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Strides Arcolab: The strides are much too long - Outside View

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Strides Arcolab: The strides are much too long
Jun 25, 2010

If one wants a classic case study in corporate chest thumping, look no further than Strides Arcolab. This 20 year Bangalore headquartered pharmaceutical company is also aiming for superstardom at break neck speed. The singular objective of the management appears to be, to becoming a global 'Navaratna' at light speed. And, it is tom-toming its intentions in mega style via its annual report to its shareholders. The report for 2009 runs into a prodigious 204 pages and printed at considerable cost for sure. There is so much written matter to imbibe, that by the time one has gotten to page 15, it is difficult to remember the contents of the first 14 pages. It gets even more complex as you read on. It will however take quite a while for the company to get to where it is going. The consolidated revenues for 2009 totted up to US$ 286 m (Rs 13.2 bn) which is small beer by international reckoning, with a pre-tax profit of US$ 31 m (Rs 1.4 bn).The consolidated sales were scaled up with the help of some of its myriad international affiliations. In end 2009 it had 7 'wholly owned subsidiaries' with direct holding, 13 such 'wholly owned subsidiaries' with indirect holdings, 2 'other subsidiaries' with direct holding, 16 such 'other subsidiaries' with indirect holdings and 3 joint ventures. One wonders what else is planned.

More to the point did domestic sales get a leg up in 2009 following the merger of 4 group companies with the parent? There is no immediate indication of any such. There is for example no change in the installed capacities of its product lines in 2009 vis- a -vis 2008. So what exactly was the benefit accruing from these mergers? As a matter of fact, installed capacities of some product lines dived in 2009 but that was due to the transfer of its specialty business division to a wholly owned subsidiary. Ditto the fate of the R&D department. Where domestic sales did get a leg up in 2009 was through traded sales. Traded sales accounted for 16% of gross sales of Rs 6.8 bn against a smaller 9% contribution in the preceding year. Though the traded sales have not been separately classified the company appears to have roughly earned a gross margin of Rs 264 m from traded sales in 2009 against much smaller Rs 86 m in 2008. Then there is an interesting revenue item called Development Income.

Such was the action in every sphere, ranging from mergers , demergers, acquisitions, transformational deals with MNC pharma companies, intercompany transactions, quite some pennies spent on R&D, the side effects of foreign currency exposures on derivative instruments, NDA and ANDA filings and approvals, corporate guarantees and advances on behalf of its affiliates, the influx of human resources, restructuring costs and, capacity additions etc, etc, that the finance department was in a manner of speaking a little more than overburdened. Its new manufacturing unit at Bangalore to make Oncology products and set up at a cost of Rs 1.7 bn also went on stream in 2009. More so since the company simply could not generate enough cash from 'operating activities' to keep up with the frenetic pace of activity. The fact of the matter is that, bottomline profits and, cash generation from operations, do not necessarily go hand in hand, you see. What is more interesting is that, such was the state of affairs that due to inadequate profits in 2007 and 2008 the company was unable to pay any dividend on its outstanding preferred stock in these years.

It may also be pertinent to point out here that inspite of the oncology unit going on stream in 2009 installed capacities at end 2009 show no change over that of the previous year. What then is the magic mantra here?

Cash generation from operating activities was deep in the red at Rs 1.3 bn in 2009 against a marginal black ink figure of Rs 102 m previously. Significantly higher levels of holding of trade debtor receivables, inventories and a decrease in payables choked the money supply chain. So much so that the company had to frantically resort to fund raising through debt and equity, in a hurry, especially since there was a ongoing capex programme which had to be funded. With the equity base expanding as a result and with the management keen to keep some sort of hold on to its percentage stake, they sensibly converted some of the maturing foreign currency convertible bonds into equity. Hopefully, the management will give the accounts staff a less stressful 2010 and also downsize the annual report to more manageable proportions.

The directors seem intent on catching the bull by its horns, come what may, and all obstacles in its path, if any, be damned. It will be interesting to see how the many subsidiaries shape up over the years. Safe to presume that any substantial contribution from these lilliputs to the bottomline will take time to mature. In the interim, mega changes are taking place in the Indian pharma universe as multinationals are suddenly developing a fancy for devouring Indian branded generics and formulation units at 'going forward' valuations, and are also resorting to contract manufacturing agreements too, to cut costs and face the oncoming competition. What other plans Strides has in this emerging scenario will in all probability be unveiled sooner than later.

Disclosure: Please note that I am not a shareholder of this company

This column "Cool Hand Luke" is written by Luke Verghese. Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.
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