‘’We expect MNCs to bring in next generation products and improve accessibility’’

Globally, pharma companies are facing increased regulatory scrutiny and government pressure to bring down the price of medicines. How are they looking at developing/ emerging markets like India in terms of takeovers, etc.?

Mahesh Singhi

Despite the regulatory scrutiny by other countries or restrictive pricing policies being adopted by our government, pharma sector still remains a lucrative space for takeovers or strategic investments, but with a cautious approach. Even after factoring the relative slow-down and dearth of visible large-sized transactions, the underlying industry drivers, including substantial advancement by the Indian API manufacturers, make India an attractive destination for global pharma companies.

Pharma companies in India are also under a lot of stress given the increased regulatory scrutiny of global regulators like the US FDA as well as pricing pressures by the Indian regulator. Are they stressed enough to contemplate exiting the sector?

Many Indian pharma companies are developing fatigue, not only due to high regulatory scrutiny from global regulators such as US FDA but also because of margin pressure in the domestic market. As the result, many Indian companies which lack the required sustaining capital, organisational strength, access to advanced technologies and global exposure, are generating some level of stress in certain companies, mostly mid-sized, leaving some of them open to accept strategic options, either to survive or to partially/fully exit/monetise and de-risk themselves.

If so, what could be the possible solutions for such companies in the near and long term?

Global players can bring their global experience and access to the global market, advanced product lines and scale of operations to benefit such Indian companies and in turn benefit themselves by getting access to low-cost, fast-growth markets like India. Such synergies and mutual needs may result into multiple joint ventures (JVs), strategic investments and staggered/planned buyouts between the global players and Indian companies wherein the strength of each can be leveraged to stitch a win-win investment structure. In the past we have successfully completed many such transactions across different geographies.

As per your estimates, how many such cases exist and are actively looking for options? Are the valuations meeting expectations from both sides?

I cannot put down the exact number of cases at this stage. But, we are in the know that many companies from India and abroad are in constant touch to explore these options and even Singhi Advisors is currently handling three such assignments. Certainly other firms would also be engaged in similar transactions. The rate of buyouts will certainly have an upward trend this year also.

Apart from pure domestically-oriented or branded generics formulation companies, most of the independent API players and sub critical sized pharma companies, including contract manufacturers, are facing multiple pressures and resultant stress. The key issues being faced by most of them is below optimal level of operations, stretched working capital cycle and above all lower RoCE, much in the range of 8-12 per cent, which doesn’t even cover the cost of borrowing (12-13 per cent), making the enterprise succumb to financial pressures and eventually becoming available for sale. In a distressed situation as above (APIs, contract manufacturers), there are many valuable assets which are potentially available for acquisitions but would make it difficult for many global companies to acquire the same as many of them are in default/non performing assets (NPAs) with lenders or under corporate debt restructuring (CDR), making it quite cumbersome to take it out of the clutches of stakeholders with diverse interest. There are about six critical sized API players and a couple of contract manufacturing units. Their cumulative exposure towards lenders are in the range of Rs 10,000 crores. This has been referred to CDR or are already NPAs with the lenders. However, some of the business, despite facing financial distress have been able to attract fantastic valuations, based on the earning capabilities of the underlying business or brands, such as Elders’ acquisition by Torrent.

At the end of it, transactions take place at a level where either party doesn’t have an option better than what comes as a result of the negotiations.

What kind of global entities have already targeted such stressed Indian pharma companies and why?

The indicators show that more mid-sized companies will be targeting Indian firms in the time to come. Especially those looking for a global generic route will eye the Indian companies. Financial stress, and as a result, cheap valuations in the Indian market would not be sufficient enough reason for any global company to look for an acquisition in India but it would depend largely on the value-building capability or possible integration to the global business chain. Even for Indian companies, the stress itself would be a result of the lack of organic growth or sub-optimal level of operations or cash-flow mismatch, and unless the transaction results into fulfilment of such gaps, the principal stakeholders would never come to terms with the transaction As such, business integration, market access and complementary needs added by fulfilment of financial obligations towards the seller’s creditors would be the key drivers for transactions between global and Indian companies under stress.

Some recent M&As would further explain this.

• Mylan acquired SMS Pharma to expand its oncology API product portfolio. Deal valued at $32.5 million.
• Hospira acquired certain API manufacturing and R&D facilities of Orchid Chemicals and Pharmaceuticals. Orchid being in deep financial stress.
• Mylan acquired the sterile injectable business of Strides Arcolab’s Agila Specialties in a $1.75 billion deal. Agila would bring a portfolio of 300 global filings, including 61 abbreviated new drug applications (ANDA) in the US, and a marketing network covering 75 countries. Strides was not in immediate financial stress but they were hugely invested and leveraged which could have posed future stress.
• Mylan also acquired a new formulation facility from Unichem Laboratories (Madhya Pradesh) for $26 million.
• Rohto Pharmaceuticals, a over $2 billion Japanese company, being the largest OTC healthcare company in Japan, entered into a JV with Sunways Group, India to set up a state-of-the-art global manufacturing facility in Gujarat for manufacturing advanced eye care and skin care products. Advised by Singhi Advisors, Sunways was not in a financial stress but didn’t have the required financial resources and matching global access to be in a position to do the same on their own.
• Similarly, $700 million ARKRAY from Japan acquired the In Vitro Diagnostics (IVD) business from India’s largest player in IVD, Span Diagnostics, a deal advised by Singhi Advisors, whereby Span was a prominent player in India but the margins were in constant pressure and sales stagnating in the absence of next level of product lines, which Arkray had to its advantage.

