Honda's exit from Hero depends on returns

A private equity (PE)-assisted buyout of Honda Motor Co. Ltd’s stake in motorcycle maker Hero Honda Motors Ltd hinges on the Indian promoters, the Munjal family, being able to guarantee returns once the new entity comes into being, said three persons familiar with the discussions, who did not want to be identified.

This return is determined by the discount the Munjals are willing to offer on the current share price to the PE firms. Hero Honda’s shares closed at Rs. 1,953 apiece on the Bombay Stock Exchange on Tuesday.

Japanese auto maker Honda’s 26% stake in the 26-year-old joint venture (JV), Hero Honda, is worth approximately $2 billion (Rs. 9,120 crore) at the company’s current market cap of Rs. 38,853 crore.

The negotiations, which could extend over the next 6-12 months, are aimed at narrowing the gap with valuations by PE funds, said to include Warburg Pincus Llc, Kohlberg Kravis Roberts and Co. and the Carlyle Group, the same persons said.

A Hero Honda spokesperson refused to comment, as did the PE investors, while a Honda spokesperson said he was not authorized to comment on the issue.

“Hero (the Munjal family) has to guarantee returns somehow,” said a senior official with a top consultancy firm familiar with the development. “The expected purchase will go through only if the Munjal family is able to guarantee results once the new entity comes into being.”

The same person said Honda’s evaluation of its 26% share “is on the table and unlikely to change. The Japanese party is sitting pretty. The terms being debated are by Hero and the PEs”.

Meanwhile, the structure of the deal is still being finalized, an investment banker familiar with the development has said. “Private equity funds, the only ones who can provide the kind of liquidity required for the purchase”, will be paying $500 million each. The person did not want to be identified.

“The promoters will borrow a further $500 million for picking up the remaining shares, which will be used as collateral in case the new entity fails,” the investment banker said.

Another detail being discussed is a non-compete agreement between the Indian and Japanese parties, said a management consultant familiar with the deal.

Meanwhile, Hero Honda, which is the market leader in two-wheeler sales, is facing an erosion in market share. In the quarter ended September, this fell to 52.9% from 60.4% in the same period last year, according to data from the Society of Indian Automobile Manufacturers.

Analysts say the firm is losing ground to Bajaj Auto Ltd, which re-entered the 100cc motorcycle segment in July 2009. It has also not been able to keep pace with the spurt in demand because of capacity constraints. Bajaj Auto’s market share increased to 34% from 29% a year earlier.

Honda’s exit from Hero is not the first such separation between Japanese and Indian partners. In 2000, Suzuki Motor Corp. pulled out of its JV with TVS Motor Co., which bought the 25.97% stake of the Japanese company for Rs. 9 crore, much lower than an estimated Rs. 52.4 crore it was worth based on the prevailing share price.

Honda has previously exited its JV with the Firodias and sold its stake in Kinetic Honda to the Indian promoter. LML had problems with Piaggio, resulting in the Indian promoter buying out the stake held by the Italian partner. Yamaha bought out its Indian partner’s stake in the Escorts Yamaha JV.

Both Suzuki and Honda are present in the Indian two-wheeler market through fully owned subsidiaries.