Getting the M&A dose right

Getting the M&A dose right

Everyone works hard at Ranbaxy Laboratories Ltd—one of India’s largest drug makers—but the team that works the hardest is the one that looks after mergers and acquisitions (M&A). The work hours of the four-member team, headed by Amitabh Gupta, are only symptomatic of what’s happening in the global pharmaceutical industry, and the growing role of firms such as Ranbaxy in such events.

G.V. Prasad, vice-chairman and CEO, Dr Reddy’s Laboratories Ltd

It all started almost 24 years ago, when two US lawmakers—Henry Waxman and Orrin Hatch—introduced a legislation to encourage off-patent drugs, essentially copies of patented medicines, in the world’s largest economy. Since then, the so-called generic pharmaceutical products (or generics for short) business has grown. And grown.

Demand for such drugs continues to rise, and new drug makers from countries including China, Brazil and India are getting regulatory approval to enter new markets. And even as they do, governments worldwide, prompted by patient groups and insurance firms, are moving decisively to reduce prices of generics.

The as-yet young industry—sales of generic drugs are estimated at just 10-12% of global drug sales of $643 billion (approx. Rs25.7 trillion)—is turning to an old trick in the game to meet this demand for low-cost products: build scale rapidly to cut costs. Almost in parallel, big drug majors want to exit from their low-value businesses such as generics, and focus on research and development-led, so-called innovative drugs. The result has been a spate of acquisitions.

Globally, the value of pharmaceutical acquisitions almost doubled to $113 billion in 2006 from $61 billion the year before, according to consultant PricewaterhouseCoopers. Although the value of the deals for the first nine months of this year is not out yet, going by the number of such deals, 2007 might not be far behind: The first half has seen 334 deals, compared with 719 in all of 2006.

Malvinder M. Singh, managing director, Ranbaxy Laboratories Ltd

Indian drug makers—among the fastest growing generic industry in the world—are not isolated from this consolidation wave (one reason why Gupta’s team at Ranbaxy works as hard as it does). Buyouts by Indian companies have been relatively small but experts say it may not be long before local drug makers go out and make acquisitions in the $2-3 billion range.

Investment bankers routinely pitch before Indian drug makers assets being readied for sale across the world. Since 2004, the Indian pharmaceutical sector has made buyouts of more than $2.5 billion. The appetite has largely been fuelled by ambitions of entering new markets through acquisitions rather than spend long years in getting drug approvals, doing research, setting up manufacturing sites, and reaching supply agreements.

While Ranbaxy, Dr Reddy’s Laboratories Ltd and Sun Pharmaceutical Industries Ltd have been among the most active acquirers from India, almost every company in the country’s Top 20 drug makers’ list has picked up an asset globally (see table). Mostly, the buyout destination has been Europe, although targets in developing markets are beginning to catch the attention of Indian drug companies. However, experts say Indian pharma firms are yet to really leverage the M&A opportunity.

Size, scale and intent

At a cumulative $2.5 billion, the value of Indian deals is tiny by global yardsticks, even after discounting the lower valuation in the generics drugs space. Industry veteran and former Ranbaxy chairman D.S. Brar says he has yet to see an acquisition by an Indian firm aimed at acquiring scale. “Be it on account of a conservative approach or lack of investible surpluses, the Indian pharmaceutical industry has not participated in the global generic consolidation story in a big way. Indian deals have largely been focused on gaining market entry, and not really been a ‘scale play’," he adds.

Dilip S. Shanghvi, chairman, Sun Pharmaceutical Industries Ltd

And no Indian drug maker has moved ahead on an acquisition or a merger with the intention of altering its fundamentals, says Gautam Kumra, a partner at the New Delhi offices of McKinsey & Co. “Indian companies have largely pursued M&As with a market-access approach. There have been no mergers where two companies have merged to form a fundamentally new company."

The one Indian company that came close to doing this was Hyderabad-based Matrix Laboratories Ltd. In 2005, Matrix launched a bid to merge the company with compatriot Strides Arcolab Ltd in what was seen as a “merger of equals". The deal fell through in two months over differences in valuation. Matrix then acquired Belgian company Docpharma NV for $263 million and in August 2006, was acquired by US-based Mylan Laboratories Inc. for $736 million. “Docpharma gave us a foothold in South Eastern Europe," says Matrix’s chief executive Rajeev Malik.

