Transparent royalty

On Tuesday, Hindustan Unilever Ltd’s (HUL) shares tanked after the company’s board approved a new technical collaboration and trademark licence agreement with its Anglo-Dutch parent for making higher royalty payments. The markets haven’t taken kindly to the announcement, fearing that the phased increase in royalty — from 1.4 per cent to 3.15 per cent of HUL’s turnover by 2017-18 — would eat into its margins and, ultimately, dividend payouts to shareholders. Unilever Plc, the argument goes, already owns 52.5 per cent in HUL and that itself gives it a lion’s share of the dividends payable. By milking the Indian subsidiary through other means, it would essentially reduce the earnings to which other shareholders also have a claim. An extension of this logic is that the promoter or parent firm shouldn’t have any claim on a company other than that by virtue of being the dominant shareholder.

What this contention ignores, though, is the value that a promoter may bring to a company, apart from supplying a major part of its equity capital. In this case, HUL claims it has benefited from “an increasing stream of new products and innovations, backed by technology and knowhow from Unilever”. These have helped boost HUL’s overall business performance, thereby generating more value for all its shareholders. It may have a point: A growing share of HUL’s revenues is, indeed, coming from brands owned by its parent and introduced relatively recently in India (Dove, Knorr or Axe), as opposed to old homegrown ones like Wheel, Fair & Lovely, and Kissan. One can cite similar justification for Tata Sons’ charging its group companies a 0.25 per cent royalty on their turnovers for using the Tata name. There is little doubt here, too, that the Tata brand equity has contributed something extra to the companies they wouldn’t have earned otherwise — for which the parent is entitled to an income beyond dividends accruing to a shareholder, albeit the largest.

Having said that, there are limits as to how much the above logic can be stretched. A Tata Sons, for instance, definitely has a better case for levying a brand fee from TCS or Tata Motors than, say, Britannia Industries and Bombay Dyeing — both brands by themselves — being forced to pay the same to Nowrosjee Wadia & Sons. Minority shareholders, therefore, have every right to know what ‘extra’ thing the promoter firm is bringing to the table, allowing it to earn revenues in addition to normal dividends. If it has to do with providing access to high-end innovation and promising greater genuine engagement with the listed Indian arm’s operations, shareholders may not look askance at higher royalty or technology fees. Ideally, such payments should be product-linked, rather than an omnibus royalty charged on all sales. That would mean paying for any new brand or technology, and fixing rates that can be reasonably determined at arm’s length. The problem comes only when there is no transparency.