By Hema B Rajashekar

It isn't just a cosmetic change. Having sold off its business to the Rs 8,343-crore Hindustan Lever Ltd (HLL) in two stages between January, 1996, and February, 1998, the Rs 59.11-crore Lakmé has, virtually, undergone a face-lift. Despite boasting of a cash corpus of Rs 256 crore, the once-aggressive marketer of its brands (Lakmé, Maximum, Orchids, Elle 18) bears, at the moment, only the gloss of a shell company. For, Lakmé's deals with HLL signal the exit of the Tata Group from the cosmetics business, but not its re-entry into a colourful new business.

Left in limbo, in the process, appear to be Lakmé's shareholders. First, they saw the price of the shares they hold rise dramatically from Rs 129 on February 1, 1996--after Lakmé floated a marketing venture with HLL, the Rs 134-crore Lakmé-Lever--to Rs 462 by June 15, 1997. Before plunging to Rs 266 on February 12, 1998, when Lakmé announced that it was, after 46 years, selling out of this sector. Thereafter, the Lakmé scrip went into a free fall, quoting at Rs 154.40 on February 24, 1998--a 66.58 per cent decline in eight months.

Worse, Lakmé did not appear to have any concrete plans to deploy the money it had received from HLL (as columnist Debashis Basu first pointed out in The Economic Times on February 18, 1998). Only after the deal was done did Simone Tata, 67, the chairperson and CEO of Lakmé, say that the company would develop a "business plan." Added Tata: "We will consider our future plans in due course. Till then, the net proceeds will be temporarily invested in such financial instruments that would yield the highest returns."

Given that the past proceeds from this process--HLL paid Lakmé Rs 140.40 crore in January, 1996--were invested in financial assets by the company (which is always a high-risk proposition), and the fact that Lakmé's future plans are not obvious, wouldn't its shareholders have been better off receiving cash for their shares? Although it may not be common in this country, company managements in the developed markets often distribute the cash received from the sale of assets to their shareholders.

However, the wrinkles at Lakmé have been evident for some time now. A two-year balance-sheet analysis clearly shows how the cosmetics company was transformed from a marketer to a contract-manufacturer to a shell company. In 1995-96, the marketing and distribution functions of both Lakmé and its subsidiary, the Rs 8.43-crore Lakmé Exports, were transferred to Lakmé-Lever.

At that stage, the Tatas' agreement with HLL stated that Lakmé would only manufacture products that would be sold by the new marketing outfit. Then, the company set up another subsidiary, Lakmé Brands, which acquired all the trademarks, brands, and R&D-related infrastructure from Lakmé. And Lakmé Brands authorised Lakmé-Lever to use the brands after paying it a pre-determined royalty.

In return, hll paid Lakmé Rs 140.40 crore--including Rs 32.40 crore for Lakmé's marketing and distribution network; Rs 30 crore for both Lakmé and Lakmé Exports to sign non-competing covenants; and Rs 75 crore as subscription to the Optionally Fully-Convertible Debentures (OFCDs) issued by Lakmé Brands. Eventually, the amount invested in these debentures too went to Lakmé, which received Rs 78 crore for transferring its brands and trademarks to Lakmé Brands.

In addition, Lakmé-Lever used to regularly pay royalties to Lakmé Brands which, in 1996-97, amounted to Rs 5.77 crore. Finally, last month, Lakmé sold its two manufacturing units and all its brands to HLL, which paid the company Rs 200 crore as part-compensation. That's because this does not include the price of the two manufacturing facilities, which are still being valued by auditors.

Obviously, the 1996 deal affected Lakmé's income from its manufacturing operations, which plunged from Rs 86.04 crore in 1995-96 to Rs 33.24 crore in 1996-97. But the drop fails to explain a net loss of Rs 2.38 crore from these operations. Thus, it was only the income from its financial assets which resulted in Lakmé posting net profits (before extraordinary income) of Rs 12.37 crore in 1996-97. Which leads to the question: could Lakmé have been selling its products to Lakmé-Lever at a loss?

Strangely enough, the annual reports are silent on this issue. However, there could be other reasons for the losses from the manufacturing operations. Explains Nirmal Jain, 31, the CEO of the Mumbai-based equity research firm, Probity Research & Services: "A transfer price is usually based on cost plus-margins. But, in Lakmé's case, it is possible that manufacturing expenses are higher (than manufacturing income) because they include additional costs due to restructuring, or because of past losses." Do shareholders have a right to know the details of transfer pricing?

"Of course they do," avers R. Balakrishnan, 42, president, Dil Vikas Finance. But even if we assume that the expenses incurred in 1996-97 are an aberration due to the inclusion of costs that are not related to manufacturing, the fact remains that Lakmé's margins were always going to be slim. Why? Because the cosmetics business is about branding, marketing, and retailing; manufacturing is actually a low-technology, low-value part of the value chain.

What Lakmé's shareholders must also recall is the manner in which its cash surpluses were invested by the company. The directors' report in the 1996-97 annual report states: "The company is looking at other avenues to expand its capacity to service the needs of the joint venture (Lakmé-Lever)." What is intriguing is that the same directors now contend that the "possibilities of future growth in manufacturing profits were not large due to small profit margins." That was the reason why the company decided to enter the retail business: it purchased the Bangalore-based Littlewoods, utilising "only a part of the financial resources available at that time" while "leaving sufficient funds to generate returns for the shareholders."

Of course, it is true that, as in 1996-97, most of the money that accrued to Lakmé was invested in financial assets. That year, the loans advanced by Lakmé increased by Rs 91.59 crore to Rs 112.56 crore. Of this sum, Rs 57.42 crore was extended as bills discounted, and Rs 36.50 crore as loans to corporates. An analysis of Lakmé's 1996-97 annual report reveals that the income from short-term loans and other financial assets constituted 41.60 per cent of its total revenues (excluding extraordinary income) of Rs 56.94 crore. And financial assets comprised a whopping 85.15 per cent of its total asset base of Rs 69.14 crore compared to only 16.74 per cent of the Rs 166.43-crore asset base in the previous year.

Moreover, the investments schedule in its 1996-97 balance-sheet shows that Lakmé has purchased shares and fully-convertible debentures in many of the companies in the Rs 35,000-crore Tata Group--including Lakmé-Lever (Rs 10 crore), Tata Sons (Rs 5.30 crore), Rallis India (Rs 2 crore), and Lakmé Brands (Rs 8.25 crore). Clearly, the company is likely to continue with such investments until it finalises its business strategy. At this stage, according to Dil Vikas' Balakrishnan: "Shareholders should view Lakmé the way they would look at a finance company." Which means that roe, rather EPS, will be Lakmé's Source Of Radiant Beauty in the near future.

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