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Beyond betapharm

Dr Reddy's Labs has learnt plenty from a global acquisition that went spectacularly awry. Just one of those lessons: Build depth before breadth.

E. Kumar Sharma | Print Edition: March 21, 2010

February 16, 2006: Dr Wolfgang Niedermaier, CEO of betapharm Arzneimittel GmbH, Germany's fourth-largest generics company, is ecstatic. The Hyderabad-headquartered Dr Reddy's Laboratories has paid around Rs 2,550 crore to buy out betapharm, making it the largest overseas acquisition by an Indian pharma company. "We fit into Dr Reddy's like a piece in a jigsaw puzzle," beams the good doctor, in a chat with BT two months after the acquisition is announced.

Little did Niedermaier, who has since left the company, realise that what was to unfold was the puzzle itself. Just a year after the acquisition, the German healthcare market changed almost overnight. Drug prices came crashing down as the German government took to healthcare sector reforms, turning the once attractive branded generics market into a predominantly commoditised, tender-driven business.

Result: The carrying value (the fair value in accounting terms for the operations) of betapharm is down to e90 million from the acquisition cost of e480 million after four rounds of impairments in its books. The Indian company, for its part, has been feeling the pain of the buyout-gone-bad—it went into the red in 2008-09, thanks to huge write-downs because of betapharm. This is essentially due to a non-cash charge in the books because of loss in betapharm's value.

To ensure it is viable, Dr Reddy's brass has been working on betapharm's cost structure—four years after the acquisition, 35 per cent of betapharm's products (by value) have been transferred to India, and the workforce downsized from 400 at the peak to around 80 today. At the same time, the German major's business model has been modified to make it more attuned to winning tenders.

 WHAT WENT WRONG IN GERMANY...

  • Government ushered in dramatic reforms in healthcare just a year after Dr Reddy's acquired betapharm.
  • Virtually overnight, an attractive branded generics market changed into a commoditised tender-driven business.
  • Dr Reddy's hurtled into the red in 2008-09 because of huge write-downs in its books.
  • betapharm's operations scaled down from sales of e150 million in 2008-09 to e100 million this year.

... AND HOW DR REDDY'S IS ATTEMPTING TO STEADY THE SHIP.

  • Changed betapharm's business model to make it more attuned to winning tenders.
  • Cost structure is leaner today.35% of products (by value) transferred to India (with scope to transfer another 20%).
  • Workforce downsized from 400 to 80.
  • Focus sharply on just five global markets (including Germany) apart from presence in around 10 others, as against over 30 earlier.
But making betapharm — and, therefore, Dr Reddy's — work is going to be a long haul. "I don't think we have dealt with betapharm. What we have dealt with is writing down the value of betapharm, and we have cut costs," says G.V. Prasad, Vice Chairman and CEO, Dr Reddy's Labs, adding: "We have not grown but shrunk the business." Prasad is clear what needs to be done: Turn around betapharm, "convert it into a growth engine and create value out of it. It is still an unfinished task and will take another 2-3 years," he adds. It is, perhaps, because of uncertainties like these that there are reports that big MNCs like Glaxo and Pfizer could be eyeing a stake in Dr Reddy's.

The e90 million question today, however, is how much lower can betapharm's value go? Umang Vohra, the 38-year-old Senior VP and CFO of Dr Reddy's, is confident that "we think it has reached a bottom as the sales of betapharm this year are expected at e100 million (as against e150 million in the previous year); so a carrying value of e90 million justifies the scale at which we are operating there." A Mumbaibased analyst, who has tracked the company for years, agrees: "betapharm will no more cause ulcers for Dr Reddy's."

The company knows a thing or two about treating ulcers—it's made a small fortune by knocking off the generic version of the best-selling anti-ulcer drug, Zantac. But it's not just betapharm that's a source of heartburn for the Dr Anji Reddy-founded, innovationfocussed drug major. US operations have been plagued with product recalls, and audits by the US Food and Drug Administration have impacted production schedules. That explains why revenues for the third quarter of 2009-10, at $373 million, were 6 per cent lower than a year ago, and the consolidated bottom-line was in the red to the tune of Rs 522 crore. For a company that's committed to becoming a $3-billion entity by 2013—nearly double its revenues for 2008-09—the current setbacks are not encouraging.

To be sure, Dr Reddy's future hangs not just on betapharm's fate but going beyond it to build a solid base for operations in key global markets. And it's here that learnings from the betapharm experience will stand the company in good stead. For instance, like Germany, a number of overseas markets are getting price-regulated, and Prasad's shift in strategy, to go after government tenders, will come handy in such countries, too.

