The company said the Suzuki unit would sell cars to Maruti on a cost basis and Suzuki's profits would be derived only through the stake it holds in Maruti.
Also read: Maruti tanks: Did street wrongly read Suzuki move?
In an interview with CNBC-TV18's Sonia Shenoy, Maruti Chairman RC Bhargava discussed the rationale behind the move.
Below are excerpts of RC Bhargava's interview with Sonia Shenoy on CNBC-TV18.
Q: We heard you speaking on the analyst call about a lot of the issues that Suzuki or Maruti may have to face because of this particular deal. You did mention repeatedly that Suzuki is not going to get any kind of returns from this and it is going to be a zero-margin game for Suzuki. What is the real rationale behind why Suzuki went ahead with this if they are not going to get any kind of returns?
A: It is not as if Suzuki will not get returns, but as we have clarified Suzuki's returns will come through Maruti, because Suzuki owns 56 percent of Maruti and the profits, which could have been made in Gujarat would actually be made in Maruti.
We will buy the cars without any profit margins being taken by the Gujarat company. So that profit margin that could have been taken by the Gujarat unit would actually be realised by MSIL here.
So this means is instead of Suzuki getting 100 percent of the profit in Gujarat, it will get 56 percent of the profit and 44 percent of the remaining profit goes to the minority shareholders.
Q: Why such a complicated procedure? If Maruti is sitting on cash at this point in time why did Maruti not decide to invest directly into this plant and why did you have to go through this route?
A: Because this is a more profitable way of doing it. For Maruti, it is a much more profitable way because if I invest my money, in the initial few years I lose all return on that money because the plant takes at least three years before it starts functioning on a Greenfield site.
After that to get up to full capacity will take another year and a half or two. Only then will I possibly start making some profit out of it. So, for about five years I would be losing all my earnings on the investment.
In layman language, if somebody puts up a plant for me and the money for that plant comes without cost surely it is better for me to get a plant like that rather than to put my own money and lose my potential for earnings. I can earn from this guy's money.
Q: What is the exact return on capital (RoC) now that Maruti will be earning on this? What was it before?
A: It is too early to say how much the RoC will be. Today, we have been earning 17 percent average RoC. We are assuming that when the production from Gujarat comes into being, the RoC on the sale of Gujarat cars would not be less than 17 percent.
The difference here is that when we calculate the ROC in Maruti, while the profit will be what it would have been at 17 percent, there is actually no extra capital employed, because the total capital employed on which the returns have to be calculated is still the MSIL capital employed. The Gujarat capital employed does not count, because that is not my capital employed.
Q: So, you are saying that the RoC for a normal plant is somewhere on an average around 17 percent odd and the cost plus some amount of cash will be kept. So, in effect is it safe to say that the Gujarat plant will be able to have about 12 percent RoC?
A: Gujarat plant is at no RoC except for the period when they are doing capital investment roughly -- as I mentioned in the conference -- of the margins which are made from the sale of cars we have been using here.
I am talking about our experience in Maruti Suzuki -- about one-third for capex and two third goes into our reserves. That is how we have expanded up to 1.5 million cars capacity without any increase in borrowings or anything and we have in addition Rs 7500 crore of cash available.
What it means is while I have invested everything into this capital which is required to expand and this is almost like the Gujarat plant from nothing to 1.5 million. I have also generated Rs 7500 crore of cash.
Q: Will your margins get impacted at all because of this new deal and if they do not get impacted are you trying to say that you will continue to maintain margins at this 12.5-13 percent odd that you have done in this quarter?
A: As far as the sale margins are concerned, they will not get impacted at all, because the price of the car which Suzuki will make in Gujarat and the price at which we would have made the car in Gujarat -- I am talking about cost of production now -- there is no reason why it should be different.
It would be the same price, because essentially most of the things which will be done in Gujarat would be exactly what we were doing in the plant because Suzuki has no organisation other than Maruti here. It is our vendor department, which will get the whole vendor chain organised there.
You still have cash of around Rs 7500 crore what is Maruti going to do with that cash now that it won't be needed for the Gujarat plant?
A: At the moment we need to strengthen our marketing network substantially because from a domestic sale of 1 million we have to go up to a domestic sale of 2 million. It means doubling of our marketing infrastructure.
These days it is not easy to increase the marketing infrastructure, it is very difficult to get properties. Secondly R&D is going to take money anyway because more and more R&D is going to be done here. Then we have to keep seeing what other opportunities come because any other opportunities for investment are not precluded.
Q: Is Maruti looking at any kind of buyback?
A: Not at the moment. Why would we do a buyback, it does not make sense for us. If I do a buyback I will earn about 8.5 percent post-tax on this money.
Q: What would be the exact manufacturing margins that Suzuki will make on this?
A: Suzuki is not going to make a margin except to the extent required for capex.
Q: What would that be ballpark?
A: I cannot give you a number. Let me put it this way. Let us say the second plant which we will put up costs about Rs 3,000 crore and let us say the money for that has to come over a period of 2.5 years and on 250,000 cars if price of a car it is roughly 2.5 lakh each, then this would be about Rs 6,250 crore.
On that, roughly I could make 17 percent. It will be Rs 6,250 crore and about one sixth of that is profit, so I make about Rs 1,000 crore margin on the car itself, plus the depreciation which will come in over this period.
Q: Will there be any incremental sales royalty from this plant?
A: The royalties will not go up. They will remain exactly what they would have been if we were doing the plant. No extra royalty deposits to Suzuki plant.
No margin depreciation as well is what you are expecting?
A: That's correct. No.
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