Hyderabad: Three years after the acquisition of Betapharm Arzneimittel GmbH, its most expensive cross-border experiment to date, Indian drug maker Dr Reddy’s Laboratories Ltd, or DRL, says it may be yet another year before it starts reaping dividends from the purchase.
DRL is finally admitting it may have overpaid for Betapharm because of competitor pressure and inaccurately assessed its earnings potential.
When DRL bought Betapharm, the fourth largest German generic drug marketing firm with sales of €164 million (Rs1,085 crore now) in 2005, for €480 million in February 2006, it was expected to be a key driver of growth for DRL.
Overvalued: The Hyderabad-based firm admits that it may have overpaid for Betapharm. Bharat Sai / Mint
While Betapharm has increased DRL’s revenue, it has been a drag on the Indian drug maker’s profits due to a sharp decline in price in the German market, the world’s second largest generics market with an addressable size of €9 billion.
The price erosion was the result of new regulations that essentially transformed the German pharma market from a prescription-driven branded generics market to a tender-based market driven by insurance companies.
The Hyderabad-based firm had beaten its then main competitor, Ranbaxy Laboratories Ltd, and other big pharma firms in the race for Betapharm. “We were in a very competitive environment and we may have paid more than what we would have liked to,” DRL chief executive G.V. Prasad told Mint recently.
As of 31 March, Betapharm and its assets were valued at €210 million on DRL’s books, and could fall depending on market changes.
“The decision to acquire was in the right, but price was not justifiable,” said Prashant Nair, an analyst with Citi Investment Research.
DRL said the unexpected changes in the German pharma market that turned it into a tender-based market driven by insurers rendered obsolete the model it used to arrive at a price for Betapharm. Analysts, however, say the change was not completely unexpected. The acquisition was concluded on 7 February 2006 and healthcare reforms in the German market started on 1 April 2007.
“While the company may have been aware of the direction of the regulatory changes expected in the German market, they probably did not expect the changes to be this drastic,” Nair said.
DRL admits that a key lesson from the Betapharm acquisition is that inorganic expansion as a way of entering a new market is a risky proposition. “Ideally, we should have built up our own presence and a deep understanding of the local market,” Prasad said.
After the regulatory changes, the value of Betapharm’s product portfolio and the projected sales of those products declined sharply, forcing DRL to record these declines in its accounts.
In the quarter ended 31 March 2007, DRL saw the first write-down of $36 million on account of the reduced value of its Betapharm assets. Saumen Chakraborty, DRL’s then chief financial officer (CFO), had said the write-down was on account of “the healthcare reforms and consequent industry reaction leading to significant price erosion”.
In the just-concluded March quarter, DRL wrote down Rs1,402 crore to reflect further falls in the value of its Betapharm assets. At the announcement of the firm’s 2009 financial results, DRL’s current CFO Umang Vohra did not rule out future write-downs but said that if there were any, they would be smaller in magnitude.
DRL was also forced to change Betapharm’s organizational structure to survive and grow in the new environment. While the earlier model required building and maintaining relationships with doctors who prescribe the medicines, the evolving model required developing relationships with insurance companies.
In alignment with the market reality, Betapharm’s salesforce had been cut to 110 at the end of the March quarter, from 250 at the time of the acquisition, and is expected to be brought down to 60 by September.
“This year (fiscal 2010) is still going to be one of adjustments but from FY11 (fiscal 2011) onwards, we expect Betapharm to be a key driver in our overall growth,” Prasad said.
Citi’s Nair, while agreeing that the acquisition has given DRL scale and entry into the German market, is not sure when the gains will start showing. “It will contribute significantly to DRL’s topline and profitability, but it is not clear yet when that will happen as the market is still in transition,” Nair said.
Despite declining prices, Betapharm has managed to expand its revenues aided by volume growth. In 2009, its revenue stood at Rs985 crore, a 20% increase over the previous year.
Further, as of March, Betapharm had won 33 contracts across eight products from Allgemeine Ortskrankenkassen, or AOK, the largest health insurer in Germany. According to Citi analysts, AOK contracts are cumulatively valued at €180 million at current market price, which is expected to decline.