Sun Pharmaceutical Industries Ltd plans to acquire the 25% stake it does not hold in US subsidiary Caraco Pharmaceutical Laboratories Ltd. It will offer Caraco’s shareholders $4.75 (around Rs213) per share, a 5% premium over the market price prior to the offer, which translates into a consideration of about $48 million.The proposal submitted to Caraco’s board indicates that the buy-back could lead to the acquisition of additional shares, the merger of Caraco with Sun or its affiliates, and delisting from the NYSE Amex. Sun has said that it expects the proposal to build upon the existing commercial relationship between itself and Caraco, and result in significant incremental benefits from combining their operations. Sun Pharma’s stock rose 2% on Monday after the news became public.
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The decision to go private will utilize Sun’s cash hoard. As of 30 September, it had about Rs3,000 crore of cash on its balance sheet. It recently completed the acquisition of a majority stake in Taro Pharmaceutical Industries Ltd, without having to make a special tender offer, after the Israeli Supreme Court’s ruling went in its favour. The acquisition cost would have increased if it had lost the case. Winning the case has given it additional financial flexibility.
The offer comes at an interesting juncture. Since end-2008, Caraco’s stock has faced rough weather, after the US Food and Drug Administration (FDA) began scrutinizing its manufacturing operations. The share price, which was about $16 in September 2008, fell to about $3 in June 2009, when FDA ordered it tocease manufacturing at its Michigan facilities and its stocks were also seized.
Since then, Caraco has been working with the US FDA to resolve its compliance-related issues, rationalizing costs and simultaneously selling third-party products to keep the business going. In the September quarter, its sales rose by 25% over the year-ago period, but it incurred a loss due to higher expenses because of consulting fees, royalties and expenses relating to supplemental filings to allow the shifting of generic drug production to alternate sites. Caraco entered into a consent decree with FDA in September 2009, and after fulfilling specified procedures and certifications, will start producing two products by end fiscal 2011 at its Michigan facilities.
Production of another two-three products is likely to start in the third quarter of fiscal 2012. Caraco has said that all its prior product approvals and pending generic drug approvals (31 filed from Michigan) will be subject to these procedures. Caraco has played down these positive developments as it expects all five products to contribute to insignificant sales volume, and even if it resolves all pending issues, ramping up volumes at Michigan will take significant time. But Caraco is headed in the right direction, with greater certainty of a resolution, compared with a year ago.
While a material impact on Caraco’s performance may be visible only later, investor expectations have a tendency to precede events, which could result in the share price rising. Already, Caraco’s price has risen gradually to about $4.5, and other than the issues dogging its production facilities, it has a good line-up of products, and linkages with Sun give it access to a strong product portfolio for distribution.
The timing is, therefore, right for Sun, as its outlay may increase if Caraco’s share price rises on further positive FDA-related developments. Getting 100% ownership will also give Sun full control on how it runs Caraco. At present, it has to maintain an arms-length relationship since it is a listed company. Besides, on the financial front, all of Caraco’s profits will reflect in its books. That may seem immaterial given the current state of affairs, but will change when Caraco’s revenue and profit rises.