Within a year, a flurry of M&As in the US (Sandoz bought Eon Labs Inc. and Hexal AG; Teva bought Ivax; Actavis bought Alpharma Inc.; and Barr Pharmaceuticals Inc. took over Pliva d.d.) reduced Matrix’s customer base sharply. Meanwhile, competition back home in Hyderabad intensified.

“Customers were decreasing, suppliers were increasing, we needed a US partner, and we had financial investors holding a 40% (stake) who could exit anytime," says Malik, explaining the Mylan buyout.

Brar, currently chairman of GVK Biosciences Pvt. Ltd, is also critical that Indian firms have ignored acquisitions in the US drugs market—the world’s largest at $252 billion, where Indians have less than 3% market share. That could be changing.

Top Indian drug firms are in the race to buy assets of New Jersey, US-based Bradley Pharmaceuticals Inc. and cross-state peer Par Pharmaceutical Cos Inc., according to executives in the industry who did not wish to be identified.

If Indian companies have fought shy of US acquisitions and avoided large acquisitions, or those that involve a fundamental change in strategy, it is because of the recent buyout integration experiences of Indian drug makers that have acquired companies overseas.

Some acquisitions, seen as ill-fitting initially, have turned out to be smart at the integration stage.

Most analysts had dubbed the $324 million buyout of Terapia S.A by Ranbaxy in March 2006 as overly expensive and aggressive, especially in a developing market such as Romania.

They had hailed the acquisition of betapharm Arzneimittel GmbH, concluded a month earlier, by Dr Reddy’s as a landmark. Albeit expensive—three times of sales—it was considered a springboard into Europe. Paying €480 million (Rs2,529 crore then) for the fourth largest generics company in Germany, Dr Reddy’s scored a first for an Indian drug maker—it swallowed a fish bigger than itself. Its own revenues for 2005-06 were $546 million.

Analysts have redone their numbers since then.

Ranbaxy’s Romanian business has added, in the first nine months of 2007—Ranbaxy reports financial results for the calendar year—nearly $90 million to its revenues. “Acquisition of Terapia was a strategy aimed at consolidating market share in Europe, and the strategic fit was so sound that it has turned out to be a rather good acquisition," says Sanjiv Kaul, managing director of private equity firm ChrysCapital.

For Dr Reddy’s, betapharm brought an instant market share of 3.5%, an employee strength of 370 with a sales force of 250, and 145 market products. That was in early 2006. Between then and now, the German government has undertaken two rounds of price cuts for generic drugs, putting profit margins under pressure. Betapharm added more than $202 million to Dr Reddy’s revenues in 2006-07 and the previous year. “Unfortunately, acquisitions such as betapharm and Heumann (Pharma GmbH & Co.—it was acquired by Torrent Pharmceuticals Ltd) have not turned out as attractive as the landscape in Germany changed," says Kaul, himself a Europe expert—he used to be employed thereby Ranbaxy.

G.V. Prasad, Dr Reddy’s chief executive, conceded in an interview a few months ago that betapharm had taken a 10-15% hit on revenues which, analysts say, could have pushed back the payback period to 10 years from three. “The situation is still fluid there; can’t say how it will unfold. There is a strong possibility of future price cuts too. These could be either driven by market or insurance companies," says Nimish Mehta, head of India research, MP Advisors Pvt. Ltd, the Indian unit of a New York-based investment analysis and asset management firm, Mehta Partners Llc.

The betapharm acquisition will pay dividends in the long run, insists Dr Reddy’s chief financial officer Saumen Chakraborty. “Germany is the second largest generics market after the US. It was an orbit-changing event and, in the long term, will be good for us," he says, adding that benefits will show up as manufacturing is shifted to India and some costly supply agreements are terminated.

Romania, when it became part of the European Union in January, gave Ranbaxy access to big sourcing deals across the continent—a strategic geographical advantage that will continue to buoy its sales in future. Yet, Ranbaxy managing director Malvinder Singh is cautious about Europe. “Acquisitions in Western Europe can be challenging because of changing regulations," says Singh, adding his company is not looking at buys in that part of the world.

