Q+A: Why is India’s Hero Honda preparing to break up?

By Chang-Ran Kim and Tanmaya Nanda

TOKYO/MUMBAI (BestGrowthStock) – Japan’s Honda Motor (7267.T: ) and India’s Hero Group are in discussions to review the structure of their joint venture, Hero Honda Motors (HROH.BO: ), India’s top seller of motorcycles.

Speculation has swirled since summer that Honda, the world’s biggest motorcycle maker, would reduce its 26 percent stake in the 26-year-old venture to focus its energy on wholly owned unit Honda Motorcycle & Scooter India, set up in 1999.

Media reported on Thursday that Honda has “formally decided” to sell its stake in Hero Honda.

Earlier media reports have the Munjal family’s Hero Group acquiring Honda’s 26 percent stake for $1 billion to $1.2 billion, a discount of about half to their market value, while Hero would pay bigger royalties to Honda for its motorbike technology. The Hero Group also owns 26 percent of Hero Honda.

Hero Honda’s shares sank as much as 9 percent on Wednesday on news that a break-up agreement was imminent.

Both companies have declined to comment on the talks.

Below are some questions and answers on the reasons behind the discussions, and the likely aftermath.

WHY WOULD HONDA MOTOR WANT OUT OF HERO HONDA?

Companies prefer the freedom of making their own decisions, and having a partner often gets in the way.

When Hero Honda was formed in 1984, Indian regulations forbade foreign firms from owning 100 percent subsidiaries in the country. For Honda, entering India on its own without knowledge of the local market was risky anyway, and having Hero as a partner was valuable for the group’s marketing expertise.

By the time the government relaxed those regulations in the 1990s, Honda had accumulated enough know-how to set up a wholly owned unit, Honda Motorcycle & Scooter India (HMSI), in 1999.

HMSI started off selling scooters to differentiate itself from Hero Honda, which mainly sold 100 to 125cc motorcycles. But once HMSI launched a motorcycle model in 2004, it became evident that Honda would focus more of its efforts on developing the Honda-only brand. Speculation intensified then that was the beginning of the end of the Hero Honda venture.

With the Indian motorcycle market growing by double digits, Honda needs to be more nimble, making quicker decisions on investments, and having a partner could be a burden. A minority stake in Hero Honda also yields limited profits for Honda compared with a fully consolidated 100 percent unit.

Underscoring the difficulty of joint ventures, Japan’s Suzuki Motor Corp (7269.T: ) also ended a 19-year-old motorcycle venture with India’s TVS Motor (TVSM.BO: ) in 2001.

WHY WOULD HONDA SELL ITS STAKE FOR THE REPORTED DISCOUNT?

The big discount represented in the reported sale price is not surprising, analysts say. With Honda’s exit from Hero Honda, the remaining company will likely eventually lose the right to keep Honda in its brand name in a huge negative for goodwill. Honda is by far the world’s biggest motorcycle maker, and its brand is synonymous with two-wheelers in many countries.

The sale price would also have to be taken in the context of what Honda gets in return, such as increased royalty payments for licensing its technology.

HOW WILL THE BREAK-UP AFFECT HERO HONDA?

Analysts expect the Hero group to lose market share, currently around 40-50 percent, in the long term as Honda becomes more aggressive. Other makes such as Bajaj Auto (BAJA.BO: ) and TVS are also increasing market share, while Mahindra & Mahindra (MAHM.BO: ) is looking to follow.

A rise in royalty payments, currently at around 2-3 percent of sales, would hit profits at Hero Honda. It would take time for Hero to develop its own technological capabilities, and it remains to be seen whether the partners’ technology licensing would continue through 2014 as agreed under the current contract.

For Honda, with a wholly owned unit already in place and expanding fast, a pull-out from the joint venture would be positive for its growth over the long term, although it would have to make sure its sales network is sufficiently robust to compete with Hero.

(Editing by Muralikumar Anantharaman)

Q+A: Why is India’s Hero Honda preparing to break up?