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Pharma MNCs: The menace of 100% subsidiaries

Jul 10, 2000

Over the past one year most MNC pharmaceutical companies seem to have gone through a de–rating in valuations. Most of the stocks are quoting at prices almost 60% below their yearly highs.

Company 52 week high CMP % decline
Glaxo 971 430 -55.7%
Hoechst 1,340 472 -64.8%
SmithKline 445 151 -66.1%
Knoll 658 354 -46.2%
Novartis 1,436 914 -36.4%
Pfizer 640 561 -12.3%

While the overall slowdown in pharmaceutical sector and a consequent slowdown in topline growth seems to be the prime reason for the current valuation there is another factor pertaining to MNC companies in general and MNC pharmaceutical companies in particular which seems to have affected the sentiment in these stocks. And that is the presence of 100% subsidiaries of the parent companies operating in India.

Company 100% subsidiary Comments
Glaxo No Can use SmithKline's 100% arm after the merger is consummated
Hoechst No The only MNC pharma co active in introducing new products through the listed co
SmithKline Yes Crocin, Tums, Eno form part of the 100% sub
Knoll Yes Outsources most of its mfg; new class of products likely through 100% sub
Novartis Yes Introduction of nutritional products through the sub
Pfizer Yes Ostensibly for R & D; lifestyle products likely through the 100% sub.

Of the top six pharmaceutical MNCs four companies viz. Pfizer, Novartis, Knoll and SmithKline Pharmaceutical have 100% subsidiaries operating in India. While the ostensible reason seems to be that these companies would conduct research in India, the fact is that these are most likely to be used to introduce new products.

It could also lead to a situation that eventually the listed company is functional only as a trading company. The strategy that could be adopted is  milk existing brands by transferring manufacturing to low-cost third parties and reduce overheads through VRS and the closure of own plants;  transfer profits where feasible through royalties and technical know how fees and  launch drugs through fully-owned subsidiaries.

To be fair to the management’s of these companies it is far more advantageous for the parent to maintain a 100% subsidiary for the simple reason that while the company earns from the Indian market, it need not share its profits with Indian shareholders. Some large MNC's notably Hoechst and Glaxo are introducing more products through the listed subsidiary and exploring possibilities of tie-ups and alliances to leverage their existing distribution strengths and franchise.

However, it is for the government to have a clear–cut policy on this matter. While the government has allowed MNC pharma companies to hike their stake in their existing subsidiaries to 74%, it is still allowing the setting up of 100% companies (Pfizer has been one of the most recent examples.)

What the government needs to do is to make it compulsory for companies to offer 26% of their equity to the Indian public and free up investment norms for pharmaceutical companies rather than give permission for 100% subsidiaries on a case by case (or is it suitcase by suitcase?) basis. Only that could allow Indian investors to participate in the relatively higher profits of top class MNC pharmaceutical companies who introduce their top of the line patented products post 2005.

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