Torrent stretches its balance sheet to acquire Unichem’s India business
If Torrent is able to integrate the Unichem business well, wring out costs, accelerate sales and manage cash flows better, then the acquisition can work
Unichem Laboratories Ltd gains significantly in the near term from the sale of its domestic (including Nepal) pharmaceutical business to Torrent Pharmaceuticals Ltd. The Street, it appears, was already clued into the deal. Unichem’s shares have risen by 24% since 18 October but Monday saw a slight decline.
At the current price of Rs310, its market capitalization is Rs2,818 crore, and it is getting paid Rs3,600 crore for the India business alone. This business earned Rs842 crore in revenue or about 60% of the company’s stand-alone revenue in fiscal year 2017 (FY17). Unichem has said it plans to return over half the money to shareholders. If it returns half, it works out to Rs200 apiece pre-tax, but shareholders should expect a lower amount post-tax.
Once the payout is done, attention will shift to the longer term, with Unichem planning to focus on its international business. Retained profits from the transaction will be invested in research and development, especially for the US market where it will file about 20 generic drug filings a year over the next three years, according to a Mint report.
How this works out remains to be seen as the US generic market has turned into a tough one, what with price erosion, competition and stringent inspections that have tripped plans of many firms. While the filing plan may be aggressive, approvals take time. Unichem may take the acquisition route to speed up the process.
Coming to Torrent, the deal is not cheap so why did it do it? One answer is scale (and a higher seat at the ranking tables). If it had been done in FY17, the acquisition would have added about 40% to the company’s India business revenue. In scale, Torrent moves up from number 13 to 5 in terms of sales, as per AIOCD Awacs data, and its market share moves up from 2.4% to 3.4%.
Apart from scale, Torrent also liked the fit with its own portfolio. It cites Unichem’s portfolio having a two-thirds contribution from drugs to treat chronic/sub-chronic ailments (such as hypertension). It improves the depth of Torrent’s existing portfolio, rather than adding several new categories which may then have stretched its resources. In addition, it gets Unichem’s plant at Sikkim and 3,000 employees.
Torrent’s presentation talks about cost synergies and its own productivity track record. Chances are it will seek to trim the headcount somewhat, improve productivity and eliminate overlapping functions or activities to lower costs.
One big concern about this acquisition is what it does to Torrent’s balance sheet. The company is expected to fund about 75% of the consideration with debt, at an interest of about 8.25-8.75%, according to a Motilal Oswal Research note. That takes its debt to equity to 1.1 times from 0.5 time. It remains to be seen if the company raises some equity capital, to add some liquidity and lower the debt to equity.
The debt-raising also leaves it with a potential interest outgo of Rs200 crore. Sure, profits of the acquired business will partly fund this interest but may not be enough, and that’s also why Torrent expects the deal to add to earnings only after three years. The amortization of goodwill due to this acquisition is also likely to weigh on its earnings.
If Torrent is able to integrate the Unichem business well, wring out costs, accelerate sales and manage cash flows better, then the acquisition can work. But that’s asking for a lot to go right. There is one business risk. Unichem’s portfolio has a low exposure to the price control list as of now. But the government keeps expanding that list, and if future additions change the portion of sales under price control, it could upset Torrent’s calculations. Policy changes on this and other fronts are a key risk to this deal’s success.
Torrent’s shares have been in a range for the past three months and on Monday, its shares were down a bit. The Street does not seem unduly worried by the price or the funding and seems confident that Torrent can pull it off.
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