Sun Pharmaceutical Industries Ltd is buying Ranbaxy Laboratories Ltd through an all-stock merger in which five shares of Ranbaxy will fetch four shares of Sun Pharma. Based on their closing prices on Friday, a share of Ranbaxy valued at Rs.460 will get four-fifths of a Sun Pharma share valued at Rs.458.
It seems a fair exchange ratio but Ranbaxy’s shares have risen sharply since 27 March. The market appears to not only have got wind of the deal but the ratio as well, since the share levels match the ratio so well. That is something for the market regulator to investigate, if the rise in Ranbaxy’s share price was a mere coincidence or if somebody had insider information on the deal and acted on it. If we consider the closing prices as on 27 March, Ranbaxy shareholders would have got a 29.3% premium, which seems fair.
Daiichi Sankyo Co. Ltd: Daiichi is the parent company of Ranbaxy since it bought the Indian drug maker from its earlier promoters. Daiichi faced criticism after Ranbaxy’s plants came under the US Food and Drug Administration’s (FDA’s) scanner shortly after the acquisition. Even after so many years, Ranbaxy’s inability to overcome its FDA-related problems has put pressure on its promoters.
With Sun Pharma acquiring Ranbaxy, Daiichi is relieved of the burden of managing Ranbaxy’s problems. It will hold a 9% stake in Sun Pharma, as a result of its current stake in Ranbaxy, though one can expect it to sell that stake eventually. On a conference call, however, Sun Pharma’s management indicated they plan to work together with Daiichi to grow the business.
Ranbaxy: Along with the acquisition news, Ranbaxy announced that it received a subpoena dated 13 March (why this was not disclosed earlier is something that should bother shareholders) asking for information about its Toansa facility that recently received an import alert from the US FDA.
That this is material is evident from the fact that Daiichi has agreed to indemnify Sun Pharma from any costs or expenses that may arise from this subpoena. Eventually, this news would have emerged inthe public domain and may have further damaged investor sentiment.
But things change now for Ranbaxy. This is the end of the road for Ranbaxy as it exists but it perhaps is the best outcome for the company and its shareholders, given the circumstances. Ranbaxy is a company with a very bright future in the US generics market, with a sizeable drug pipeline and some big product launches in the waiting, but for frequent run-ins with the US drug regulator.
The fact that these glitches continued even after a new management was in control was a big surprise for investors. It is now up to the new owners to ensure that the plants become and remain compliant with US FDA norms.
Sun Pharma: Sun Pharma’s managing director Dilip Shanghvi has acquired a reputation for acquiring companies in trouble at a good price, and then turning around their operations. Ranbaxy will certainly be a big challenge.
The merger will see Sun Pharma’s revenue jump by a healthy 40% but its operating profit will rise by a meagre 7.5%, based on pro forma 2013 financials. Its operating profit margin will decline from 44.1% to 29.2%. Thus, the merger will have a negative effect on its performance in the near term. Pro forma financial statements are designed to reflect a proposed change, such as an acquisition, or to emphasize some figures when a company issues an earnings announcement to the public.
In terms of size, Sun Pharma will now have a pro forma 2013 revenue of Rs.25,911 crore and an operating profit of Rs.7,577 crore, with a net profit of Rs.1,710 crore. Ranbaxy’s profits have been hit by provisions related to inventory write-offs and foreign exchange-related provisions.
So, what does Sun Pharma hope to gain from this acquisition? Sun Pharma has said it expects to get $250 million, or Rs.1,550 crore, in merger-related synergies by the third year after the acquisition is completed. That is fairly significant and these savings should be from sales growth, procurement and supply chain efficiencies. But this merger is not really about scale and its benefits.
In the Indian market, the combined entity’s portfolio becomes much larger, covering more therapeutic areas. The challenge is that Ranbaxy’s margins have been relatively lower and that is unlikely to satisfy Sun Pharma. The company management has said they will work on improving its margins. In the US market, the priority will be to resolve all of Ranbaxy’s FDA-related troubles to ensure that every major generic product in Ranbaxy’s pipeline makes it to market. These are crucial factors, in addition to their efforts to grow their combined business in Europe and emerging markets, to ensure this acquisition works out in Sun Pharma’s favour.
Shareholders: Ranbaxy’s share is evenly placed based on the merger ratio and no further gains are likely to accrue to its shareholders. Ranbaxy’s shareholders will now become Sun Pharma shareholders. They can choose to stay invested if they believe that Sun Pharma will be able to make a much bigger and better combination, or exit at this point.
Sun Pharma’s shareholders may blink at the immediate effect of equity dilution of 16.4% and the effect on its profitability in the near term. This is reflected in the stock market reaction to the announcement: On Monday, Ranbaxy’s shared declined by 3.1%, while Sun Pharma’s share faced some volatility but closed with a decent gain of 2.7%.”
There is also the matter of uncertainty on what further lies ahead for Ranbaxy’s regulatory troubles and how soon Sun Pharma can resolve them. Running counter to these fears should be Sun Pharma’s ability to make this acquisition work in the long run. The company’s successful track record in turning around acquired companies should give investors some hope that it can pull off the same magic at Ranbaxy as well.