Hero gets Honda stake at big discount

CHENNAI: It's a sweetheart deal all right but the Street feels it's just too sweet to be true. The $4-billion Hero Group announced on Tuesday that it was acquiring Japanese partner Honda Motor Co's 26% stake in JV, Hero Honda, at Rs 739.97 per share, which translates into a deal size of around $851 million (Rs 3,841 crore).

Analysts greeted the news with skepticism wondering how the Indian promoters managed a heads-I-win, tails-I-win deal under which Honda sells at less than half the current share price while the PE firms finance the deal at close to market price. In a relatively good market, the Hero Honda stock on the BSE lost 0.8% to close at 1,518 on Tuesday.

The Brij Mohan Lall Munjal-led Hero group said in a statement that it has signed "definitive agreements" with private equity firms BC India Private Investors II, an affiliate of Bain Capital LLC, and Lathe Investment Private Limited, a wholly owned subsidiary of Government of Singapore Investment Corporation (Ventures). The PE firms will finance Hero Investments' (HIPL) acquisition of Honda Motor's stake in the JV. Elaborating on the deal, an analyst with a Mumbai-based broking firm said that there could be corporate governance issues in this deal. "That's because we are simply not privy to what the arrangements are between Hero and Honda". "Hero Honda's stock has had a sharper southward movement since December when this deal was announced compared to Bajaj Auto or TVS which shows the market has discounted this deal," says Rakesh Batra, industry leader-auto practice at Ernst & Young. While analysts have been speculating on whether Honda will demand a higher royalty or model fee to make up for this loss, Hero Honda maintains there's nothing underhand about a good deal.

Speaking to TOI, Hero Honda CFO Ravi Sud said: "We have categorically said that for the next three years we will use technology from Honda and the royalty figure will be an average of around 2.8-2.9% of net sales. That's pretty much where it is now -it was 2.7% in 2009-10 and 2.8% in 2010-11. It won't increase." Sud says the new models that Hero Honda will source from its former Japanese partner will attract both a royalty and a one-time model fee paid for development of a brand new model. "That's the way technology payments are usually structured where normally payment can vary between $4-5 million for a brand new model to $250,000 for modified variants." Post split, the royalty that Hero will cough up for Honda will not exceed 5%, the highest rate that the company has ever paid for Honda's technology, he added.


The pricing apart, auto experts are also talking about Hero's life after Honda. "It is a good deal for the Hero Group happening at half the market price of Hero Honda. It will be important for Hero to develop its own technology and become self sufficient going forward. Managing the transition is very important for both parties," says E&Y's Batra. Hero, he says, is a strong brand in its own right so if the company manages the transition-related uncertainty well, the impact should not be too much. "Hero Honda's biggest advantage is cost and if they can maintain that, they're no a good wicket." Besides, Hero also gets to enter the export market.


The company is already working on a re-branding strategy and is looking to get rid of the Honda tag earlier than the June 2014 deadline. But the company, Sud says, plans to launch 7-8 products a year, of which 3-4 will be new products and the rest modified variants. Since Honda and Hero have decided to part ways, "the earlier we drop the Honda brand name the better for us," he says. That apart, Hero Honda also has the option of driving the strong products in its portfolio as brands. "Like the Pulsar is a brand, Hero Honda's biggest sellers Splendor and Passion are brands," says a rival auto CEO. "How does it matter whether the corporate brand is Honda or Hero. The products sell on their own brand strength." Sud agrees that's an option the company has. Apart from the CB and CD brands which are owned by Honda, the rest of the product "pet names" are owned by Hero."


However, he agrees, that the company will have to rebrand itself not only for products that don't have strong individual brand recall but also for the new products Hero Honda will launch. The company knows former partner Honda's 100% subsidiary HMSI is planning a low-cost 100 cc product to attack its bread and butter market. "The motorcycle business is not only about technology and products, it's also about distribution, spares, customer interface and on all those we are very strong," says Sud.

Hero Honda's confidence is understandable. No one thinks the split from Honda will hurt in the short-term. But as a rival auto firm CEO points out, "this is a long-term game".