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Sun Pharma’s acquisition of Taro: Our view - Views on News from Equitymaster

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Sun Pharma’s acquisition of Taro: Our view

May 30, 2007

Sun Pharma announced the acquisition of Taro on May 21, 2007 for a consideration of US$ 454 m, making it the second largest acquisition by an Indian pharma company after Dr.Reddy’s acquisition of Betapharm in Feb 2006. In this article, we shall analyse the finer points of the deal and how this acquisition benefits Sun Pharma going forward. About Taro Pharma
Taro Pharmaceutical Industries is a multinational generic manufacturer based in Israel with established subsidiaries, manufacturing facilities and products across the US, Israel and Canada. Taro operates mainly through three entities namely Taro Israel and two of its subsidiaries, Taro Canada and Taro USA. North America accounts for more than 90% of Taro’s sales. For 2005, Taro Pharma had reported sales of US$ 298 m and profits of US$ 5.7 m. While the company has not yet released the 2006 numbers, Taro has incurred significant losses in 2006. The company’s performance in the last three years has not been too enthusing, as it had to account for chargebacks for those periods (the company estimated sales at a much higher price than what it realised). Taro has invested US$ 225 m in capex in the last three years.

On the R&D front, the company invests around 15% of sales on R&D. Its lead molecule T-2000 is being developed for essential tremors and is undergoing Phase II studies in Canada. Besides this, the company also has a novel formulation of ‘Ovide’, used for the treatment of lice in its proprietary product portfolio.

Consolidation is gathering steam
Acquisitions will be one of the critical factors to achieve scale, given the heightened competition in the global generics market. The right target would be that company, which has a significant presence in more than one market, a deep product pipeline and an established marketing network. Acquisitions alleviate the need to make investments (especially on the sales and marketing front) in any region right from scratch. Therefore, many players are looking to acquire companies that already have a strong presence in one particular region with a large product portfolio. However, just as consolidation is gathering steam, valuations are also proving to be expensive. The following table gives an indication of the kind of price that has been paid for acquiring companies across geographies.

Global and Indian big-ticket acquisitions
Acquirer Target company Acquired in Consideration paid (US$ m) Price to sales (x) EV/EBIDTA (x)
Global
Sandoz Hexal and Eon Labs Feb 2005 8,290 4.0 N.A
Teva Ivax July 2005 7,400 4.0 27.0
Actavis Alpharma Dec 2005 810 1.0 N.A
Watson Andrx March 2006 1,900 1.8 45.2
Mylan Matrix Labs (71.5% stake) August 2006 736 2.9 20.9
Mylan Merck Generics May 2007 6,700 2.7 14.9
Indian
Matrix Docpharma June 2005 263 2.2 14.3
Dr.Reddy's Betapharm Feb 2006 570 2.9 12.6
Ranbaxy Terapia March 2006 324 4.1 11.6
Wockhardt Pinewood Oct 2006 150 2.1 10.2
Ranbaxy Be-Tabs Dec 2006 70 2.2 7.7
Wockhardt Negma Laboratories May 2007 265 1.8 9.7
Sun Pharma Taro Pharma May 2007 454 1.5 11.4
Source: Equitymaster research

What is in the deal for Sun Pharma?
Taro has a strong franchise in dermatology and topical products in addition to product baskets in the cardiovascular, neuropsychiatric and anti-inflammatory therapeutic categories. The company has more than 100 drug approvals in the US with around 26 ANDAs pending approval. Sun Pharma is looking to leverage on Taro’s customers to sell Sun and Caraco products and vice versa and is expected to augment Sun Pharma’s product portfolio in the US market going forward. Sun Pharma already has a presence in the US market through its subsidiary Caraco (75% stake) and derives around 22% of the revenues from this region. Sun Pharma, in the past, has adopted the strategy of acquiring loss making companies and successfully turning them around to add value to its overall business. Hence, the acquisition of Taro, which posted losses in 2006, falls in line with this strategy. Having said that, it should be noted that in terms of size this is a considerably much larger and more complex acquisition than the ones in the past. While this acquisition is expected to strengthen Sun Pharma’s specialty product portfolio and its presence in the US market, everything hinges on how and when the company is successful in turning around Taro.

Investors should note that Sun Pharma has demerged its innovative R&D into a separate listed entity called SPARC. While Sun Pharma has acquired Taro primarily for its generic business, the latter does have some amount of focus on innovative R&D and no clarity has emerged as to whether the innovative R&D of Taro will remain with Sun Pharma or will be transferred to SPARC.

Taro's financials
(US$ m) 2003 2004 2005
Sales 278 261 298
Expenditure 227 265 257
EBDITA 52 (4) 40
EBDITA margin (%) 18.5% -1.6% 13.6%
Net profit 30 (31) 6
Net profit margin (%) 10.9% -12.1% 1.9%
Taro's cost breakup
Cost of sales 36.8% 45.9% 43.2%
R&D 14.6% 16.1% 15.4%
SG&A 35.2% 47.3% 36.3%

How do valuations compare?
Sun Pharma has acquired Taro for a total consideration of US$ 454 m, which implies a price to sales of 1.5 (based on the 2005 financials), which compared to the acquisitions made in the last couple of years in the global generics market, is relatively cheaper. However, the thing to be noted is that the profitability of Taro has not been impressive and the company actually incurred substantial losses in CY06. Out of the total consideration of US$ 454 m, the equity component has been valued at US$ 230 m and Sun Pharma will also refinance the balance US$ 224 m in net debt of Taro. In addition to this, Sun Pharma will provide interim financing to the extent of US$ 45 m to provide immediate liquidity to Taro. The financials of Taro are likely to be reflected in Sun Pharma’s financials from 3QFY08 onwards and in the medium term is expected to put pressure on Sun Pharma’s margins on a consolidated basis.

What to expect?
At the current price of Rs 1,106, the stock is trading at a price to earnings multiple of 24.1 times our estimated FY09 earnings. Sun Pharma’s domestic formulations business is likely to witness strong growth going forward, due to the company’s focus on the lifestyle segment and technologically complex products. In the international arena, branded formulation sales to the CIS countries, China, South East Asia, South Africa and the Middle East are expected to pick up momentum. As far as the US markets are concerned, Sun Pharma is in a position to leverage its cost advantage in manufacturing and R&D by launching new drugs through Caraco Pharma. However, the pricing pressure in the US is likely to be an area of concern going forward. While the formation of SPARC is expected to contribute to the margin expansion going forward, the integration of Taro with Sun Pharma is likely to impact margins on an overall basis. We shall soon update our research report on the company.

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