Self-Serving Motives – Mockery of Corporate Governance?

Self-Serving Motives – Mockery of Corporate Governance?
Summary

  • The company kept very low dividend payout ratio over the years, even when it had no re-investment/acquisition opportunities. It distributed entire cash on its balance sheet as a special dividend when the parent’s tax rate reduced.
  • The company provides significantly higher credit period to the parent irrespective of the impact on its own working capital.
  • Generated negative IRR on a contract manufacturing plant started exclusively for a fellow subsidiary.

Often in the case of locally operating subsidiaries backed by a global parent, governance and capital allocation decisions are driven by the global parent. Minority shareholders are deprived of the true economic return potential of the business and are often left with no choice but to surrender to the whims and fancies of the global parent.

Such has been the situation in the case of an air compressor manufacturing company.

In this case, we found that the company had been maintaining a large cash balance on its balance sheet. Neither was there any planned capex nor was it looking for an acquisition. Yet, the company kept its dividend payout ratio very low, resulting in poor asset turnover asset turns and a decline in returns over the years.

The company declared a special dividend of Rs. 202 per share in 2018, which was done at the whims of the MNC parent to take advantage of reduced tax rates in the US. The opportunity cost was borne by minority shareholders over these years.

Particulars20052006200720082009201020112012201320142015201620172018
Cash as a % of total assets40.7%42.8%40.6%62.3%59.5%59.7%55.8%47.7%46.4%38.1%36.9%41.0%56.1%59.9%
Cash as a % of Net Worth52.9%60.1%58.3%73.5%68.9%69.7%65.4%55.4%54.4%45.6%43.6%47.8%63.4%68.3%

 

Particulars

2005

200620072008200920102011201220132014201520162017

2018

Dividend per share

6.00

6.006.006.006.006.006.006.006.006.006.006.006.00

6.00

Dividend payout ratio

57.3%

49.5%36.1%29.9%27.7%37.9%27.3%22.9%24.3%28.2%31.6%29.7%27.0%

22.6%

 

Particulars

2005

200620072008200920102011201220132014201520162017

2018

Asset Turnover ratio

0.70.80.90.50.40.40.50.60.60.50.60.50.5

0.5

Asset Turnover ratio (Excl Cash)

 1.2

1.31.51.31.11.01.11.21.10.80.90.91.2

1.2

 

Particulars

2005

200620072008200920102011201220132014201520162017

2018

RONW

8.1%

9.1%11.8%9.0%9.2%6.5%8.5%10.2%9.0%7.3%6.3%6.4%6.6%

7.4%

Core RONW

15.3%

18.9%23.9%21.6%18.8%16.4%18.0%16.2%13.5%8.7%7.0%7.9%12.6%

16.3%

Difference

-7.2%

-9.8%-12.1%-12.6%-9.7%-9.9%-9.6%-6.0%-4.6%-1.3%-0.8%-1.5%-6.0%

-8.9%

It is very common for an MNC to source goods from subsidiaries domiciled in a low-cost manufacturing base. Such was the case with this company. The global parent purchases goods from this subsidiary (avg. 15% of revenue). However, the credit period offered to the parent was significantly higher than that offered to others, thus impacting the company’s working capital cycle.

Particulars

2005

200620072008200920102011201220132014201520162017

2018

Receivable Days(Total)

134

111 85 111 112 9874 83 89 111 100 80 54

66

Receivable Days(Related Parties)

191

182 189 150 157 185 141 132 126 173 130 100 70

104

Receivable Days(From others)

115

94 64 99 100 78 55 68 77 88 88 73 50

58

The company also entered into a new segment to manufacture goods exclusively for a fellow subsidiary, for which, it incurred significant capex to start a new plant. A few years later, the company had to discontinue the business citing lack of orders from the fellow subsidiary.

INR in millions

Particulars

2010

201120122013201420152016

2017

Total Assets

87

8281601,4451,3541,012

11

Capex

(516)(265)1(781)(441)90342

1,000

Operating profit (assumed realised in cash)

3(4)(78)(183)(146)4123

Net Cash flow

(513)(269)(77)(964)(587)131 366

1,000

 

IRR of Chennai operations

-11%

We tried calculating IRR of the plant and were shocked to find that the company generated an IRR of -11% on the business started exclusively for a fellow subsidiary. Also during the years when the plant was operating, the company reported a large portion of assets & expenditure under ‘unallocated corporate assets’ & ‘unallocated expenditure’ heads in segment reporting. These ‘unallocated assets’ and ‘unallocated expenditures’ in the segment report reduced significantly on the closure of the plant. This implies that the company could have been reporting higher than actual margins and ROA on this plant. Thus, as a result of the closure of this plant, the company’s margins and returns improved.

Albeit known for high-standard governance, transparency, and prudent capital allocation, investors must be wary of MNC companies that operate like some family businesses that only serve their own interests and deprive minority shareholders of true economic returns of the business.


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