Do you think that promoters of pharma companies who opt for takeovers/buyouts will regret their decision?

Any promoter including those of pharma companies would assess existing risks associated with their businesses, possible future growth or stagnation with the company and relative valuations/options in hand while factoring in their limitations and challenges before concluding any transaction. So there could still be some who may find it otherwise. But most often, post 100 per cent sale, Indian promoters usually align themselves to reality. The exceptions are in the JVs or partial sell situation, where both parties as continuing partners may get stuck with each other if the intended plans don’t materialise. It is difficult to comment whether these deals would disappoint or content the promoter. Only time will tell.

Will such deals have an adverse impact in the future from the point of view of patients, the pharma industry and finally the country’s economy?

We believe that as the number of serious MNC participants in the market increases, it will create a healthy competition that will in turn benefit the patients, industry and the country as a whole. Apart from this, we also expect these MNCs to bring in next generation products and improve accessibility to expand its generic and patented portfolio to the Indian patients. On the other hand, we also hear a lot of voices/opinions on the possible future cartelisation in the pharma industry by a few MNCs, like one seen/heard in many other industries. However, positive and proactive monitoring by the regulator can help in avoiding such a situation.

Do you sense any big deals in the offing, like the Ranbaxy-Daichii or Piramal-Abbott deals? Why?

India not only has strong expertise in manufacturing high quality, complex pharma products, it also has a large under-serviced market which is driving the growth of the Indian market. Acquisitions in India makes strategic sense from a broader and longer term view, however given that most of the global players now have their presence in India and the targetted Indian companies are few in number, the pace would slow down for sure as far as big ticket deals like Ranbaxy-Daichii are concerned. Hence, we firmly believe that the M&A action in mid-size companies is going to be far more than in the large companies.

What is the market sentiment for buyouts between Indian companies like the one between Elder and Torrent?

Market sentiments may not be the best in terms of financial structuring, but strategically we think it was very positive. There is a clear trend of consolidation and good assets/brands shifting/transferring from weaker hands to stronger hands. We saw a similar situation last year when Cadila Healthcare bought out Biochem. Consolidation is inevitable and we strongly believe that the government and banks should support such domestic transactions. In cases like that of Elder, the banks were among the happier lot. With the high multiple being enjoyed by many mid to large sized companies.

Will the US FDA ban on drugs manufactured at Ranbaxy facilities hamper the image of the Indian pharma industry globally and how much? Will this dampen investor sentiment?

It hampers the image to an extent, but ideally this should not dampen the sentiment of long term investors as this was a one-off event/situation. Mylan, Hospira, Abbott, Reckitt Benckiser and many other MNCs who have done M&A in the last decade are happy with their deals. And ‘caveat emptor’ or ‘Let the Buyer Beware’ is the contract law principle. The law tells us that based upon this principle it is important, as a prudent purchaser, to make a careful inspection of the assets/company you are considering to buy.

Indian regulators are at an early stage of formalising regulations for medical devices and incorporating it under the Drugs and Cosmetics Act. Throw some light the global framework and its relevance in India?

Medical devices are heavily regulated globally and regulations touch every stage of the life-cycle: R&D, clinical trials, pre-market approvals, manufacturing, labelling, and ultimately, marketing. Under the US FDA and the European CE Marking agencies, medical devices are regulated for quality and patient safety under a separate pathway from pharma drug regulations. Although pharma products have been regulated since 1940, medical device regulation is relatively new in India. The Indian government proposed regulatory guidelines for medical devices in 2008, through amendments to the 1940 Drug and Cosmetics Act (DCA). The new Drugs and Cosmetics (amendment) Bill, 2013, which was introduced in the Parliament already, has some solid provisions and it is a right step forward. The parliamentary standing committee, which already examined the bill, has practically denounced the central drug authority but did not turn down the proposed clauses for the medical devices sector. Since the Central Drugs Standard Control Organisation (CDSCO) currently ensures pre-market reviews of only certain devices, all other devices do not require registration prior to sale in India. Imported medical devices on the notified list, those that have already obtained approval in the US (by the FDA) or the European Union (by CE Marking) are allowed in the Indian market without undergoing separate conformity assessment procedures.

Recently, the Government of India has allowed 100 per cent FDI in the existing pharma firms while mentioning that the ‘non-compete’ clause would not be allowed except in special circumstances with the approval of the FIPB. Is more clarity required on this issue?

As earlier, 100 per cent FDI is allowed in both greenfield (new) and brownfield (existing) projects through automatic and approval route respectively. However, the recent change has a rider, a ‘non-compete clause’ which would not be allowed except in special circumstances with the approval of FIPB.

The non-compete clause is a customary part of any M&A and carries a strategic logic whereby it restricts the promoters of target companies from venturing into the same line of business for a specified period. Singling out an industry and putting restrictions without clarity will create confusion in the market although the sensitivity of this sector in view of its human cause can’t be ignored altogether.

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