M&A or MIA?

M&As have for long been the route to faster inorganic growth for companies looking to ramp up their presence in an increasingly competitive market. With the Indian pharma industry expected to grow at a CAGR of 15 per cent till 2014, one of the fastest in the world, it has always been topmost on the expansion strategy of big pharma. After the big ticket deals that India saw till 2010, including the takeover of Ranbaxy Laboratories by Japan-based Daiichi Sankyo and Piramal Healthcare Solutions Business unit by Abbott Laboratories in the US, the M&A bull run seems to have mellowed down almost giving an impression that it is missing in action (MIA). However, scratch the surface and there are new trends and a cautiously positive outlook despite gloomy figures that convince us otherwise.

Slow and steady

Last year saw key outbound acquisitions by Zydus (Nesher Pharma) and Vivimed Labs (Uquifa), and inbound acquisitions by Hikma (Unimark), Akorn (Kilitch), Par Pharma (Edict), Cilag GmBH (JB’s Russian brands) and Aventis (Universal Medicare) along with a few smaller domestic transactions in the formulations space. The most notable transaction was the disposal by Strides Arcolabs of its Australian business to Watson Pharma, for nearly $393 million. However, M&A activity in the first half of 2012 has been the lowest in three years down 19 per cent from the corresponding period last year, although pharma, biotech and healthcare together accounted for the second highest share of 15 per cent (Source: Dealtracker Pharma, Grant and Thornton). Analysts also point out other reasons, specific to the sector, for the sober performance.

Regulatory slowdown

“The outlook for inbound M&As remains more cautious owing to the brownfield expansion uncertainty from expansion of price controls, the recent compulsory licensing move and unclear FDI norms.” Karan Singh Head, Asia Healthcare Practice, Bain & Company

Towards the end of 2011, a stricter regime for foreign acquisitions was launched requiring existing Indian companies to seek government approval for FDI with all future proposals to be routed through the Foreign Investment Promotion Board (FIPB). This has increased the time length of approval thus making companies approach any deals gingerly. The sentiment is echoed by Karan Singh, Head Asia Healthcare Practice, Bain & Company, “The outlook for inbound M&As remains more cautious owing to the brownfield expansion uncertainty from expansion of price controls, the recent compulsory licensing move and unclear FDI norms.”

“We believe FDI in the industry is necessary as it enables domestic companies to get patient capital to invest in R&D and high-risk, high-return areas such as biologics and biosimilars.” Mahadevan Narayanamoni Partner – Corporate Finance, Grant Thornton India

FDI is required even for domestic consolidation in the form of private equity. “We believe FDI in the industry is necessary as it enables domestic companies to get patient capital to invest in R&D and high- risk, high-return areas such as biologics and biosimilars. It also helps ease the pressure on companies which are carrying high-cost debt,” says Mahadevan Narayanamoni, Partner, Corporate Finance, Grant Thornton India.

From aggression to caution

“Globally the pharmaceutical business model is going through the ‘perfect storm’ and is evolving to one of risk-sharing partnerships. The number of such partnerships / alliances has doubled to ~ 300 in the year 2011, up from the level of ~ 150 per year seen during 2008-2010.” Krishnakumar V Partner, Ernst &Young

While regulatory pressures have slowed down inbound deals, Indian companies investing abroad have become cautious. This is a far cry from a few years back when they were aggressive in their pursuits. “Till early 2008, Indian companies, driven by the availability of cheap capital, indulged in international M&A without clear focus on valuations and the strategic-fit of the targets to their business objectives,” pitches in Krishnakumar V, Partner Ernst & Young. “Bulk of these deals were funded by capital raised through FCCBs during the years 2006 and 2007. Indian pharma companies had mobilised around $ 2.3 billion through FCCBs during these two years. Increased market uncertainty, weak capital markets and poor performance of the acquired businesses have helped tone down the frenzy since then, and the handful of mature buyers left in the Indian pharma market today, are more focused than ever before on strategic fitment of targets – in the form of products, clientele, market-access, technology, IP and regulatory-approvals.”

High valuations

Indian pharma companies are valuations rich given their strong generic capabilities. Expectations have been high after historic deals such as Ranbaxy (sold at four times its sales), Piramal Healthcare (sold at nine times its sales) and Paras Pharma (eight times its sales). There have not been many deals with promoters wanting excessive valuation / big valuation. However, various small deals with valuation of $ 50-100 million such as Universal Medicare-Sanofi and Biochem PLC- Zydus have taken place recently. Analysts believe that companies genuinely wanting to sell are willing to transact at reasonable valuation.