Another acquisition that Mehta, the investment researcher, rates highly is that of Morpeth in the UK by Nicholas Piramal India Ltd, from the world’s largest drug maker Pfizer Inc. A good catch in the contract-manufacturing segment, Morpeth gave a supply contract of five years from Pfizer, and still left 50% of the capacity to be used for other contracts.

Changing course midway

Some experts say the art required in an acquisition is managing it at the integration stage, even if there are surprises. “An acquisition doesn’t always turn out as planned. If there is no turnaround after three years, you need to review the strategy," says Sujay Shetty, associate director with consultant PricewaterhouseCoopers

In the betapharm case, admits Dr Reddy’s Chakraborty, referring to the price cuts in Germany, assumptions made by the acquirer did “not pan out that way". Then, there were unanticipated delays in making the German unit comply with Sarbanes-Oxley or SOX accounting norms in the US; Dr Reddy’s, listed on the New York Stock Exchange, is meant to adhere to these. “Initially, there were questions (among the German employees) as to why (they) should do this, that they had never done this before and how easy it was in the older system," says Chakraborty of the initial resistance.

Anish Gupta, a partner at consultant Accenture, refers to the ability to manage surprises in an acquisition as part of the “bandwidth" at any acquirer. “Ultimately, there is only so much integration that a company can do at a time," he says.

In the years ahead, experts predict two trends: The momentum of pharmaceutical M&As will continue and arrangements with private equity (PE) players will become essential for buyouts that could exceed a billion dollars in size. GVK Biosciences’ Brar says Indian firms have “a heavy control syndrome", where they may want control in the consortium leading the buyouts—an arrangement not acceptable to the PE partners. “That is why PE has come into Indian pharmaceuticals only as growth equity but not as acquisitive equity," he adds. Deals between Ranbaxy and unnamed PE players, as also similar arrangements at firms such as Cipla Ltd, Aurobindo Pharma Ltd and Torrent Pharmaceuticals Ltd, for instance, failed in this year’s mega buyout of Merck KGaA.

Indian drug companies will have to look at all options, including ceding more control to buyout firms, advises McKinsey’s Kumra. “PE players are comfortable taking higher leverages, unlike the drug makers. The mindset of the companies will have to change where they could compromise control in exchange for money and expert advice coming into the consortium," he says. Others such as Shetty of PricewaterhouseCoopers say Indian drug makers will adopt a “string of pearls" approach—acquire a number of smaller targets rather than one big bang acquisition. In terms of therapeutic areas, dermatology, biosimilars, cancer drugs, steroids and injectibles are niches where the growth is, says Brar.

Mehta of MP Advisors’ views another emerging segment for pharmaceutical acquirers: the domestic Indian market worth around Rs34,000 crore in annual sales, and growing at 13-14% a year. Indian companies are valued much lower than global peers which are much more in demand and, therefore, see massive competitive bidding. “If you have $300 million in your pocket, there is much more you can buy in India if you get the right products than you can buy overseas," says a pharma industry analyst who did not wish to be identified.

Dr Reddy’s Laboratories Ltd

G.V. Prasad, vice-chairman and CEO

Turnover (2006-07): Rs6,509.5 crore

Major acquisitions:

1) betapharm Arzneimittel GmbH (Germany) for $580.8 million in 2006

Contribution:About $202 million to revenues in 2005-06 and 2006-07

2) Hoffman-La Roche’s API (Mexico) for $59 million in 2005

Contribution: Helped boost Mexico revenues to Rs539.7 crore in 2007 from Rs80.5 crore in 2006

Ranbaxy Laboratories Ltd

Malvinder M. Singh, managing director

Turnover (2006): Rs6,070 crore

Major acquisitions:

1) Terapia S.A (Romania) for $324 million in 2006

Contribution: $90 million in revenues for first nine months in 2007

2) Be-Tabs Pharma (South Africa) for $70 million in 2006

Contribution: Not available

3) RPG Aventis (France) for $80 million in 2004

Contribution: Just turned Ebitda positive (earnings before interest, taxes, depreciation and amortization)

Sun Pharmaceutical Industries Ltd

Dilip S. Shanghvi, chairman

Turnover (2006-07): Rs2,132.1 crore

Major acquisitions:

1) Taro Pharmaceutical Industries Ltd. (Israel) for $454 million in 2007

Yet to close the deal