Demerger of Bajaj Auto

Mr. Bajaj announced in New Delhi that there was a proposal for demerging
Bajaj Auto into two companies, by spinning off a part of the investment
portfolio. 

While one will be a pure automobile manufacturer, the other will be

an investment company. 

The main objective of such a move is to prop up the depressed P-E (price
to earnings) multiple and increasing share-holder value. 

For this, a third of the Rs 2729 crores cash surplus may be forked out into a
separate investment company. 

The return on capital employed (ROCE) in fiscal year ended 2003 for Bajaj
Auto was around 20 per cent, compared to 99.5 per cent of its rival, Hero
Honda. 

Obviously, as pointed out by some of the analysts, this could be improved

upon for Bajaj, and theoretically if some funds are returned to shareholders,
ROCE will improve and so would valuations. 

In 2000-01, Bajaj Auto’s operating margin declined to 9.8 per cent, but
powered by a growth in motorcycles bounced back to 16.8 per cent next
fiscal, and closed fiscal year 2002-03 at 19 per cent. 

Higher dividends or a share buy-back are the possible line of action

recommended in this scenario. Rahul Bajaj feels that declaring a huge
dividend pay-out would be a ‘‘stupid thing to do’’.

The other options such as a buy-back of shares would dilute the company’s
equity, so is not a good idea. 
A majority of the investments (75 per cent) — Rs 2173.5 crores are fixed
income investments, while the balance, Rs 735 crores are invested in equity
shares and equity share based mutual funds. 

Of the fixed income investments, Rs 865 crores (about 30 per cent of total)

investments are locked in government securities and bank deposits, and Rs
869 crores in debentures and bonds. 

About 6 per cent —Rs 173.9 crores — are invested in mutual funds including
UTI, Rs 165 crores (5.7 per cent) in inter-corporate deposits and a
minuscule Rs 14 crores has been loan to Bajaj Auto Holdings Ltd. 

The company earned a net non-operating income of Rs 117.6 crores for FY

2003, with interest on debentures and bonds giving it maximum returns of
Rs 41 crores, and Rs 40.5 crores on government securities. 

Its returns on profit on sale of investments earned Rs 21 crores during the

last fiscal and Rs 23.9 crores through interest on ICDs and other loans. 
Positive Buzz

The demerger proposal caused a mixed response from the financial

fraternity. 

Bajaj Auto generated an income of Rs 1,450 crores just from investments in

2002-03, which is considerably higher than the assets of the largest equity
mutual fund scheme, Franklin India Blue-chip.

The possible demerger of Bajaj Auto into two separate entities created a
positive buzz in the analyst community. 

For the shareholders, they are in a win-win situation. 

However the auto company stands to benefit as the return on capital factor
improves for its auto business in particular in case of a demerger. 

Industry observers feel that the proposed demerger would not have any
effect on the company’s manufacturing activities. 

The businesses are generating cash, so this would not be a problem. So,
unless something seriously goes wrong it seems to be a “win-win” situation. 
Competitive Realities

Equity analysts have never found the company’s cash surplus attractive. Mr.
Bajaj wanted to keep a war chest for fighting out the cut-throat competition
in the motorcycle market, with its scooter business being in the doldrums. 

In fact, it will need some funds to work on the scooter project to take on the
fairly new entrant Honda Motorcycle and Scooter India’s products which
have overtaken the staid ‘Hamara Bajaj’ metal scooters”. “

From a shareholders’ point of view, things may remain pretty much the
same with the shareholding pattern of both the companies remaining the
same, though it may give some the option of exiting from the company. 

But for some investors, it could give them a chance to invest the company’s
stock without its huge baggage of debt investments, a feeling that has been
expressed by a section of the investing community. 

It seems that there is a mixed reaction to the demerger scheme, with a lot
of finer details still to be worked out.