»The Honest Truth by Ajit Dayal

Perverse Engineering: Ranbaxy
15 JULY 2008

In a previous Honest Truth ( Profit Reservation: Ranbaxy's patent? ) we discussed the absurdity of a law that allows founders to sell their equity stake in a company at a higher price than the price paid to the other "minority" shareholders. In this specific instance, the Japanese company, Daiichi Sankyo, and the founders of Ranbaxy agreed on June 11th that Daiichi Sankyo would:

  1. buy about 130 million shares from Mr. Malvinder Singh and his family at Rs. 737/share
  2. buy 46.26 million new shares from the company, Ranbaxy, at Rs. 737/share
  3. buy 23.83 million options that could be converted into shares at Rs. 737/share sometime in the next 6 to 18 months
  4. make an open offer to the general public at a price of Rs. 737 per share for up to 20% of the emerging capital (the original 373.2 m + preferential issue of 46.3 m shares + 34.7 m shares based on the FCCB conversion + 8.4 million shares of ESOP = a total of 462.6 m shares), as per the SEBI regulations. This would mean that 92.5 million shares of the emerging capital of 462.6 million shares

The interesting aspect of this "deal" is that Mr. Malvinder Singh and his family get to sell all their shares at Rs. 737.

All the other shareholders get to sell only 1 out of 3 shares they own at Rs. 737.

And the balance 2 out of 3 shares that the other shareholders have in Ranbaxy will fluctuate with the market price. Of course, we have the option to "get out" - but not at that wonderful price of Rs. 737 reserved for the Singh family.

The reversals.

Well, a lot has happened in Ranbaxy since June 12th "buy-out". On June 18th Ranbaxy and Pfizer announced a settlement over Ranbaxy's ability to sell a generic version of the cholesterol drug, Lipitor. The worldwide sales of Lipitor are approximately USD 13 billion while sales in USA are about USD 9 billion. Ranbaxy was keen to sell the generic version of the drug in the year 2010. Pfizer was keen to see its patent extended till the year 2014. The settlement allowed Ranbaxy to sell the generic version of the drug from November, 2011 with a 180-day exclusivity period.

While some people tried to put a spin on this as a long-term victory for Ranbaxy, the stock price of Pfizer rose 2% when this deal was announced. The share price of Pfizer, noted Bloomberg News, rose the most in more than 2 years. But Ranbaxy defended the settlement saying that there was now more visibility in the future launch of its generic for Lipitor. Maybe.

And now, on July 14th it has been revealed that the US government had filed a motion on July 3rd asking Ranbaxy to reveal a consultant's report. This report will apparently prove the US government's case that Ranbaxy was using unapproved materials from unapproved sources to sell generic drugs in the US. The end drugs may no longer have the same characteristics as the drugs approved for sale. If true, the damage to Ranbaxy " with penalties " could be in the billions. With revenues of USD 1.5 billion, Ranbaxy would be in trouble paying such a hefty fine.

Ranbaxy, for its part, "strongly denies the allegations" and states that this investigation has been on for three years. "The allegations", says Ranbaxy, "are baseless". The shares meanwhile have plunged by 11% to Rs. 475 as of July 14th.

On June 18th the share price had crossed Rs. 597 on speculation that Pfizer may top the Daiichi Sankyo offer. But that did not happen. Instead, Pfizer and Ranbaxy announced the settlement. News of the Pfizer settlement on the generics " and the 20 month delay in Ranbaxy's ability to sell generics for Lipitor into the US markets " saw a 9% decline in Ranbaxy's share price on June 19th.

Perverse engineering.

Whatever the outcome of the court proceedings, the Ranbaxy episode highlights many of the risks of investing:

  1. We have invested in a company that has gone global, but may not have the management bandwidth to, indeed, deliver on its promises. The sale of Daiichi Sankyo was an admission of that "failure".

  2. As a minority shareholder in Ranbaxy " on behalf of our clients " we seem to be the victim of some unusual judgements and events within a very short period of time and, we hope not, a victim of some perverse engineering. Information available to us is what is in the "public" domain. And our actions are based on such information and the assumptions we may make.

As minority investors, we do not seek any "inside" information. And we are willing to be applauded for " or laughed at " for the investment decisions we make. But the sequences of dates in Ranbaxy are quite coincidental.

A founder family sells its equity stake to Daiicho Sankyo for a wonderful "special offer" price of Rs. 737 per share. The minority shareholders are left holding the packaging and get the privilege of riding the share price in the stock market. Again, this is within the laws of SEBI. The promoters get to keep their windfall gain.

Within a few days, a settlement is reached between Ranbaxy and Pfizer that delays the launch of a generic alternative to the world's best selling drug, Lipitor, by 20 months. Is this a potential loss of revenues " or more clarity for the future? But this will make no difference to the founder shareholders: they have their "deal" with Daiichi Sankyo.

Then, a US legal battle is brought to the forefront. The negative impact of a loss in the US courts could have a significant impact on the intrinsic value of Ranbaxy and its share price. But this will make no difference to the founder shareholders: they have their "deal" with Daiichi Sankyo. The Japanese company's spokesperson re-confirmed it. The US court filings will have no impact on the deal.

The Ranbaxy saga is intriguing: it brings to light the "us" and "them" mentality of founder shareholders (what we call "Promoters"). The question to be asked is: how much of this negative news flow was coincidental " and how much was known or anticipated? If anticipated, was the sale by the founding family a case of reverse engineering " maximising the price to the founder shareholders in a future negative environment? Or are the minorities " like us - just plain unlucky to have taken all that risk and not received a fair share of return?

The Dubai government has recently sent policemen to the beaches to remind the western tourists that Dubai, for all its modern buildings, is still a conservative society and proper clothing is necessary.

Ranbaxy has reminded us that, for all the exciting investment opportunities that exist in India, we swim naked much of the time. And, for all our speeches and TV talk of how modern our business operations are, a founder shareholder will always know a lot more than a "minority".

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Note: Ajit Dayal, the author is a Director in Quantum Information Services Private Limited and Quantum Asset Management Company Private Limited. Views expressed in this article are entirely those of the author and may not be regarded as views of the Quantum Mutual Fund or Quantum Asset Management Company Private Limited or Quantum Information Services Private Limited.

Mutual Fund Investments are subject to market risks. Please read the offer documents of the respective schemes before making any investments.

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