Cipla Ltd’s investors had begun to wonder what it would do with its rising pile of cash, as it had already completed a large part of its capital investment. They have an answer now, as the company has proposed to acquire a 51% stake in pharmaceutical company Cipla Medpro South Africa Ltd (Cipla Medpro).
The South African firm took Cipla’s name in 2008 (it was earlier known as Enaleni Pharmaceuticals Ltd), effectively conveying the importance of Cipla to its existence. Medpro’s chairman said in its 2011 annual report: “Our pipeline of dossiers from Cipla India continues to provide huge potential for our business, is attributable to the success of our business, and will support our goals going forward.” Medpro distributes Cipla’s products in the South African market. It also has been investing in its own factories.
Cipla plans to offer Medpro’s shareholders about $220 million (or Rs 1,214 crore at current exchange rates), for a 51% stake. Medpro’s revenue in the half year ended June had risen by 28% to 1.1 billion South African rand (Rs 682 crore), and gross profit (sales less cost of goods sold) rose by 18%. Cipla is offering a price of 8.55 rands per share, valuing the company at about 12 times its annualized 2012 normalized earnings per share, and 15 times its reported earnings per share.
Medpro is the third-largest firm in South Africa, with the pharmaceutical segment contributing to nearly three-fourths of both sales and PBIT, while its over-the-counter medicine segment contributed to 21% of sales and 16% of PBIT, with others, including animal healthcare, contributing to 6% of sales and 8% of profit. PBIT stands for profit before interest and tax, and these figures are for the half year ended June. Africa is one of the leading emerging markets in pharmaceuticals.
At the offer price, the acquisition does not seem expensive, but it’s also because Medpro trades at a discount to peers. Aspen Pharmacare Holdings Ltd, the number one firm, for instance, trades at a price to earnings multiple of 25.4 times, according to Thomson Reuters data, and earns higher profit margins. One reason could be that it is a distributor, implying it has to share margins with the producer, Cipla in this case.
Medpro’s statement says that Cipla is a principal supplier of products to the company, and it anticipates that the proposed acquisition will strengthen its market position, help in expanding local manufacturing capacity, and expand into other African markets. Its dependence on Cipla makes this transaction advantageous to it.
For Cipla, this will be a test case, a big one at that, of having its own front-end presence in a key market. Funding the acquisition will not be difficult, as Cipla already has about Rs 1,500 crore in cash and current investments as of 30 September, and that figure is likely to increase further by the year-end.
In financial terms, Medpro’s 2011 sales represent about 16% of Cipla’s 2011-12 revenue. However, some of Medpro’s revenues are already present in Cipla’s revenue, since it is a key supplier. Therefore, Cipla’s sales will not rise proportionately after this acquisition. It does not change the market opportunity either, as Cipla was already selling in Africa through Medpro. But the acquisition will add to profits, as the distribution profits earned by Medpro will accrue proportionately to Cipla. Still, given Cipla’s size, that may not be a material number.
The real impact of this transaction will play out in the longer run. It addresses a key concern investors have had that, unlike other Indian players, Cipla does not have its own front-end presence in key overseas markets. This acquisition will be termed a success, if Cipla is able to grow the Medpro business into a much larger and more profitable one.
And, success may also mean that Cipla may begin investing in front-end operations in other regions as well. Cipla’s share rose by 2.6% after the acquisition was announced.