of the biggest cement companies in India have been anything but commodity stocks over the past few years. Their balance sheets are not only cash rich but they have also been able to exercise a fair degree of control over cement prices across India. And one of the key factors driving this change is the consolidation in the industry in recent years. Cement manufacturing has become more concentrated with only a handful of players commanding a bulk of country's capacity. Thus, not only has pricing discipline improved but companies have also benefited from operational efficiencies arising out of size.

And if this wasn't enough of a concentration, we now have international giants Lafarge and Holcim both joining hands. Of course, with Holcim owning both ACC and Gujarat Ambuja and with Lafarge also having a large presence in India, another round of consolidation is almost inevitable. This will no doubt be very good news for the companies involved as there will be further benefits to exploit. We just hope that the customer is not short changed and the Competition Commission of India has its eyes set firmly on the possible developments in this space.

Indians may be hoping for a reform oriented government. But make no mistake! The Chinese are ahead of the curve on this one too. The authorities in China have already set the ball rolling when it comes to economy oriented reforms. There are many of them such as freeing up bank interest rates or dismantling state monopolies that will cause short-term pain. However, the leaders recognize that such reforms will prove worthy over the long-term. Hence they are taking one step at a time and tackling the easier ones first. As per Moneynews, the

Chinese economy is expected to grow by 7.3% this year, the slowest in 24 years. Hence, the Chinese policymakers are keen to preserve financial and social stability. So, while the difficult reforms will have to wait, the easier ones may see the light of the day. Having said freeing up the Yuan and opening up of China's capital account are still years away. We believe that Indian policy makers take some lessons from their Chinese counterparts to make economic reforms a sustainable effort.

That India has the potential to become a manufacturing powerhouse cannot be denied. This is due to the vast population of the country. But despite this, India Inc. seems to have been focused on capital intensive industries rather than labour intensive ones. And one cannot entirely blame them given that India's labour laws are very complex and restrictive, adjectives that the World Bank has used.

But it seems that there are some hopes of things changing due to the 'Modi' factor. With high expectations of Mr. Modi becoming India's next Prime Minster, there are hopes of there being a major revamp in the Indian labour laws. To accompany this, the expectations are of cheap land, steady power supplies and better infrastructure as well. Nevertheless, being a sensitive topic, the revamp in Indian labour laws will be a challenge for the BJP. Having said that, considering India's need to employ 12 m people - as reported by First Biz - to absorb the growing workforce and urban migrants, this definitely cannot be an area that should be ignored; and in fact, should be high on the agenda.

US payroll and unemployment data is probably the most awaited event in the US as it gives an indication as to where the economy is headed. And the latest data appears to be optimistic. However, a deeper analysis reveals what is camouflaged under those optimistic revival numbers. The US unemployment rate fell to a five and half year low of 6.3% recently. And the job growth increased at its fastest pace in the last two years. By any means these numbers are sanguine and reveal that the US economy is showing signs of revival.

However, analyzing the reason behind the fall in unemployment rate reveals a completely different picture. It may be noted that a part of the decline in unemployment rate is because many people have left the labor force! Labor force constitutes people who are actively seeking out job. So, obviously if people leave the labor force, unemployment rate shall fall. And this is precisely what has happened in the US.

This situation again highlights the issues that arise when dealing with data interpretation. Any analysis should remove all the biases and adjust data skew so as to make the comparison meaningful. Else there are chances that the final conclusion could be wrong as was the case here.

In the meanwhile, the Indian stock markets pared some gains but continued to trade higher. At the time of writing, the benchmark BSE-Sensex was up by 92 points (+0.4%). Barring IT and metal, all the sectoral indices were trading strong. oil and gas and FMCG were the biggest gainers. Asian markets are trading mixed with Taiwan being the biggest gainer and Hong Kong leading among losers. European markets opened the day on a negative note.

04:56  Today's investing mantra
"Do not take yearly results too seriously. Instead, focus on four or five-year averages." - Warren Buffett
Today's Premium Edition
How your home can take care of your retirement needs..
How reverse mortgage can help you fund your retirement needs...
Read On...Get Access
Recent Articles:
This Company Beat the Business World's 'Three Killer Cs'
August 16, 2017
And what it has in common with beating the stock market too.
Let's Hope This Correction Continues
August 14, 2017
Last week's correction is making a number of Super Investor stocks look a lot more attractive...
Insider at It Again. This Time Stealing from Buffett and Berkshire
August 12, 2017
What is Equitymaster Insider Ankit Shah stealing from Berkshire's success?
The '26% Secret' to Buffett's First Billion
August 11, 2017
This is what led value investors Mohnish Pabrai and Warren Buffett to their first million and billion.

Equitymaster requests your view! Post a comment on "Will this move stop MNCs milking their subsidiaries?". Click here!

3 Responses to "Will this move stop MNCs milking their subsidiaries?"

V. Jagannathan

May 14, 2014

Yes. I fully agree with you. In other countries alert shareholders would have raised and questioned on this point. We have only passive shareholders.This would have been taken up with regulators also.


Sanjay Thakkar

May 7, 2014

Royalty Cap should be Re-introduced & Implemented Strictly; and also the Deal like Suzuki with Maruti Suzuki should BANNED as this Explicitly Evident that Suzuki is Cannabalizing the Indian Entity and taking the Indian Investors For a Ride !!!


O B Dias

May 7, 2014

Yes, most definitely so.

Don't we eat more chocolates than are good for us, when plenty of chocolates are available all over the house?

Bonnie Dias

Equitymaster requests your view! Post a comment on "Will this move stop MNCs milking their subsidiaries?". Click here!


Copyright © Equitymaster Agora Research Private Limited. All rights reserved.

Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement

Disclosure & Disclaimer: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. The Author does not hold any shares in the company/ies discussed in this document. Equitymaster may hold shares in the company/ies discussed in this document under any of its other services.

This document is confidential and is supplied to you for information purposes only. It should not (directly or indirectly) be reproduced, further distributed to any person or published, in whole or in part, for any purpose whatsoever, without the consent of Equitymaster.

This document is not directed to, or intended for display, downloading, printing, reproducing or for distribution to or use by, any person or entity, who is a citizen or resident or located in any locality, state, country or other jurisdiction, where such distribution, publication, reproduction, availability or use would be contrary to law or regulation or what would subject Equitymaster or its affiliates to any registration or licensing requirement within such jurisdiction. If this document is sent or has reached any individual in such country, especially, USA, the same may be ignored.

This document does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Our research recommendations are general in nature and available electronically to all kind of subscribers irrespective of subscribers' investment objectives and financial situation/risk profile. Before acting on any recommendation in this document, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek professional advice. The price and value of the securities referred to in this material and the income from them may go down as well as up, and subscribers may realize losses on any investments. Past performance is not a guide for future performance, future returns are not guaranteed and a loss of original capital may occur. Information herein is believed to be reliable but Equitymaster and its affiliates do not warrant its completeness or accuracy. The views/opinions expressed are our current opinions as of the date appearing in the material and may be subject to change from time to time without notice. This document should not be construed as an offer to sell or solicitation of an offer to buy any security or asset in any jurisdiction. Equitymaster and its affiliates, its directors, analyst and employees will not be responsible for any loss or liability incurred to any person as a consequence of his or any other person on his behalf taking any decisions based on this document.

As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407