IiAS seeks greater clarity on basis for royalty payouts

Royalty payments by multinational companies in India outpace their local subsidiaries’ performance, according to a new analysis by the proxy advisor Institutional Investor Advisory Services (IiAS). In FY16, aggregate royalty payments of 32 MNCs in the BSE 500 aggregated ₹7,100 crore, up from ₹6,300 crore in FY15. The trend of increasing royalty payouts without commensurate improvement in revenues and profits continues, according to IiAS.

In FY16, the paid out royalty aggregated approximately 21 per cent of the MNCs’ pre-royalty pre-tax profits, reporting a 13.2 per cent five-year CAGR. In contrast, pre-royalty pre-tax profits have grown at a CAGR of 9.6 per cent and net sales have grown by 8.7 per cent.

IiAS said companies must provide greater clarity regarding the basis on which royalty is paid out, given that it has outpaced both sales and profits in the past five years.

Royalty is a legitimate payment, but its value must be evidenced in sales growth or higher pricing power (and therefore higher margins). Revenue growth for MNCs has been higher than that of S&P BSE 200 companies over the past five years and at margins that are comparable as well. However, royalty payouts are high, resulting in average post-royalty margins being lower by over 7 per cent in recent times as compared to pre-royalty pre-tax margins.

According to the analysis, Gillette India, Procter & Gamble and Cummins India rank the highest because they have never paid royalties to parent companies that are higher than the dividends paid to domestic shareholders. At the other end of the spectrum are BASF India, Schneider Electric and United Spirits who have annually paid more in royalties and haven’t grown as well in income, profits or dividends.

Royalty payment is a compensation for brand and technical knowhow given to the subsidiary. However, such payments need to be pegged at an appropriate level, IiAS said. While the brands that these MNCs bring carry value — faster revenues at comparable margins to other S&P BSE 200 companies — the question remains on what is the appropriate level of royalty. An over 7 per cent lowering of margins driven by royalty alone is significant, and deprives investors of the EPS upside, of investing in a stronger business or brand proposition, the report concluded.

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