Unrealised potential

There are a lot of companies with capacity willing to cede controlling stake in the API intermediates space. However, with an increasing demand for US FDA approved facilities (which they don’t have), the transaction opportunity here is not possibly being maximised.

No product differentiation

Most of the Indian companies have grown in size by focussing on a single product. “This leaves only a few handful targets which remain attractive in terms of their product pipelines thus making them ready assets for companies on the look out. With MNCs already having a historical presence in India and similar product offerings of, there is less value a deal offers to a foreign investor,” opines Shiraz Bugwadia, O3 Capital Advisors.

Future Trends

According to Narayanmoni, India would continue to be an attractive investment destination for companies since it offers access to good quality manufacturing capacity across the generic pharma spectrum (especially in areas such as injectables, with only a few US FDA approved facilities abroad). Access to a fast growing Indian pharma market, talent and R&D capability / facilities for new product development alongwith domestic consolidation in several sub-sectors (APIs, intermediates and branded generics) would work in its favour, he adds. There are other trends that would define the deals going ahead.

Emerging markets ahoy!

Traditionally, Indian companies began by acquiring companies in the US and EU, but this is finally giving way to newer, emerging markets with untapped potential, where the outlook for generics is favourable. Several companies are looking at markets such as Indonesia, Latin America and Africa to expand their footprint by aligning or tying up with distribution partners, given an increasingly competitive and regulated domestic pharma market. This helps build up their value, as they in turn would be deemed attractive targets by global pharma companies looking to expand their footprint in these new markets. Japan has historically been the slowest developed market to make a move towards generics, but it looks promising in the coming years.

Can’t acquire? Partner

Says Krishnakumar of EY, “Globally the pharmaceutical business model is going through the ‘perfect storm’ and is evolving to one of risk-sharing partnerships. The number of such partnerships/ alliances has doubled to ~300 in the year 2011, up from the level of ~150 per year seen during 2008-2010.”

“M&As are giving way to JVs, wherein both partners focus on their core competency while still retaining their identity. It is a win-win partnership for both unlike M&As where the freedom comes with riders.” Ajay kumar Sharma Associate Director – Pharma & Biotech – Healthcare Practice South Asia & Middle East Frost & Sullivan

This statement is echoed by Ajaykumar Sharma, Associate Director – Pharma & Biotech – Healthcare Practice, South Asia & Middle East, Frost & Sullivan, “M&As are giving way to JVs, wherein both partners focus on their core competency while still retaining their identity. It is a win-win partnership for both unlike M&As where the freedom comes with riders.” Regulatory reforms, India’s strength in manufacturing and a reluctance of Indian companies to sell off would see foreign partners looking to participate by inking strategic alliances.

Selective acquisitions

While a desire to scale up and get market access in emerging markets (irrespective of the product portfolio) would drive mid-scale companies, companies looking to be global players, would rather look at the specific products in the basket before making the decision. For instance, Abbott bought the domestic formulations business of Piramal Healthcare to gain a leadership position in the segment in the Indian market. There are few companies of their ilk in India who would have such an acquisition strategy and financial bandwidth to execute a mid to large transaction. Companies are also rethinking their strategies after having seen the consequences of the Biocon-Pfizer deal and Dr Reddy’s acquisition of Betapharm and hence they are careful, remarks Sharma.

R&D driven deals

While outbound deals would not be R&D driven on account of the historical inability of Indian companies to meet valuation expectations of such targets overseas, there are a limited number of companies that will be attractive to a global pharma player from a pure R&D perspective in India with respect to inbound deals. “We have to understand that R&D is more than just developing NCEs or NBEs, the product development aspect of R&D is also critical and valuable and can be a key driver for inbound deals going ahead,” asserts Narayanmoni.

Consolidation in domestic formulations

Plagued by challenges in competing without scale, pricing pressure in some areas with price control norms and succession planning issues, small to mid-cap companies with revenues ranging from Rs 30-150 crore having a specific geographic focus or product portfolio are increasingly looking at selling out. With valuation expectations normalising, this segment will see increasing consolidation.

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