Activist investor Dan Loeb of Third Point announced a new stake in Suzuki Motor per his 2Q investor letter.
Now, Loeb isn’t the first activist involved here. Recall that back in June we covered the Japan Sohn Conference. At the time, Balydasny Asset Management pitched buying Suzuki. He called it a misunderstood play and one that needs to be unwound – where Volkswagen owns 20% of the company and Suzuki owns 1.5% Volkswagen. Suzuki also owns Maruti Suzuki India, which is a pure play on the growing car market in India.
But back to Loeb’s thesis – here’s his thoughts from the letter.
Suzuki Motor Company We are invested in the Japanese auto manufacturer Suzuki. The company’s greatest asset is its low-cost manufacturing process for vehicles for the emerging market consumer which relies on high commonality of parts to drive continuous cost reductions.
An overhang from a protracted litigation with Volkswagen has resulted in significant balance sheet inefficiency and created an attractively valued investment opportunity in this auto OEM with a dominant position in the Indian market and exposure to India’s rapidly growing middle class. Most of Suzuki’s intrinsic value originates from the company’s 56% stake in its consolidated subsidiary, Maruti Suzuki, which is listed in India with a $20 billion market capitalization. Maruti has an unmatched network of dealerships and service shops in India, providing low-cost and more reliable servicing to customers, and a sustainable scale-based advantage over its competitors. Suzuki also receives a 5.5% royalty stream on all Maruti sales. This royalty stream is often overlooked by investors.
Suzuki does not even mention it in its regulatory filings and instead groups it into its Japanese business. We view this misunderstood piece of the business as a $500 million (and growing) annual cash dividend that deserves a very high multiple given both its recurring nature and the substantial future revenue growth expected from Maruti. By our estimates, Suzuki’s Indian assets – the publicly-traded Maruti stake, the royalty stream, and Suzuki’s 100%-owned Gujarat plant (which will produce one million vehicles annually and become an emerging markets export hub over time) – are worth more than the parent company’s entire market capitalization. This suggests that no value is being ascribed to Suzuki’s other assets: its Japanese auto business, with over $500 million in annual EBIT; its cyclically depressed ASEAN operations; its European business; a $5 billion net cash position; and $2.75 billion worth of listed equity stakes in Volkswagen and a number of large Japanese companies.
To make this proposition even more appealing, we expect meaningful additional value appreciation for Suzuki’s Indian assets. The Indian automotive market remains one of the last global opportunities for open-ended secular growth with less than 2% of the population owning passenger cars. After an unusually long downturn from 2011 – 2014, the nation’s automotive cycle has turned, supported by low oil prices, accommodative monetary policy, and the reform and infrastructure investment agenda of Narenda Modi’s government.
Maruti’s 45% domestic market share is on the rise thanks to an impressive line-up of new models, an expanded diesel and automatic transmission product portfolio, and the company’s ongoing entry into higher-end segments of the market, such as sedans and SUV’s. Our on-the-ground diligence leads us to believe that Maruti is a much higher quality business than a traditional auto OEM because of the Indian populace’s reliance on OEM-run networks for repairs and service. Maruti’s servicing and dealer networks are more than twice as dense as those of its closest competitor with the company the sole provider in many rural areas.
This scale allows Maruti to offer the most inexpensive servicing, dramatically lowering the total cost of ownership and preventing new entrants from gaining market share. Maruti’s margins have significant room to expand on the back of falling discounts, higher ASPs, raw materials benefits, rising capacity utilization and a depreciating yen, supporting an annual EPS growth of over 30% for the next several years. Unfortunately, while Maruti’s equity value has appreciated 3.5x since 2013, the parent company’s shareholders have been much more modestly rewarded due to a nearly five year arbitration with Volkswagen that has apparently paralyzed the company, leaving it unable or unwilling to fix its inefficient balance sheet. Suzuki is seeking to terminate a failed 2009 cooperation agreement with Volkswagen and buy back Volkswagen’s 20% stake which was previously owned by General Motors.
Volkswagen has vehemently defended its right of ownership of the stake and we believe it wants to buy all of Suzuki. Should Suzuki be successful in the arbitration, the company’s significant net cash position and the potential unwinding of its sizeable cross shareholdings provide ample liquidity for the repurchase as well as for the ongoing investment needs of the business. In contrast, if Volkswagen retains its investment, we expect Suzuki management to find a way to work together with its minority shareholders and Volkswagen to maximize shareholder value. With a resolution to the arbitration finally on the horizon and the improving cyclical tailwinds to its dominant Indian business in place, Suzuki seems undervalued today.
