Royalty Payment : Recent developments

On 26th July 2010, the Indian stock market woke up on a shock. Infact many investors are yet to realize that there has been a shock at all. But the reality is : there has been a shocker for all MNC Companies listed on Indian stock exchange.

For instance, erstwhile government company Maruti Suzuki's share opened at Rs.1302, hit a high of Rs.1317 and fell to a low of Rs.1126 before closing at Rs.1191. Simply speaking, the stock swung Rs.176 before closing at Rs.1191 at a lose of Rs.111 or 9% lower.

Many investors who are familiar with the roller coater ride of the stock prices, thought it was yet another ups and down. Some others 'thought' the results should have been bad. But the reality is different.

Infact, Maruti delivered a big negative surprise as Suzuki raised royalty
payments by 1.5% from 3.6% to 5.1%. And maruti is notalone.There are atleast 75 (32 of them to foreign entities) companies in BSE500 that pay royalties largely dominated by automotive, capital goods, pharmaceuticals and FMCG sectors.

So what if the royalty is paid? The end result is that an increase of 1.5%
in royalties could hurt margins substantially by 3.7% bps if implemented across
the board.

All of a sudden - why this surge in Royalty Payment ?
The answer is : Govt. allows companies to pay royalty under automatic route.
Upto 8% on exports, and 5% on domestic sales on foreign technology collaboration under the automatic route. Hence there is no need of Govt nod for making these transfer 'on account' of royalties.

Companies have since raised royalty payments to foreign collaborators: Maruti raised royalty payments to parent Suzuki Motor Corp by 150bps to 5.1% of sales this quarter.
15% of the BSE500 pays royalties, 32/500 to foreign equity holders: Royalty
payments are made by 75 companies in the BSE500 universe.

The new notification affects companies (32/500) that have technical collaborations with foreign (non-portfolio) equity-holders, and thus excludes domestic companies that have no restrictions on royalty payments. Whollyowned foreign subsidiaries have no restrictions either.

Sector/stock focus: Royalty payments are generally made by companies in the auto and capital goods (technical know-how and collaboration), pharma (marketing rights) and FMCG companies (brand equity).

Royalty payments vs. dividends: Royalties paid amounted to more than 40% of the total dividends declared in FY09. With little information on the actual value of the technical expertise, or by way of equity of certain brands, a potential rise in payments could raise questions on fair distribution of earnings to common stockholders.