New Delhi: Three years after completing the acquisition of German generic-drug maker Betapharm AG, Dr Reddy’s Laboratories Ltd, or DRL, is hurt financially from the purchase that cost $570 million (Rs2,832.9 crore). But India’s second biggest drug maker by revenue, which said recently that it would gradually exit some generic markets as part of a rationalization of its business, still considers Betapharm a good investment, chief operating officer Satish Reddy said in an interview. He also spoke about the changing dynamics of the global drug market. Edited excerpts:
What is happening at DRL right now, especially with the decision to exit some markets?
If I just talk about the highlights, in terms of how things are seen, one is clearly in terms of the strategy itself. It has not changed or anything like that but there is a little bit of realignment in terms of what we are doing. And that realignment has a lot to do with how we now focus on our global operations.
In terms of realignment, what prompted this to happen was obviously trying to look at the next wave of growth for the company. What emerged was that there is a significant scope to improve in the large markets that we were already present in and gain significantly…whether it is in terms of growth or in terms of size…in markets where it’s more of a meaningful presence.
Real picture: Satish Reddy, chief operating officer at Dr Reddy’s Laboratories, said that though Betapharm was a good buy, if one looked at the reality of the financials, the company had definitely taken a hit. Hemant Mishra / Mint
There were also several markets which were becoming increasingly difficult to serve. These were less than 1% in size because of the complexity in operations as well as the focus that is required to serve these markets as against markets in which we already have a significant presence comparatively.
Were there other reasons for the realignment of the global generics business?
It is also to do with external influences that we are seeing in the market compared with the past. One is the growth in the mature markets. Mature markets are not showing that level of growth as before.
Not too many products (are) coming out in the market. And also, if you see in terms of influence of the payors (such as health care insurers)—especially in developed markets— that’s also increasing because obviously they want to lower the cost of health care. Because of the influence of the payors it’s increased.
In certain markets such as the US, it’s even more stark because they traditionally had a very high level of spend and higher pricing in the markets, which obviously needed to move towards more of generic penetration. So, that’s a hell of a big change going on in the market.
And then when you look at emerging markets...here it is all about the growth story… The economic growth, which has happened in most of these markets and its consequent effect on the quality of health care and its delivery. That’s also changed.
So, if you put everything together, you are finding that the mature markets are slowing down, emerging markets are increasing. The influence of payor sales is also increasing in most of the markets, especially the maturer markets. Also, it calls for a certain opportunity. So, there is opportunity in terms of volumes of generics going up.
Where are you seeing this opportunity right now?
This is all over. In the US and in Europe. Again, the reasons are slightly different. In the US it is mainly because of a significant portion of products going off patent.
In Europe it’s more influenced by what’s happened because of the health care reforms by the government. But overall you are seeing significant scope for volumes of generics increasing in the developed markets.
In the emerging markets, it still continues to be led by branded generics, and also lower pricing compared with other markets.
Which will be your core focus market now?
Our biggest market is the US. What’s happening in the US is that big products are going off patent and the important thing for DRL is there is a base business at this point of time, which we can put in a range of, say, $200 million.
When I say base business, it’s not to do with these one-off exclusive opportunities or deals but just the base business—commodity generic-centred opportunities. So, at least there is a strong base of critical size at which we can operate. That’s one big comforting factor because there has been a lot of variability in the past. Its been low in one year, because of an upside it is big in another year, and then again declined.
So, now there is at least a solid base business of critical size and then it’s poised to grow from that point of time.
So, are you saying that you have more such authorized generic deals lined up?
Not really. In the past if you see one of the things that happened, one is authorized generic. One is also winning court cases—patent challenges—those were predominant in the past. That will not change. But it will not be just one of these things. There will be three factors in that. One will be the exclusive six-month opportunities because of the patent challenge we settle or we expect to win, especially one particular chunk of products.
Second is to do with more exclusive opportunities—not necessarily six-month kind of a thing. These could be because of limited competition in the market. The third one is when the product is already generized but no one has been able to launch the generic. So, that also provides a certain type of exclusivity because there is no patent.
So, many opportunities are there but compared with the past, these are more certain now. I can’t disclose opportunities due to competitive reasons, but all I am saying is that there is more certainty on that.
How is DRL faring in Germany? (Betapharm has won eight supply contracts in a tender by Germany’s largest health insurer, Allgemeine Ortskrankenkassen or AOK).
The model (in Germany) has shifted towards a tender-based model, so that’s still playing out in the market. What we have seen is that the AOK tender was released last year, but once it was through, it was also expected to face certain challenges. But it is pretty much being overcome. That is the AOK part, which covers about 40% of the population. So this should go through and the supplies should come in June, that’s what we expect.
