Sun Pharmaceutical Industries Ltd crossed a key hurdle in the acquisition of Israel’s Taro Pharmaceutical Industries Ltd.

Sun’s initial investment in the company of around $60 million (Rs 280 crore) has been lying idle after the acquisition was stuck in litigation. Sun’s shares closed up by 2% on Wednesday on news that Israel’s Supreme Court has allowed Sun to go ahead with its open offer for Taro’s publicly held shares. It rejected an appeal by Taro requiring it to make a special tender offer.

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The timing is opportune, too. Sun has been facing two major obstacles. Taro’s acquisition was one and another was the problems related to the US Food and Drug Administration (FDA) faced by Caraco Pharmaceutical Laboratories Ltd, its US subsidiary. Recently, FDA issued a warning letter to another of Sun’s US drug factories. A positive outcome in Taro’s case, therefore, will be welcomed by shareholders.

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Sun had announced Taro’s acquisition in May 2007. Taro’s main market is the US, which contributes to over three-fourths of revenue. As of December 2007, dermatology and topical products contributed to 67% of sales, while cardiovascular contributed 12%, with the rest coming from anti-inflammatory, neuro-psychiatric and others. Sun’s aim was to add Taro’s complementary categories such as dermatology to its own and benefit from cost synergies.

Based on pro forma numbers, Taro’s income in the first half ended June was $187 million, up by around 3% over the year-ago period, while its operating income was up by around 6%. The June quarter numbers were unimpressive, affecting its half year results.

Taro’s annualized 2010 sales could potentially add around one-third to Sun’s estimated revenue of around Rs 4,800 crore. But that also depends on how soon it can actually close the acquisition and the eventual stake it ends up with in the company. More importantly, Taro’s numbers are pro forma figures and audited figures are available only till 2007. An audit could result in a change in these financials as well.

Sun currently holds a 36.4% equity stake and a 24.3% voting right in Taro. In the next stage, it will have to pay $36 million to the promoters, exercising its option to acquire their stake in the company. If they choose to go to court, however, it may cause further delay. The open offer will proceed at the original offer price of $7.75 a share with an outlay of $156 million. The current market price is higher at around $11.50, so Taro’s shareholders may not sell.

With zero acceptance also, Sun will still be left with an equity stake of 48% and a voting right of 65%. It may have to cross a few more obstacles in the form of residual litigation, or any new ones. But it has won the major battle, and it appears to be a matter of time before it gets control. That will blow away one big uncertainty. Shareholders will now await news on Caraco resolving its issues with FDA.

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