No limits on royalty may be bad news for shareholders

No limits on royalty may be bad news for shareholders
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First Published: Mon, Nov 09 2009. 06 20 AM IST

Updated: Tue, Dec 15 2009. 06 20 PM IST
Liberal economic policies give entrepreneurs more freedom, but can have unintended consequences for others. Take the government’s move to allow companies the freedom to pay royalties for foreign technology or for using trademarks and brands. It is a sensible step. But any sharp increase in royalty outflows of listed multinational companies (MNCs) will lower their profit growth and may even affect their market valuation.
Typically, companies that sell international brands— chiefly consumer goods companies—in India will pay royalties for trademarks. Yet others, such as automobile or industrial product firms, will also pay for technology transfer. Some industries may pay for both. The existing policy allowed companies to pay for technology transfer a fee of $2 million (Rs9.4 crore), and 5% royalty on domestic sales and 8% on exports. Anything more had to be approved by the government. Companies were also allowed to pay 1% of domestic sales and 2% of exports for using foreign brands or trademarks.
Graphics: Yogesh Kumar / Mint
Hindustan Unilever Ltd paid Rs116 crore to its parent company during fiscal 2009 (15-month period), or about 0.6% of its domestic sales of consumer goods, as royalty. Maruti Suzuki India Ltd paid out Rs677 crore, or 3.3% of sales. The impact on profit is, of course, even higher, which should be a cause of concern for shareholders.
A question that arises is: Should foreign companies charge Indian companies royalty at all? It will evoke very strong responses from minority shareholders. After all, the foreign parent is the ultimate owner—even if it does not own 100%. The parent also gets dividend income and it also accounts for its share of profits. And most foreign products are adapted for local markets by the Indian company, which also invests significant sums in product and market development. They need not charge royalty to benefit from the subsidiary’s performance.
But MNCs see it differently. Many of them are listed because of a government diktat to divest. They rarely raise domestic equity, resorting to debt or even capital grants from the parent company when needed. Whether the market capitalization of their Indian subsidiaries goes up or down makes no difference.
While they get a share of profits and dividends in the subsidiary, the royalty is all theirs to keep. Take an example of a 51% foreign-owned company, with a profit of Rs100, dividend of Rs20 and royalty of Rs10. The foreign company can account for Rs51 as its share of profit, and its income is Rs81, after adding dividend and royalty. If the royalty is doubled to Rs20, lowering its profit, its total income will still be higher at Rs86. The losers will be the residual shareholders. Watch out for a bump in “other expenditure” in the coming quarters—higher royalties could be the reason.
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First Published: Mon, Nov 09 2009. 06 20 AM IST