Would Orchid Chemicals and Pharmaceuticals Ltd have sold a good slice of its active pharmaceutical ingredients (API) business if it was not weighed down by debt? Perhaps not, and that may explain why investors do not appear thrilled by the transaction, despite it being done at a good price. Orchid’s shares have fallen by 1.8% from its closing price on Tuesday (the deal was announced on Wednesday).

This business contributed about 450 crore to Orchid’s consolidated revenue and had an Ebit (earnings before interest and taxes) margin of about 16%, said the company’s chairman and managing director in an interview with CNBC-TV18. The company, therefore, got a price of about 2.5 times the sales of the unit, which is a good valuation for a contract manufacturing business, reflecting Hospira’s keenness to control the full manufacturing process. It was buying these APIs from Orchid to make the finished products.

Naveen Kumar Saini/Mint

Orchid’s high debt burden was already reflected in its valuation and was being balanced by expectations of faster business growth. While debt will fall, and earnings will improve, the question is whether it can make good the lost sales and profits. The deal is expected to close in the December quarter. The full impact of this transaction will thus be visible in 2013-14, a year in which the company expects to earn revenue from first-to-file generic drug opportunities in the US. If Orchid offsets the dip in API revenue with higher contribution from generic drug sales, investors may find the deal worthwhile in hindsight.

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