Shapoorji Pallonji Group’s (SP Group) decision yesterday to sever its relationship with Tata Group will likely end the ongoing battle between the two groups. The need for the SP Group to sell its stake to raise capital is not a surprise: the Sterling and Wilson Solar Limited episode, the recent debt default and the attempt to pledge Tata Sons shares are telltale signs of the Group’s desperation. SP. Importantly, for stakeholders on both ends, it marks the end of an era.
With the SP Group breaking the relationship with Tatas, Tata Sons needs to buy 18.37% of the SP Group, which is conservatively valued at $ 20 billion. There are two possible scenarios that can unfold, says IIAS report
First, for Tata Sons to buy SP Group, it will have to sell about 16% of TCS, at current market valuations, reducing its shareholding to 56% from the current 72%. This will mean that the Tata Group will continue to control TCS, but its cash flows from the company will be lower than before. Over the past few years, and even now, Tata Sons’ ability to infuse capital and provide liquidity support to its businesses has been driven by dividends and buybacks from TCS. The sale of 16% of TCS will restrict Tata Sons’ financial flexibility and slightly weaken its ability to hold the group together.
Alternatively, Tata Sons can sell its non-core assets and pledge equity from its listed companies to increase debt. Traditionally, the Tata group has pledged shares of publicly traded companies with the financial services businesses of the Tata group. While debt was incurred, there has rarely been concern about a possible loss of control. But the amount to be raised is significantly large in this case, and you will need external (not group) funders. In doing so, the group will reverse its effort over the past 24 months to reduce debt, shore up participation in publicly traded companies and unravel cross-holdings across the group. The group will be affected by more debt, thus increasing its vulnerability.
The second possible outcome is that strategic partners or external investors (private equity, sovereign wealth funds) enter Tata Sons. This will come with attached conditions. On the one hand, outside investors in Tata Sons will want the company to return to being a public company from its current state of private limitation. The group’s structural limitations are likely to come to light.
In all of these scenarios, there will be increased performance pressures on the operating companies of the Tata group. The group will no longer be able to depend on TCS performance; other group companies will have to give up or, in some cases, perish. The group’s patience thresholds on performance are likely to contract, according to the report.
The Tata Group has a unique structure: it is essentially a philanthropy running a commercial business. Tata Trusts exercises control over Tata Sons, which exercises control over operating companies, several of which are listed and subject to scrutiny by outside shareholders and are accountable to a broader set of stakeholders. Tata Sons plays an intermediary role in driving the performance of operating companies and supporting the objectives of the Tata Trusts.
This structure worked perfectly for several decades with the support of the SP Group, which owns 18.37% of Tata Sons. Because the residual capital of Tata Sons was held by charitable trusts, they were not allowed to vote their equity shares until 2000, resulting in the SP Group effectively becoming the guardians of the group. The SP Group had more power than it claimed and the basis for how Tata Sons operated and the group was based on the ancestral relationship between the Tatas and the Mistrys. Because the structure worked, it was rarely questioned, until Cyrus Mistry’s defenestration. The subsequent battle between him and the Tata group has involved Tata Sons and the rest of the publicly traded companies, leading to this announcement.
Performance pressures are likely to drive a cultural shift – one that’s tougher, more commercial, and focused on a single bottom line rather than the triple bottom line in which the group finds its genesis. Changing the spirit of the group will be an extraordinary leadership challenge. Although the Tata group evolved, began to enter new lines of business and had global aspirations, it remained ingrained in its culture. A change in corporate culture is likely to cause a change in corporate governance practices and, more importantly, in the structure of the group.
What the Tata group may have been pushing has come true. The SP Group has decided to establish severe ties, but there are several uncertainties about how this will play out. There is no immediate impact on operating companies, including those listed – they will not be developed next month or next year, but several years into the future. Still, the end of a 70-year relationship between two families, one that built both business houses (Tatas and SP Group), should not be set aside. It will bring unprecedented change to Tata Group, India’s oldest trading house, whose fundamental premise, more than a century ago, was to bring social good.
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