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Pharma: The buying spree continues... - Views on News from Equitymaster

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Pharma: The buying spree continues...

May 23, 2007

Given the highly competitive nature of the global generics market, consolidation has been gaining significant momentum in the past couple of years in the global generics industry. While 2005 saw Teva and Sandoz make headlines for acquiring Ivax and Hexal respectively, 2006 was when Dr.Reddy's (Betapharm) and Ranbaxy (Terapia) made strides on the consolidation front. It is now 2007 and already three companies have joined the acquisition bandwagon namely Mylan (Merck Generics), Wockhardt (Negma Laboratories) and the most recent Sun Pharma (Taro Pharma). The aim of these acquisitions has been pretty obvious. To acquire scale in the global generics market where the prices continue to erode relentlessly on the back of increasing competition. The aim is also to be present across geographies and mitigate the risks in one particular market by a strong performance in another market.

The one notable feature of these acquisitions has been the fact that companies including Ranbaxy and Dr.Reddy's have been focusing on strengthening their presence in the emerging markets (where the products are branded and consequently enjoy higher margins). While the US generics market continues to be a major focus area for most of the major Indian pharma companies, many of them are looking to de-risk their business model by increasing focus on the semi regulated markets of Asia, Russia, CIS, Central Eastern Europe and Africa. This is largely due to the fact that while the US generics market continues to be the largest in the world, increasing level of competition and brutal price erosion has led Indian pharma companies to focus on other markets to sustain their overall revenue and profitability growth.

While the acquisitions made by the Indian pharma companies are expected to augment the overall performance in the longer term, challenges are abound in the medium term. Some of aspects that need to be addressed are as follows:

Successful restructuring: Integrating and restructuring the acquired company is critical to derive value from the acquisition in the longer term. To put things in perspective, Sun Pharma acquired Taro Pharma, an Israeli company, on Monday for US$ 454 m, making it the second largest acquisition by an Indian pharma company after Dr.Reddy's. While the financials for 2006 have not been divulged yet, it must be noted that Taro has ended 2006 with considerable losses. While Sun Pharma's strategy has been to acquire loss-making companies and turn them around, it has been successful in the past. Nevertheless this being a much bigger acquisition - is likely to dent the margins of the company in the medium term. Also, while Taro is expected to add value to the company in the longer term, everything hinges on how soon Sun Pharma will be able to turn it around.

Overcoming regulatory risks: Given the fact that different countries have different regulatory environments, changes in regulatory policies could impact the performance of the acquired company and thus increase the payback period for the acquirer. For instance, the regulatory changes in the German market have put pressure on Betapharm, which was acquired by Dr.Reddy's last year. Betapharm has had to undertake price cuts on a host of its products, which have dented the margins of the company. Thus, the key challenge for Dr.Reddy's is to consistently launch new products in the market and boost volumes to lessen the impact of the price erosion. Similarly, regulatory changes in Brazil has resulted in Ranbaxy having to re-file applications for its generic products impacting sales from this region in CY06.

Achieving cost synergies: Since a low cost advantage has become the prime requisite for survival in the generics market, achieving cost synergies from the acquisition also assumes importance. For instance, after acquiring Terapia, Ranbaxy sold off its manufacturing plant at Ireland and has chalked out plans to shift the production to the low cost manufacturing sites of Terapia. In fact Ranbaxy intends to make Terapia as a hub to cater to the European region now that it has become the member of the EU. Even in the CRAMS space, Nicholas Piramal shifted some of the production from Avecia to its sites in India to achieve efficiency at the operating level.

To sum up...
The global pharma industry is getting highly competitive and global generic companies are scrambling to acquire scale to have that 'edge' over their peers in terms of bargaining power and pricing. However, number of generic companies up for sale has been relatively lesser, pushing up valuations as a result. At the end of the day, what matters is how the company is able to derive value from the acquisition and augment the overall performance despite the slew of challenges in the medium term.


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