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Pharma: Walking the tight rope?

Oct 3, 2006

The rupee has depreciated considerably against the US Dollar (by around 7%) since the high of Rs 43.28 it had reached on May 11, 2005. While a weaker rupee is definitely a major plus point for export-oriented sectors such as software, pharma and textiles, for pharma companies in particular, it could prove to be a double-edged sword. In this article, we shall try to find out why. Since the domestic pharma market is highly fragmented, most of the Indian pharma companies (excluding the MNCs) are placing a considerably higher thrust on exports. The introduction of the product patent law and the considerable potential in generics in the global market has also aided the increased emphasis on exports. Also, amongst global markets, the major focus areas of companies have been the US and countries in the European region. This means that depreciation in the Indian currency against the dollar and even the Euro is definitely a huge positive for pharma companies.

Export contribution to sales
Company % of sales
Ranbaxy 80%
Cipla 47%
Sun Pharma 39%
Wockhardt 70%
Glenmark 38%

That said, there is also a flip side to the same. It must be noted that due to the intense competition in the US and certain European generics markets, severe price erosion has dented realisations and consequently, margins of companies. Therefore, in a bid to remain competitive, global generic companies are looking to acquire scale and therefore, consolidation in the sector has been heating up. Domestic pharma companies have also emerged as frontrunners in the global acquisitions arena.

On one hand, valuations and consideration to be paid for the targeted company has inched higher (there are many companies vying for the same potential takeover target). On the other hand, domestic companies are not in a position to pay the entire consideration either through cash or internal accruals. This has prompted them to raise funds either through debt or equity. One popular trend that has emerged is raising funds through the FCCB route. And this is where the hitch lies. This is because depreciation in the Indian currency unit will lead to an increase in the value of FCCBs and also a rise in the interest obligations thereby affecting profitability.

In the case of zero-coupon FCCBs (which have also gained popularity), while companies do not have to pay interest, payment pressures (magnified further by the rupee depreciation) could arise during the time of redemption. Of course, if the price of the stock moves ahead of the conversion price, and the bonds are converted into equity, then the company is obviously relieved of the obligation to pay interest or for that matter face redemption pressures.

FCCBs: The hot thing...
Company Amount (US$ m) Conversion price (Rs) Purpose
Ranbaxy 440 713 For funding Terapia and other acquisitions
Sun Pharma 350 729 For future acquisitions
Wockhardt 110 486 For future acquisitions
Glenmark 100 - N.A

To sum up...
We do believe that the Indian Rupee will be weaker against the greenback in the long-term (2% to 3% per annum is a possibility). Given this backdrop, on an overall basis, increased thrust on exports is most likely to offset the negative impact of foreign borrowings for pharma companies. Besides, companies that have not yet utilized the funds for acquisitions have parked the issue proceed with banks overseas thereby generating income. Whatever the case, besides a strong growth in overall exports, pharma companies need to focus on gaining maximum synergies from the acquisitions that they have made to contribute to the overall performance and justify the high valuations. More importantly, at the end of the day, while it is not easy to completely eliminate forex risks, it all boils down to what prudent risk management measures pharma companies are adopting to hedge against the same.

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