Consider Russia, for instance, where the government has been talking of imposing some form of price control. For Dr Reddy's, clearly, the worry is whether its Russian operations— which along with the CIS Region account for some 13 per cent of sales— will also go the betapharm way. "Given our experience in Germany, we think we are better prepared to catch early signs and act quickly," says Vohra, although he does not think Russia is another Germany in the making.

That's because, adds Vohra, Russia imports a lot of medicines and 40 per cent of the total Russian market is over-thecounter (OTC). Another big opportunity there is biosmilars (newer versions or generic equivalents of biopharmaceutical products whose patents have expired). Both OTC and biosimilars would not come under the purview of price control. That's why Prasad has, in fact, shortlisted Russia and the CIS amongst the company's five key markets. His mantra today is "build depth before breadth". The other markets it will focus sharply on are the US, Europe (mainly Germany and the UK), and India. Till 2008, Dr Reddy's had spread itself thin across as many as over 30 markets, including such countries as Trinidad and Tobago and Haiti. Today, that number is down by half, and will go down further.

For each of its key markets, Dr Reddy's has worked out a different strategy. For instance, in the markets of the US and Europe, the company will focus on generics that are either difficult to make or in which competition is limited. For Russia, it will be OTC and biosimilars. And in India, the game plan is to move into rural markets and aggressively launch products.

But then, analysts point out, Dr Reddy's isn't the only Indian pharma firm following such a strategy of tapping niche opportunities. Lupin, for instance, is targeting the less-competitive oral contraceptive market in the US, which is worth close to $4 billion. What's more, Lupin has built a significant presence in Japan, the world's second-largest pharma market, where the government has introduced reforms to increase consumption of cheaper generics. Analysts at Angel Broking reckon that makes Japan "a high-growth market".

Yet, there's little doubt that margins are going to be under pressure for Indian pharma as more and more countries follow the European model of price control. Says Prasad: "We need to have globally-competitive costs, for which the whole company must be oriented towards competing in commodity markets with a low-cost structure and a frugal work culture." That, adds, Prasad, is one reason why the company's discovery and research operations in Atlanta, US, got the axe. "But that does not mean that we have given up on research," he says. The company still does innovation and drug discovery work at its facilities in Bangalore and Hyderabad.

Indeed, Dr Reddy's is one of the pioneers in drug discovery in India. However, the results are still not proportionate to the effort. The fear is that those efforts will now be compromised at the altar of cost-rationalisation. Prasad dismisses such speculation. "We have only restructured our research to spend more money on programmes and projects and less on overheads, which means our commitment to NCEs (new chemical entities) has only increased."

Yet, the fact is that the pipeline of NCEs has withered from 6-7 molecules a few years ago to just three now. The company's defence is that rigorous measures were applied to evaluate the molecules. And Prasad loves to point out that Dr Reddy's is still the only company in India with a phase III asset (Balaglitazone, Dr Reddy's anti-diabetic NCE candidate). Dr Reddy's is also widening its scope beyond NCEs to "differentiated formulations", where improvements are made in existing products.

The probability of success here is higher although returns in absolute terms won't be as huge as if an NCE gets to market. Clearly, as margins come under pressure with increasing competition and governments attempting to restrain prices, Dr Reddy's best bet to come from behind and reclaim its pride of place in Indian— and, perhaps, even Big—Pharma is to make its research and discovery efforts pay off.


THE KEY MARKETS
 NORTH AMERICAEUROPE (mainly Germany and the UK)RUSSIA AND THE CIS REGIONINDIAOTHERS
REVENUESRs 1,670.4 crore (31%)Rs 1,319.9 crore (24.5%)Rs 698.6 crore (13%)Rs 940.7 crore (17.5%)Rs 755.7 crore (14%)
KEY UPSIDESIt will be a key market, what with a host of products expected to go off-patent over the next 3 years.betapharm unlikely to be a drag anymore. Shifting of products to India helped. Also, it has been able to bag tenders in Germany.Huge opportunityto
build the OTC and oncology markets. About 40% of the Russian market is OTC. The biosimilars market in Russia is 3-4 times that of India.
In nine months of fiscal 2009-10, it launched 56 new products (as against 36 in the entire previous fiscal). Launched a rural markets initiative, which has been scaled up to a field force of 600. Moved up in domestic market from #16 to #12. 
KEY CHALLENGESMany of the products going off-patent are difficult-to-make products; regulatory delays can't be ruled out, either.Having shrunk the German business to keep it as a viable entity, the challenge now is to turn it around.The Russian government is considering pricing reforms. It hopes to leverage learnings in Germany to act fast and catch early signs of changes in Russia.Getting the new products in time for the market and leveraging a portfolio that matches the needs of the rural market. 

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