In the wee hours of April 7, news broke that Sun Pharmaceutical Industries Ltd would acquire Ranbaxy Laboratories Ltd for $3.2 billion, or roughly Rs 19,286 crore (the deal size is $4 billion if you factor in Ranbaxy's $800-million debt).
The landmark deal makes Mumbai-based Sun Pharma not only the country's largest drug company, but also the world's fifth largest speciality generic drug maker with revenues of $4.3 billion. That is just half way, in terms of size, to the global generics leader Teva, the role model of generics companies worldwide.
What set this all-stock, no-cash deal apart, at least financially, was this equation: Japanese pharma giant Daiichi Sankyo's 63.4 per cent stake in Ranbaxy was equated with a nine per cent stake in Sun. In 2008, Daiichi Sankyo took a big bet in generics when it bought into Ranbaxy, based in Gurgaon, near Delhi. Ranbaxy's market cap today is $3.2 billion. The deal has made Daiichi Sankyo the second largest shareholder in Sun.
The man of the moment is Sun's founder, 59-year-old Dilip Shanghvi. The commerce graduate embarked on his entrepreneurial journey in 1983 with a small factory in Vapi, Gujarat, to make tablets and capsules, aided by a marketing team of just two people.
To acquire Ranbaxy, instead of paying cash he leveraged Sun Pharma's market capitalisation. G.V. Prasad, Chairman and CEO of rival drug maker Dr Reddy's Labs, describes it as "a smart move", and adds that Sun Pharma now has a good presence not only in India but also in emerging market. He notes that "Ranbaxy is a low-cost acquisition, as its peak market cap was much higher" than it is now. He adds: "Sun has the ability to acquire distressed assets and turn them around," he says. "They have done this with Taro and Caraco."
In his April 7 conference call with analysts, just after the deal was announced, Sun's Shanghvi referred to his company's acquisitions since 1995/96, saying: "We acquired Taro in 2010, and from an EBITDA [earnings before interest, tax, depreciation and amortisation] of less than $100 million, we have in the last three years been able to reach an EBITDA of close to $400 million... with almost no change and the same people... by running the business with a clear focus and running it efficiently."
But Ranbaxy will be no cakewalk. The value of the latest deal is more than all of Sun's 16 previous deals put together, and Ranbaxy's problems are serious. Daiichi Sankyo, which coughed up $4.6 billion for its stake in Ranbaxy in 2008, announced in January 2009 that it was making a $3.8-billion write-down. It was to record a valuation loss and a one-time write-down of goodwill on its investment in Ranbaxy for the quarter ended December 31, 2008. In a note on January 5, 2009, the Japanese company said: "On a non-consolidated basis, Daiichi Sankyo plans to record a non-cash valuation loss of 359.5 billion yen [more than Rs 21,210 crore today] on its shares in Ranbaxy in its fiscal third-quarter to reflect a more than 50 per cent decline in the market value of these securities versus the purchase price."
So Sun Pharma's challenge in the Ranbaxy deal is not just financial, but also one of regulatory compliance. Soon after the deal, Shanghvi said he acquired Ranbaxy because of the "overall business value" of the deal, rather than its "one-time costs" and losses incurred on hedging on the dollar. He says his decision was driven by the "underlying business in India and emerging markets, and its robust pipeline and profitability".
Sanjiv Kaul, Managing Director at ChrysCapital Investment Advisors, who worked at Ranbaxy before 2004 and knows the company well, says the deal is in the best interest of all three companies - Sun, Ranbaxy and Daiichi. Ranbaxy, he says, is "finally, at long last, getting direction and a strong leadership, which was missing for the last 10 years". Daiichi, he says, found the "face-saving exit" it was looking for. And Sun Pharma, he says, "has bought a good asset at an attractive valuation... the very fact that they have bought the asset at virtually half of what Daiichi paid eight years ago shows the strength of the bargaining power and diligent eyes of Dilip Shanghvi".
So what can he do to salvage it? Conversations with analysts have underscored two broad concerns. One is how Sun will leverage Ranbaxy's pipeline of approved drugs (or those in the pipeline), given that a regulatory turnaround could take a couple of years.
But there are larger issues at stake in this deal. ChrysCapital's Kaul says: "Ranbaxy has seen individual creativity and entrepreneurial culture change to a systems orientation under Daiichi, with its people caught between the two today." This, he says, makes it different from, say, Taro, where cultural differences were the result of geographical peculiarities (and which was also a much smaller acquisition).
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