Why Nestle India’s shareholders rejected higher royalty payment to parent

Bengaluru: Nestle India’s proposal to increase royalty payout to its Swiss parent met with strong opposition, as over half of the shareholders voted against the decision, approved by the board earlier this year.

On Friday, 57.17% of shareholders rejected the Nestle India board's decision to raise the royalty payout from 4.5% to 5.25% of net sales over the next five years, according to voting records published on the BSE on Saturday.

About 71% of larger investors, who own nearly 21% of the company's stake, voted against the resolution.  

Nestle S.A. and Maggi Enterprises hold 34.28% and 28.48% of Nestle India, respectively, giving the promoters a combined stake of 62.76%. The remaining 16% is held by non-institutional and retail investors.

What money managers said 

According to filings reviewed by Mint, two of the largest money managers in Europe opposed the decision of the board of Nestle India. 

“The performance of the company does not sufficiently demonstrate the benefits of the royalty payments over the years, which have grown at a rate higher than the company's revenues and net profit,” said Legal & General Investment Management (LGIM), UK’s largest fund manager, managing $1.5 trillion of assets. 

Nordea Asset Management, the investment arm of the Nordic region’s largest bank, having $400 billion in assets under management, also opposed the resolution. “Based on the level of expenses incurred by the parent entity on marketing, research and development costs, there is lack of a compelling justification for the increase in royalty from the current arrangement,” it said.

“We do not support the proposal as it does not protect or enhance long-term shareholder value creation,” said Nordea.

Also Read: Nestle India board approves hike in royalty payment to Swiss parent

“This proposal is not in shareholders’ best interests,” reasoned British Columbia Investment Management Corp. (BCI), a large Canadian pension fund that manages $200 billion in assets, when it voted against the proposal.

The California Public Employees’ Retirement System (CalPERS), which has about $500 billion in assets under management (AUM), and the City of New York Group Trust, with about $200 billion of AUM, were the two other large investors that rejected the resolution.

An email sent to Nestle India seeking comment went unanswered. 

The proposed royalty fee was to be effective 1 July. Under the new plan, the Indian arm of the Swiss food company had agreed to pay an annual 0.15% increase in royalty payments, for the next five years. This would have implied Nestle India paying 5.25% of revenue in royalty payments to the parent firm by 2029. Nestle India had come up with this royalty increase after a recommendation from consultant McKinsey &Compay. 

What proxy advisory firms said

At least two proxy advisory firms had recommended that investors reject the proposed resolution as it reasoned that companies cap royalty payments as a percentage of profits instead of revenue.

“We are unable to support the resolution,” Institutional Investor Advisory Services (IiAS) said in a note dated 7 May. 

“Nestlé India's revenue growth has outpaced the revenue growth in other geographies over a five-year period (4.6% growth in Nestlé India’s revenue versus 0.03%growth for other geographies). Further, Nestlé SA's R&D spending has remained relatively constant over the past decade (CAGR of 0.2%); India’s royalty payments contribute to >4.5% of overall R&D spending albeit a 2.1% contribution to global sales,” IiAS said.

“Similarly, Nestlé SA's marketing and administration expenses have also contracted at a CAGR of 1.2% over a ten-year period. The proposed maximum rate of 5.25% is also higher than royalty payments by other MNCs in India." 

“In Indian currency, Nestlé India’s revenue has grown at a CAGR of 11.5% over the last five-year period. Assuming a growth rate of 12%, the aggregate license fees for next five years comes to ~Rs. 60.9 bn at the exiting rate of 4.5% of net sales and ~Rs. 67.0 bn at the revised rates resulting in an increased payout of Rs. 6.1 bn over the five-year period.” 

"Since the increasing revenue compensates the group by way of sales linked royalty, we do not approve of a further increase in royalty rates as increased royalty payments will exceed revenue growth. Further, as a good practice, the company should have capped the royalty payments as a percentage of profits,” said IiAS. 

“The company has not disclosed any peer benchmarking done while arriving at the proposed increase in royalty payout,” said InGovern Research Services Pvt. Ltd, another Bengaluru-based proxy advisory firm that recommended that investors reject the proposal.

“Given that Nestle India is already paying much higher percentage of royalty compared to peers like Hindustan Unilever (3.45% of sales) and Colgate-Palmolive India (4.9% of sales), without any proper cost benefit analysis, the increase in royalty payout if approved will further increase the gap in royalty paid by Nestle vis-à-vis its peers,” it added.

“Higher payout of royalty without any clear disclosure of the added advantage to the company could have a negative impact on the bottomline and the amount of dividend payout to shareholders could be impacted.”

InGovern also reasoned that any increase in royalty payout should be on incremental or new business, and not on total revenue.

Nestle India's shares gained as much as 3.01% intraday on the BSE in Saturday's special trading session following the news. The shares ended at ₹2,518.95 apiece, up 1.28% from Friday's close.

Nestle India, which follows a January-December financial year, reported a 13.2% increase in revenue to ₹19,247.5 crore. The company's profit jumped 25% to ₹2,998.6 crore.

The company, which currently gives 4.5% of its revenue to its Swiss parent, ended with ₹16,997.9 crore in revenue last year. This implies Nestle SA got ₹765 crore in royalty payments in 2023.

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