But Germany has been a sore point in your financials after the acquisition of Betapharm in 2006.
Let me put it this way—at the time we entered the market, we had no significant presence in Europe and Germany was the largest market there and it was a branded generics market about three-and-a-half years back when we entered. So, we entered at that point of time and financially, yes, it looks a little bit bad obviously because of the high valuation that was prevalent at that point of time in the market. It’s not what we paid for Betapharm... That was the price at that point of time in the market for a profitable entity with deep market share. Only thing is after buying Betapharm at that price, we have seen significant reforms on the health care front.
Are you saying that these reforms were absolutely unexpected?
Not really. The reforms were expected, I can’t say they were not. But the pace at which it went into the market, the changes it got in, that pace was unexpected. How fast it panned out in the market and how the entire market changed—that was something definitely unexpected.
What used to be a branded generics market is moving towards the other extreme, that is, a tender-based market. That is a significant shift in a very short span of time. That’s where the erosion of value has happened.
For DRL, the problem got compounded additionally. If you see Betapharm as an entity, it was more of a marketing-sales kind of operation. But then if you look at the manufacturing, it was contracted to a local German company at that point of time. So, with the increase in volumes and also because of competitive reasons, that situation came into something which led to more of stock-outs. That is something we faced in the first year, but we reacted pretty quickly to try and move the manufacturing back. But obviously it took time. It took almost one year to improve the supply position by moving at least a significant portion back to India. So, that was another problem that we faced in the initial stages because stock-outs compounds the problem.
That was in the first year after you acquired Betapharm. But things still haven’t looked up in Germany.
So, having sorted that out, it also called out for a little bit of restructuring in terms of operations. Also, trying to align it with the new reality of the market place. And then in the continuing change in the market, it was expected that tenders would be announced. The very first one got into a controversy. It had to be withdrawn. But then it started putting pressure on the prices. More volumes, lesser margins, but the market is still growing. That was the situation for the next one year. Now if you see in the last year, it was about tenders being floated.
First one came in November and then also, the way the contracts were delivered was only for one large portion, which is AOK. This was also done more region-wise.
So, a single product was split into five different regions. We got eight products and 33 contracts. The result was known but in the number of contracts we were third largest.
Do you still feel that Betapharm was a good buy for you?
It’s a relative thing. If you ask just whether it was a good buy, I will say yes, it is a good buy. But again, if you look at the reality of the financials, obviously there is a hit that
we are taking and that is the reality.
So how do you look at it now? Do you see it as a long-term investment that may pay off someday?
No, it should not be looked at that way. That’s where unfortunately these things get highlighted beyond what is required.
At the end of the day, if you actually see, it contributes…in the previous declared results it would have contributed about, say, close to 15% of sales. But then you see the growth in our market, which is quite significant, so this also becomes one of the other major markets where we are operating in.
So we cant just isolate this one thing. It is an important component of what the company does because in the major markets of the world for generics, Germany happens to be among the top three. From that point of view it’s an important one. But it also has to be seen in the scheme of global generics as part of the strategy of DRL.
DRL crossed $150 million of revenues in the Russia/CIS (Commonwealth of Independent States) region for fiscal 2009. What next?
Russia has been a good market for us. It is a branded generics market and we have been in the market for a very long time. So that’s a market where we are very well established.
Now the growth has been aided by different strategies that the company followed in the past and continues to do so. One of them is clearly the large brands in the market, very well established in growing therapeutic segments. Second is also our relationship with key customers.
Unlike India, which is very dispersed in terms of distribution, in Russia there are large distributors who operate in the market and we deal with the top four, and that is a very important component of your strategy when it comes to markets such as Russia. It is important that you operate through really strong and well-run distribution operations.
The third again is clearly the portfolio of products in terms of how we keep launching products and that year after year is actually adding to the growth. The fourth one is also to do with certain segments of the market which also we have exploited for growth. These would be hospital segment and the OTC (over-the-counter) segment. There have been foreign exchange losses as well in these markets.
Obviously there is the forex loss. That is something that we have to face. But there has been enormous growth in the last four or five years in the market in Russia compared with the previous years. That level of growth may not be possible from a market point of view. So, we will always be in line with the level of the growth. Not even in line, actually exceed the market growth…that’s the stand that we are taking.
What will be your new market focus for the generics business?
If you consider large markets that are still untapped with potential, one is Japan. We are actively looking at Japan as a market now. But there are no timelines for us as to when we will enter the market. It is all under the process of evaluation so whenever we complete that...