ACC-Ambuja royalty pangs
Vivek Maheshwari & Bhavesh Pravin Shah of CLSA look into implications.
LafargeHolcim levied a 1 per cent technical know-how fee in 2013 after independent directors objected to a 2 per cent payout. The agreement was for five years, with 1 per cent rate for 2013-14 and a review thereafter, but the rate was unchanged until 2017. ACC and Ambuja in 2013 also took shareholder approval on the premise of good corporate governance but despite >80 per cent of minority votes against the proposal, fees were levied as the parent voted in favour. Despite the agreement expiring in December 2017, the parent has not yet renewed the agreement, a surprise. A proposal to raise fees could be a big negative and minority approval would not be required, although past experience suggests the group may still seek their approval. Final outcome at a rate other than 1 per cent would impact ACC/Ambuja's EPS (by 5-8 per cent for every 1 per cent change in fees).
Parent proposed fee in India
- In 2012, parent LafargeHolcim (erstwhile Holcim) proposed a technical know-how fee of 2 per cent on revenues from ACC and Ambuja.
- There were increases in other markets too. For example, royalty rates were revised sharply from 1.7 per cent in 2012 to 4 per cent in 2013 and 5 per cent from 2014 in Indonesia.
- Unlike Indonesia, India had lower outgo because the brands were local.
Which became 1% during 2013-17
Ambuja's independent directors however took a strong opposition to the fees, which was later restricted to 1 per cent of net revenues for ACC and Ambuja until 2014. The proposal did not require approval from shareholders, but ACC and Ambuja decided to obtain the same on the premise of good corporate governance. Despite minority rejecting this (>80 per cent vote against), a 1 per cent fee was still levied. There was an option to raise fees from 2015, but it was unchanged at 1 per cent until 2017.
No renewal in agreement yet
Despite the expiry of the original agreement on 31-Dec-17, the parent has not yet proposed a new agreement. This creates an uncertainty on the quantum as fees (incl royalty) are at a higher rate in most other countries, in our understanding. While regulators have tightened rules to approve related party transactions which require approval from majority of minority shareholders, à there is a possibility of circumventing minority approval, as the outflow is within the permissible threshold which may be approved by the Board.
Is it fair to levy royalty?
Based on our interactions with cement industry participants, levying royalty purely on the grounds of technical assistance is difficult to justify. This is because technology is hardly a differentiator, as Indian producers rely on similar vendors for equipment as well as technology (FLSmidth, KHD, etc). Bulk of capacities even today was created before parent gained control of ACC and Ambuja. In addition, despite parent LafargeHolcim's support, both ACC and Ambuja have far lower unit margins, and hence, there does not seem to be any tangible benefit. Although not an exact measure of fundamental performance, we note that both ACC and Ambuja stocks have consistently underperformed most peers (UltraTech, Shree, Ramco and Dalmia) in the past decade.
Implications for ACC and Ambuja
A potential raise in royalty by the parent would be a negative for both ACC and Ambuja, while discontinuation in the same would be a positive. We note that every 1 per cent change in royalty impacts CY18-19CL earnings for ACC and Ambuja by 5-8 per cent. The group is already in the midst of seeking minority approval for clinker and cement swaps - an update on the know-how fees would be timely for minority, in case there is a plan to tinker with the rate, in our view.