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R&D: It's a long-term business - Views on News from Equitymaster
 
 
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  • Jun 2, 2004

    R&D: It's a long-term business

    R&D (research and development) has been a much-touted word in the pharma industry. It is said that the companies, which invest heavily in R&D, are more rewarded by the markets than pure manufacturing players. In fact, this is in line with other industries too, in which the R&D players have always been rewarded more. But is it true?

    The answer to this question lies in looking back at the history. It is a fact that companies, which have consistently invested in creating IP (intellectual property), have been successful and have survived through the ups and downs of the business cycles. Companies like GE, 3M and Pfizer have consistently delivered value to all its customers and other stakeholders in the company.

    The importance of R&D is the pharma sector cannot be understated. Companies with a track record of discovering new drugs have delivered more value to both investors as well as to the society. Global majors like Pfizer, Aventis, Eli Lily and Novartis has over the years discovered new drugs and therapies, which has given them accolades all over the world.

    In the Indian scenario, R&D is not a very old term. Earlier, R&D activities were restricted to government organization and in the private sector, R&D was restricted to reverse engineering and process research. In the pharma sector in recent years, companies like Dr Reddy's and Ranbaxy have been investing significant proportion of sales towards R&D. But when compared to global majors, the R&D spends of Indian companies is minuscule in absolute term as well as in percentage terms. For example, in the year 2003, the world's largest pharma company, Pfizer, spent about US$ 7.1 bn on R&D which was close to 17% of revenues. India's largest pharma company, Ranbaxy, spent a little more than US$ 55 m, which is 7% of revenues.

    Top six R&D spenders globally...
    % of revenues US$ bn
    Pfizer 17.5% 7.1
    Novartis 15.1% 3.8
    Aventis 16.4% 3.5
    Merck 14.5% 3.2
    Glaxo SmithKline 9.5% 2.7
    Eli Lily 18.8% 2.4
    Top four R&D spenders Indian...
    % of revenues Rs m
    Ranbaxy 6.8% 2,380
    Dr Reddy's 9.9% 1,910
    Wockhardt 7.9% 630
    Sun Pharma 4.8% 479

    The reason for this contrast is because Indian companies, which are into basic research does not involve themselves into the costly clinical trial exercise, which constitutes about 75%-80% of the total R&D expenditure. Besides, the cost of R&D experts in India is relatively lower when compared to international standards, which in fact has resulted in global pharma majors initiating R&D activities in India. Also, the Indian pharma companies are not financially very strong to match the global standards. Though Indian companies are laggards on the R&D front, we cannot demean the success they have earned in a very short span of time.

    R&D Successes...
    Name of the Molecule Company Result
    RBx 2258 Ranbaxy Phase II clinical trials
    RBx7796 Ranbaxy Phase II clinical trials
    DRF 2725 Dr Reddy's Discontinued After Phase III clinical trial
    DRF 2593 Dr Reddy's Discontinued After Phase III clinical trial

    All said and done, R&D is considerably a risky proposition to pursue. A pharma company, unless it achieves a critical mass in terms of sales and profits, does not dare to enter into basic research. It takes years (atleast 10 years) to realise revenues from R&D activities, leave alone profits. The payback period of R&D is also very long. This is the reason it is very difficult to value a R&D activity of the company. It is quiet possible that after completing 90% of the job and spending 95% of the money, the product might not be viable for commercial production.

    So, what are the key aspects that one needs to keep in mind?

    1. It will take a while before Indian pharma majors derive benefits from their R&D efforts. While companies have a 10-year perspective on their businesses, investors expect returns ‘faster', which is not rationale, especially in these cases.

    2. Most of the global pharma majors have a strong presence in the Indian market. The key benefit for the likes of Aventis, Glaxo and Pfizer is the access to global product portfolio for parent majors. For Indian pharma companies, the dynamics are different. So, it is important to identify what is the long-term business of an Indian pharma company. Some may try to be a contract-manufacturing arm while some may have an R&D plan. It is therefore, pertinent for retail investors to view the Indian pharma sector in this perspective. One cannot compare Matrix and Ranbaxy.

     

     

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