Ranbaxy sells out to Daiichi: Our view - Views on News from Equitymaster

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Ranbaxy sells out to Daiichi: Our view

Jun 11, 2008

India's largest pharmaceutical company, Ranbaxy, which in the past two years has been on the prowl to acquire companies and has actually made a string of acquisitions, now finds itself on the other side of the table. The company announced today that its promoters namely Malvinder Singh and Shivinder Singh would sell their entire stake (around 35%) to the Japanese pharma company Daiichi Sankyo at a price of Rs 737 per share. In this article, we shall take a look at the deal and the outlook going forward. About Daiichi Sankyo
Daiichi Sankyo, Japan's third largest drugmaker, was established in 2005 after the merger of two leading Japanese pharma companies. The company has been focusing on generating innovative drugs and has expertise in the fields of cardiovascular, cancer, metabolic disorders and infection. Bloomberg reports that Daiichi expected its profits to fall by around 18% this year owing to price cuts on its main blood pressure treatments. Further, Daiichi's move to acquire majority stake in Ranbaxy could be prompted by the fact that its rivals in Japan namely Takeda, Astellas Pharma and Eisai had spent more than US$ 14 bn on acquisitions since November 2007 to prop up revenues, which had been declining due to blockbuster drugs going off patent. It must be noted that Daiichi had acquired German biotechnology company U3 Pharma AG for US$ 235 m this year to gain access to the cancer treatment market.

A peek at the terms of the deal...
As per the terms, Daiichi Sankyo will acquire the promoters' stake of 35% for Rs 737 per share, at a premium of 31% to the closing price on June 10, 2008. This values the transaction at US$ 3.4 bn to US$ 4.6 bn and Ranbaxy overall at US$ 8.5 bn. Considering the fact that Ranbaxy generated revenues to the tune of US$ 1.7 bn in CY07, this implies a price to sales ratio of around 5 times, which is by no means cheap for Daiichi. This development further brings to fore the expensive valuations that are prevailing in pharmaceutical mergers in the global generics space. As per SEBI regulations, Daiichi will make an open offer to the public shareholders to purchase additional 20% shareholding, thereby taking its total stake in Ranbaxy to around 55%.

Further, given that Ranbaxy holds around 47% stake in Zenotech Laboratories (in a bid to bolster its biotechnology initiative), Daiichi will make an open offer to the shareholders of Zenotech as well. The acquisition is expected to be completed by the end of March 2009, upon which Ranbaxy is likely to become a subsidiary of Daiichi. Malvinder Singh will continue to head the company as its CEO and MD. Daiichi plans to finance the deal through a mix of debt and its existing cash resources.

...and the rationale behind it
After Dr. Reddy's formed a separate company for its NCE R&D and set the ball rolling for other pharma companies to follow suit, promoters selling their stake seems to be another theme brewing in the India pharma space. Investors would do well to recall that the Burmans, holding 65% stake in Dabur Pharma, had recently announced the sale of their entire stake in April 2008 to Fresenius Kabi, a German based healthcare company. The rationale cited by Ranbaxy behind the stake sale is to enhance capabilities in drug development and manufacturing and widen global reach and is expected to act as a platform to enable the company to become a research based global pharma company. For Daiichi, a stake in Ranbaxy would enable it to have a stronger presence in the emerging markets of India, China and Eastern Europe.

Ranbaxy had set an ambitious target of achieving US$ 2 bn in revenues in 2007 - a goal which was hampered by the considerable erosion of prices and rise in competition in the US generics market. Despite making a host of acquisitions including the biggest among them namely Terapia, the company was still not able to meet its target. The next milestone that the company has set for itself is garnering revenues of US$ 5 bn by 2012.

As on December 2007, Ranbaxy had a total debt of Rs 24 bn (around US$ 600 m) and an FCCB of Rs 17 bn (around US$ 400 m). Besides selling the promoter stake, Ranbaxy will als0 issue preference shares and warrants to Daiichi, which will result in an immediate cash infusion of US$ 800 m to US$ 1 bn. These proceeds will be used to retire debt, thereby enabling Ranbaxy to become a zero debt company (assuming the convertible bonds are converted into shares) with surplus cash of Rs 30 bn. Investors should also note that the conversion price for the FCCB has been revised to Rs 540 (earlier conversion price was Rs 723).

Shareholding: Before the deal
Category Nos (m) (%)
Promoters 129.9 34.8
Banks, MFs and FIs 87.1 25.2
FIIs 67.0 14.0
Indian public 69.2 19.7
Others 20.0 6.3
Total 373.1 100.0
Shareholding: After the deal and post dilution
Category Nos (m) (%)
Promoters 129.9 26.7
Preference shares 46.0 9.5
Warrants 23.8 4.9
FCCB converted* 34.8 7.2
ESOPs 8.1 1.7
Banks, MFs and FIs 87.1 17.9
FIIs 67.0 13.8
Indian public 69.2 14.2
Others 20.0 4.1
Total 485.8 100.0

Breaks on Ranbaxy's R&D demerger process
Another significant development pursuant to this deal is the halt in the demerger process of the NCE R&D unit into a separate listed company. It must be noted that Ranbaxy had announced its intention of demerging the R&D unit with a view to focus on its core business of generics and enable the subsequently listed R&D company to raise resources and unlock value for shareholders. Had the demerger gone through, the cost savings would have been US$ 25 m; this will now be added back to Ranbaxy’s overall expenses, resulting in lower margins to that extent.

On a global scale…
This deal will rank the combined entity among the top 15 pharma companies in the world. In the global pharma space, while most of the global innovator companies have done away with their generics business units to shore up profitability, Novartis is the only company which has so far been successful in having a strong branded as well as generics business (the latter being Sandoz, which is the second largest generics company in the world). Given that innovator companies are finding it a tad bit difficult to replenish their pipelines with new drugs, the Daiichi-Sankyo deal could pave the way for more such alliances in the future.

What to expect?
At the current price of Rs 566, the stock is trading at a price to earnings multiple of 17.1 times our estimated CY10 earnings. Against a backdrop of severe pricing pressure in the US generics market, Ranbaxy has adopted the strategy of increasing its product flow and widening its geographical reach. As far as Para IV filings are concerned, the company has been entering into settlement agreements that will provide some semblance of certainty in terms of product launches going forward. For instance, Ranbaxy is sure of getting the exclusivity period for the blockbuster drugs ‘Imitrex' in CY08, ‘Valtrex' in CY09, ‘Flomax' and ‘Lipitor' in CY10. The settlement deal signed with AstraZeneca for the latter's US$ 5.5bn drug ‘Nexium' is an added feather in Ranbaxy's cap.

Besides this, we believe its focus on the branded and emerging markets will play a significant role in offsetting the difficult conditions in the developed markets thereby bolstering its overall performance. While regulatory changes in various countries are a key risk that could impact performance going forward, Ranbaxy is countering the same by increasing its geographical reach worldwide. The company has identified biotech as an important opportunity as is evinced by the stakes it has bought in three biotech companies in India. While this is a step in the right direction, it will be a while before revenues from this field make any significant contribution.

Investors should note that we had factored in the sale of the R&D unit in our estimates and thus in light of these new developments, we will have to have a look at our numbers. Overall, we maintain our positive view on the stock.

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