Hero Honda's various challenges

The B.M. Munjal-led Hero Group will buy out the 26% stake held by Honda Motor Co. Ltd in Hero Honda Motors Ltd at Rs739.97 per share—a massive 50% discount to the market price. This is also considerably lower than the price of Rs1,200 that was anticipated by some analysts. Of course, the deal doesn’t have any bearing on the shares of the group flagship Hero Honda Motors, since the shares are being bought by a private company owned by the promoter group.

Hero Investments Pvt. Ltd, which owns about 17.3% of Hero Honda’s shares, will buy out the Honda stake. This will give the Hero Group a 52% stake in the company.

While this is a private deal between the two largest shareholders, there were concerns that the deal could have implications for Hero Honda as well. Specifically, there were concerns that there would be a trade-off in terms of higher royalty, or a one-time technology transfer fee from Hero Honda, which would be detrimental to the interest of the minority shareholder. But this concern has been addressed by the Hero Group, stating that the royalty, including that on new products, will remain at around 3% until June 2014.

The Hero Group has also announced that it would place the shares with two private equity (PE) firms. If this stake sale happens at a price that’s considerably lower than the market price, this could affect Hero Honda’s share price.

“We expect that the PE investors will agree to a lock-in period (anywhere between three and five years) and as a protection for the lock-in, the transfer of shares may be at price significantly lower than the current market price,” said a report by Emkay Global Financial Services Ltd.

Meanwhile, in the last few quarters, the company has lost ground; its market share has dropped from 57% to 52%, with its nearest competitor Bajaj Auto Ltd gaining at its expense.

Another challenge is to upgrade technology and stand on its own feet on product development in the absence of its 25-year-old technology partner, Honda. While the company fights these battles, it also has to contend with higher raw material costs.

At the current market price of Rs1,518, Hero Honda trades at about 14 times estimated fiscal 2012 earnings, in line with expected growth rate in sales for the industry over the next two years.