Sun Pharma Advanced Research: Strong R&D focus
Aiming to make a mark in the rarefied world of companies developing proprietary drugs
Competing in a brave new world
SPARC, the colourfully abbreviated name of Sun Pharma Advanced Research, is an innovative pharma research and development company focusing on developing new proprietary drugs in two areas - namely new chemical entity (NCE) and new drug delivery systems (NDDS). NCE programs are being developed with a focus on improving the therapeutic index and addressing limitations of the currently approved and marketed drugs. NDDS based programs are developed using proprietary drug delivery systems for existing drugs to improve patient compliance. These programs the company states are typically long gestation, high risk, and high reward by nature. Under the NDDS programme there are 12 products in the pipeline, while under the NCE programme there are 10 products under the pipeline - four of which for allergic diseases, conjunctivitis, spasticity and neuropathic pain - are under commercial evaluation.
For the matter of record the company is all ofeight year young and has a long uphill struggle ahead of it. The company has identified pharma research and development' as the only primary reportable business segment. For the year ended March 2013 the company has reported sharply higher revenues and a sharply lower pre-tax loss. That is to say the revenues from operations rose to Rs 873 m from Rs 290 m previously-up 201%. The pre-tax loss on the other hand fell to Rs 225 m from Rs 722 m previously-down 69%. In reality the figures on display make for an interesting concoction of odds and ends.
The revenue streams
The revenues per-se accrue from two income streams - technology and know how - amounting to Rs 716 m, while the sale of services-license fees and royalty on technology -tossed in Rs 156 m. Then there is other income amounting to Rs 16 m against Rs 11.5 m previously. Half the other income receipt in the latter year is on account of the gain on sale of current investments. From the manner in which it collects its revenues it is obvious that the bulk of the research is being done on behalf of foreign principals. (To earn the revenue streams, the company spent a total of Rs 1.1 bn - in both capital and revenue expenditure against a marginally lower Rs 1 bn previously). The noteworthy feature of the R&D expenditure is that it exceeds the revenues derived in either year. Almost 98% of the revenues from the sale of products (technology/knowhow) were in forex receipts, while 27% of the income from the sale of services (license fees/royalty on technology) was also in forex. Incidentally, the company has a spate of dealings with group companies both on revenue and capital account. We will delve more on this development of inter-se dealings later on in the copy.
The two biggest items of revenue expenditure by far are 'employee benefits' and 'Other expenses';. Employee benefits amount to Rs 366 m while the latter amounts to Rs 582 m. The cost of materials consumed amounts to a relatively paltry Re 93 m. What is most interesting here is that the principal item of outflow under the head of 'Other expenses'; is 'clinical trials and professional charges'; amounting to Rs 411 ---down 11.6% over that of the preceding year. This outflow accounts for almost 71% of all expenditure under the head 'Other expenses';. But the catch here is that close to 88% of this expense is incurred in foreign currency. Is one to understand that the clinical trials were conducted in foreign shores? If so, then, what is the value addition in India barring the employee benefit expenses? This is all rather puzzling to say the least. Besides, what is the need to incorporate a company in India to conduct almost all its principal activity in foreign shores? The interesting development from the expenditure on clinical trials is that the revenues have rocketed on declining clinical trials spend. Does one read something from this development?
The foreign revenue streams
In reality and as stated earlier there is a twist to the tale. The foreign revenues are almost entirely accruing from a group company - -Sun Pharma Global FZE. The sale of products to it amounted to Rs 686 m (98% of all revenues in foreign currency), while the sale of services to it amounted to Rs 42 m (100% of all revenues in foreign currency). There was also sale of services to a spate of other group companies. It sold services worth Rs 26.4 m to Sun Pharmaceutical Industries Ltd, Rs 44.7 m to Sun Pharma Medication, Rs 26m to Sun Pharmaceutical Industries (is this company separate from the earlier mentioned group company?), Rs 9.7 m to Sun Pharma Drugs Pvt Ltd, and Rs 4.4 m to Sun Pharma Sikkim. The total sale of services to group companies amounts to Rs 156 m. In other words the sale of services was made entirely to group companies. The bigger question to this jig-saw puzzle is what Sun Pharma Global FZE did with the products that it purchased? Was this company only an intermediary or some such? And, if all the services are being offered to group companies, is SPARC being adequately paid for its troubles? The way it pans out is that SPARC had forex earnings of Rs 741 m and forex outgo of Rs 420 m. It will help if the company can make good on such seeming anomalies.
The company is also fortuitous that it is able to save on some major revenue expenses. The total borrowings at year end amounted to Rs 803 m against Rs 683 m previously. The interest component debited to P&L account amounts to only Rs 40 m against Rs 2.7 m previously. The quantum of interest debited to P&L account does not reflect the true cost of borrowed capital. The catch here is that the company has borrowed a lump sum of Rs 738 m from a 'related party'; at year end. In the preceding year such borrowings amounted to Rs 610 m - but this borrowing was from 'other parties';. The loan was availed of at a concessional rate of interest from Sun Pharmaceutical Industries Ltd-an enterprise under significant influence of key management personnel. For the matter of record there are nine such enterprises under significant influence of key management personnel with whom transactions are entered into-and eight of them have the prefix Sun. Another such is named Taro Pharma.
The shareholding pattern
It is the promoter shareholding pattern in this company which is the most curious aspect of it all. None of the group companies with which SPARC has inter-se transactions apparently have any stake in the company. The company has furnished the details of shareholders who collectively hold 55.3% of the total voting capital base (a holding in excess of 5% each). The biggest shareholder is Dilip Shanghvi with a stake of 11.3%. This holding is followed by five private limited companies with fanciful and odd sounding names (what';s in a name anyway?) that hold another 43.9%. The total promoter holding in the voting stock of Rs 236.7 m amounts to 67.1%--including holdings below 5%.
But the company is still seriously out of pocket, given its inability to generate cash from operations. In 2012-13 it was in hock to the tune of Rs 953 m in cash flow against a negative cash flow of Rs 694 m in the preceding year. The higher negative cash flow was due to the negative changes in the working capital position during the year. To set right the anomaly the company resorted to a two pronged attack. It issued capital at a very judicious premium which rolled in Rs 2 bn in cash. This led to a marginal increase in the share capital to Rs 236.5 m from Rs 207 m previously. The reserves and surplus consequently shifted direction from a negative figure of Rs 873 m to a positive figure of Rs 847 m as the reserves and surplus got loaded with share premium pickings of Rs 1.94 bn. This was one part of the equation to balance its books. The other part as stated earlier was the company resorting to additional borrowings from group companies during the year.
The future imperfect?
More to the point what is the future of this company? The company adds a note of warning here. It states that ' the cost of bringing a new molecule to market is estimated at USD 1.2 bn. Industry experts estimate that on an average out of 10,000 molecules being developed only one or two are likely to reach market. Indian companies at this point have limited capacity to take this risk';. This should be enough to give anyone venturing into this business the frights of frights. But the Shanghvi';s are not deterred. The fact of the matter is that the promoters of SPARC have just made a big ticket investment in this company. Group companies have also advanced large sums at favourable rates of interest. Obviously the group sees a spark somewhere in the horizon. And therein hangs a tale. For the matter of record, the share price (Re 1 paid up) wavered between a high of Rs 145.80 and a low of Rs 66.75 during the year. That per se works out to a sharp movement in the share price and represents pretty good going sort of.
Disclosure: I do not hold any shares in this company, either directly, or under any non discretionary portfolio management scheme
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.
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