Sun acquisitions on hold, will resume

Sun acquisitions on hold, will resume

Mumbai: Dilip Shanghvi’s faith in the strategy that growth in the drugs business depends on overseas acquisitions hasn’t wavered all through the ups and downs of the tussle for control over Israel’s Taro Pharmaceutical Industries Ltd.

“There is nothing available locally at the moment that will make sense to our business expansion plan," says Shanghvi in the ground floor conference room at the Mumbai head office of Sun Pharmaceutical Industries Ltd, India’s biggest drug company by market value.

“It will take a while to resolve these key issues," he said. “But there are options available to us," he adds, without elaborating.

Sun has never been threatened by a liquidity crisis in the last two and a half decades of history, having always followed a guarded approach in acquisitions and business expansion.

This conservative strategy, ensuring a 25% return in investment in four-to-five years, has meant he’s sitting on Rs3,500 crore of cash even as the rest of the world emerges from a cash crunch. This is money Shanghvi will use to acquire more companies overseas once he tides over the present troubles.

According to an industry analyst with a foreign brokerage, Sun has an established track record when it comes to turning around businesses. Still, strategies that were relevant five years ago may need revisiting, given the sector’s dynamism, he said.

“Sun Pharma remains credible for its achievements" by having followed “its own way of growing the business by selecting niches in all the markets, including the US and Europe, but by not being overleveraged," he said.

Sun hasn’t been as aggressive as Dr Reddy’s Laboratories Ltd, Ranbaxy Laboratories Ltd and Wockhardt Ltd, he said. “It didn’t want to overleverage, and followed its own way of growing the business by selecting niches in all the markets including the US and Europe."

The company has also never tried a collaborative approach, which is traditional industry practice, said the analyst, who doesn’t want to be identified as his organisation doesn’t allow comments to media.

Sun is currently engaged in court cases in the US and Israel over Taro, apart from seeking regulatory compliance for Caraco.

Shanghvi, a first-generation entrepreneur who built Sun from a partnership trading firm, says “We never evaluated our decisions based on failures. Now, we make more money a day than what we used to make in a year."

Hailing from a traditional Gujarati business family, Shanghvi chose the country’s business capital as his base for the drug manufacturing company, which was formed in 1983.

“I started my career as a trader, joining my father’s small drug distribution business in Kolkata, where I grew up," Shanghvi says. “It was my father’s dream that I should get into manufacturing. The journey wasn’t quite smooth."

An initial public offer in 1994 that raised Rs55crore was followed by three local acquisitions in 1996 -- a bulk drug plant of the erstwhile Knoll Pharma in Ahmednagar, Gujarat Lyka Ltd in Ankleshwar, and MJ Pharma Ltd in Halol. This formed the foundation of what became the fourth-largest company in the Rs80,000 crore Indian drug industry.

Sun has made about 14 acquisitions, the majority of them in line with its expansion strategy of identifying distress assets with clear growth potential, and turning them around. Half of its revenue comes from international markets at present and Shanghvi wants to step up this share in the next couple of years.

While Caraco’s prospects depend on convincing the FDA that it complies with US regulations, any progress in completing the Taro deal will need a favourable order from the Israeli Supreme Court. Sun had invested about $105 million in Taro in 2007 for a 36% stake.

Management control of Taro will make Sun a large generic drug player in the US, the world’s largest pharmaceutical market, and give it access to the US-listed company’s established generic businesses in Israel and parts of Europe. Taro has manufacturing locations in the US, Canada, the UK and Ireland, with a good basket of product registrations, which would help in an easy launch of Sun’s products in these markets.

The $454 million merger agreement was signed at a time when Taro was under financial pressure and on the verge of bankruptcy. Following an investigation by independent directors, its chief executive had to resign. A sell-off was the only option for Barrie Levitt and his family, Taro’s promoters, to save the company from liquidation.

“But, when fresh capital infused by Sun helped it tide over the survival crisis, the Taro management changed its mind," Shanghvi says.

Sun is now seeking an order that honours an agreement that the two companies had entered into two years ago.

The Taro management, led by Levitt and his family, unilaterally terminated the 2007 merger agreement in 2008, saying that the deal had undervalued the company. Sun lost no time in exercising a special clause provision in the agreement to acquire a controlling stake held by the promoters by launching a tender offer, which was refused by the management of Taro demanding a special tender offer.

Taro is listed in the US on the Pink Sheet, which is similar to over-the-counter or OTC exchanges that deal with small stocks.

A special tender offer, as per Israeli company law, requires shareholder approval and a minimum of 5% additional shares already tendered to the acquirer. Israeli law mandates a special tender offer if any new acquirer intends to buy over 44% or a controlling stake in a local company unless there is an existing equity holder who owns a stake higher than 45%.

A lower court in Israel had in 2008 ruled in favour of Sun pointing out that the promoters held more than 45% at the time of the deal and that the agreement has to be honoured. But a dilution in the promoters’ stake down to 41% after they made a preferential offer to Sun to bring fresh capital made the situation difficult for the Indian company, which doesn’t want to make a special tender offer. An order from the Supreme Court will make things clear.

Sun hasn’t made a loss on the investment.

“As an investor, my company has still gained by the upside swing in the Taro share price since then," Shanghvi said.

Sun currently holds 14.5 million Taro shares, which traded between $9.40 and $9.50 last week, having risen about 30% from the $7.25 that it paid in 2007. This means if Sun does not get the management control, it can always sell its stake in the market and make money on its investment.

Caraco too has given generous returns on investment.

“Caraco, which we bought in 1997 for $7.5 million when the company was in trouble, had been turned around well and I must say it has paid back several multiples of the investment over the years," he said.

A series of quality issues raised by the FDA in 2008, followed by a seizure of inventory this year, led to Sun’s net profit dropping 80% to Rs164 crore in the April-June quarter from the year earlier. Net sales dropped 24% to Rs788 crore, dragged down by a 56% slump in Caraco sales following the regulatory action.

Caraco, which operates three plants at its Michigan facility that were closed after the FDA action, accounted for 33% of Sun’s $337 million (Rs1,618 crore) US sales in fiscal 2009. Sun’s overall sales during the year were $950 million.

Sun shares, which have risen 31% in the last 10 months, dropped along with the market during the January-March period, but have underperformed against the 76.49% rise in the benchmark Sensex and the 50.31% increase in the Bombay Stock Exchange Healthcare index.

“What makes Sun Pharma different from others is the strategy that it often spins from the trade to manufacturing, an expertise that many do not possess in the sector," said a senior executive belonging to a local rival. “Shanghvi is a person who grew up in the trade, making his vision different from other entrepreneurs, and Sun is one of the few companies that doesn’t come out with long-term growth projections. At the same time, it has maintained steady progress," he said, requesting anonymity.

While acquisitions are key to his strategy, Shanghvi has tried to prevent the company from being pushed into deals it doesn’t want. A strong believer in the “buy and build model", Sanghvi does not have a decidated team to explore mergers and acquisition opportunities, a strategy that quite a few Indian drug makers follow.

This is because it often puts pressure on the team to continously look for targets. “You may be pushed into consider proposals that may not necessarily fit to our philosophy," he points out. Shanghvi will continue to look for acquistions overseas for growth but the new deals will have to wait unti Taro and Caraco are resolved.