Core Conflict Of Interest Between Tatas & Mistrys Lies In How TCS Cash Is Used

The ouster of Cyrus Mistry from the chairmanship of Tata Sons could have had many reasons: a clash of values, differences over what to divest and what to hold, and even non-acceptance of his leadership among some Tata CEOs.

But the real reasons for the fallout and the temporary induction of Ratan Tata as chairman may be internal to how the group is structured. Tata Sons is widely regarded as the key holding company, but it has become one primarily because its only operational subsidiary, Tata Consultancy Services (TCS), has been disgorging cash in thousands of crore. It is because of TCS that Tata Sons becomes important, for the rest of the Tata group does not give it much income.

In 2014-15, for example, over 95 percent of Tata Sons’ dividend income came from TCS, which paid in Rs 11,402 crore, says a Business Standard computation. Put another way, TCS is the real holding company in the Tata group, not Tata Sons. Tata Sons is merely the vehicle for TCS to own the Tata Group, though legally this is not the case.

Who runs Tata Sons would matter little if there had been no TCS.

The controlling interest in Tata Sons is with several Tata charitable trusts, the main ones being the Sir Dorabji Tata Trust and the Sir Ratan Tata Trust, who between them control over 51 percent. Other Tata trusts and corporate entities control another 13-14 percent, while various operating Tata Companies (Tata Steel, Tata Motors, etc) own another 13.76 percent. In short, the Tata group, through cross-holdings and trust holdings, own more than three-quarters of Tata Sons.

The Pallonji Mistry Group, which owns another 18.4 percent, is the single largest non-Tata investor in Tata Sons. Given the Tatas’ overwhelming majority at Tata Sons, the Mistrys have reason to think their investment in Tata Sons is yielding sub-optimal returns.

This makes for a huge subterranean conflict of interests between the Tatas and the Mistrys, given that Tata Sons’ money is essentially TCS.

In theory, the profits and earnings from Tata Sons go to the trusts (and individuals) who own its shares, but this can happen only if all Tata shares owned by Tata Sons are spewing lots of cash. But as we noted earlier, it is only TCS that does this.

The point of conflict is simple, though unstated: if TCS is generating so much cash, nearly a fifth of it belongs to the Mistrys. But since the money is used largely to prop up long-term Tata businesses, both the Mistrys and the charitable trusts get less cash as dividends than what TCS actually generates.

When TCS cash is used more to increase group holdings or to invest in long-term businesses, it leads to a potential conflict with the minority shareholders – the Mistrys. The Mistrys would benefit most if Tata Sons merely distributed its incomes to shareholders instead of investing it in loss-making or low-yield group companies.

One cannot say for sure, but it is possible that this core conflict of interest between Tata Sons’ main shareholders and its largest minority shareholder may have played its part in the ouster of Mistry and returning the chairmanship safely to Tata hands.

It is worth recalling that Tata Sons’ investments in Tata companies hardly yield any returns if one excludes TCS.

Another Business Standard research report notes that in the past decade, Tata Sons’ investments (ex-TCS) have risen at a compounded annual rate of 22 per cent while dividends have grown only 5.7 per cent. Yields on Tata Sons investments in Tata companies were a mere 2.5 per cent. In short, the money has been flowing one way – from Tata Sons to non-TCS Tata companies. They have been swallowing capital like water.

A month before his ouster, Cyrus Mistry said in an interview that group capex and cash inflows from operations were balanced at $9 billion. But, significantly, he pointed out that “such aggregations at the group level could mislead, as the companies which have high cash generation, capex and debt are not all necessarily the same, and resources of different companies are not fungible with one another, as they are distinct legal entities with different shareholders.”

This fungibility, where the cash surpluses of TCS get funnelled into cash guzzlers, currently happens at the Tata Sons level.

Was Mistry trying to say that money generated at TCS cannot be wantonly spent in other Tata companies that don’t earn their right to more capital? In his interview, Mistry said that Tata companies “need to earn the right to grow.”

Did this statement, and Mistry’s actions to walk this tough talk, alienate Tata companies that believed they had an innate right to the group’s cash?

We may never know, but one thing is clear: the Tatas have to figure out which companies are core to the group and which are not, so that it can have a rational capital allocation policy. The group cannot assume that all Tata businesses can be given money for jam, courtesy TCS.

To get the Mistrys out of Tata Sons, the Tatas would have to pay off 18.4 per cent of their own holdings (73.33 percent) in TCS, which at current market valuations add up to Rs 63,435 crore.

That’s nearly $10 billion. The Tatas can’t afford to get the Mistrys out of their hair just yet.