Asia royalty rises provoke investor fury; Dramatic hikes viewed by many as worrying trend to remove funds from emerging markets

April 2, 2013 6:23 pm

Inside Business: Asia royalty rises provoke investor fury

Dramatic hikes viewed by many as worrying trend to remove funds from emerging markets

By Jeremy Grant

If you are a fund manager investing inAsia’s emerging markets, one way to gain exposure is by holding shares in a multinational company’s locally listed subsidiary.

Want some concrete action in India? Buy shares in Ambuja Cements, a Mumbai-listed company controlled by Holcim, the Swiss cement maker.

How about shampoo in Indonesia? Simple. Buy a chunk of Unilever Indonesia, which has been listed on the Jakarta stock exchange since 1981.

For years, this arrangement worked well for fund groups such as Aberdeen Asset Management and Arisaig Partners, a Singapore-based boutique investor with a focus on the consumer companies that are such a big part of the emerging market growth story. Unilever Indonesia made sales of $2.6bn last year from selling Dove soap, Surf detergent and Wall’s ice cream across the country’s vast archipelago. Its market capitalisation makes it one of Asia’s biggest companies. It is also highly profitable. Net profit has risen every year bar one since 1999, hitting $432m in 2011 – the last year for which figures are available. Dividends have rolled in nicely.

However, in the past few months, this neat way of investing in emerging markets has been upset. A chorus of funds is furious that Unilever and Holcim, as parent companies, have recently decided to take much bigger royalty payments from their Indonesian subsidiaries. Similar noises have been made in India where the two companies are also seeking higher royalty payments. Royalties are levied by multinationals on local units to recoup the cost of providing “shared services” – research and development, marketing, branding and so forth. But changes to royalties are not unusual and are perfectly legal.Last month, for example, Swiss food group Nestlé said the royalty levied on its Indian business would increase by 0.2 per cent of sales a year for the next five years, starting in 2014.

Holcim, which owns 80.65 per cent of its Indonesian unit, says its new royalty agreement “reflects the value of services provided more appropriately”

Even so, investors appear unnerved by the more dramatic hikes in royalties by Unilever, which is levying a tiered rate capped at 8 per cent of sales, up from 3.5 per cent, and by Holcim, which will levy 5 per cent of sales, up from 1.7 per cent.

Unilever says its royalty regime in Indonesia was last reviewed in the 1970s and the rise is about “cost recovery – nothing more, nothing less”.

It also points out – in case anyone thought this was another case of shifting profits from one jurisdiction to another to avoid tax – that the royalties are subjected to the same level of tax at home as they would be in Indonesia.

Holcim, which owns 80.65 per cent of its Indonesian unit, says its new royalty agreement “reflects the value of services provided more appropriately”.

In other words: minority shareholders should stop moaning.

While these shareholders cannot expect a say in every business decision made by a controlling parent, the scale of royalty increases still suggests a worrying new development. Some investors fear it could be the start of a thinly disguised attempt to remove funds from increasingly profitable emerging market divisions, while European markets remain anaemic.

In addition, the increasing complexity of multinationals’ shared services arrangements makes it harder for minorities to work out which part of a company is charging what for which service.

According to the parent companies, local third-party assessors were used to judge whether higher royalty payments were reasonable. But fund managers have struggled to find information about this.

CLSA, the Hong Kong broker, thinks that royalty rises could spread to Malaysia and the Philippines

In India, the government is set to pass a law requiring approval from three-quarters of minority shareholders for such “related party transactions”. Some local boards have even resisted attempts to impose big royalty payment rises.

But in Southeast Asia, where a growing middle class and domestic demand has turned the region into a honeypot for multinationals, the same cannot be said.

CLSA, the Hong Kong broker, thinks that royalty rises could spread to Malaysia and the Philippines. It warns that the “premium” valuation placed on multinationals’ businesses in the region, because they are deemed to have better corporate governance, could come under pressure if boards continue to and approve such royalty rises.

That is one lever that minorities can pull. But it would be better for authorities in the region to wake up to what is happening – and ask whether this trend is really welcome.

Jeremy Grant is the Financial Times’ Asia regional corporate correspondent

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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