The Making of a Merger

Mergers and acquisitions have always been a favourite of the pharma industry. Inspite of this, 2007 had only 25 M&As in the Indian pharma industry. Sushmi Dey finds out where India stands on the M&A front and what it takes to have a successful merger…

Mergers and Acquisitions (M&A) have always been a buzz word for any industry to grow. In 2006, the domestic pharma companies had executed more than 40 deals with 32 cross-border transactions worth about $2,000 million. This included big ticket deals like Dr Reddy Laboratories' acquisition of Betapharm of Germany for Euro 480 million (Rs 2,550 crore) and Ranbaxy's Terapia buy in Romania for $324 million (over Rs 1,250 crore), according to industry reports. Although the year 2007-08 has not seen much M&As happening on the Indian pharma front, experts say that the game is not yet over. The Indian pharma industry witnessed only 25 M&As, with 15 cross border transactions with an estimated value of about $600-700 million in the Indian pharma sector.

Why not happening?

The major pharma M&As in 2007 were Wockhardt's acquisition of the French company Negma Laboratories for $265 million (Rs 1,045 crore) and the US-based Morton Grove Pharmas for $38 million (Rs 150 crore), Jubilant Organosys' acquisition of Hollister-Stier Laboratories of the US for $122.5 million (about Rs 500 crore) and Alembic's buyout of the entire domestic non-oncology formulation business of Dabur Pharma for Rs 159 crore. Sun Pharma's acquisition of Israel's Taro Pharma for about Rs 1,800 crore has not yet been completed as it awaits shareholders' approval.

Overall, Indian majors were not so active on the M&A front this year, as compared to smaller and mid-sized firms, although these deals were comparatively small. In July, Elder Pharma acquired 20 percent stake in Neutra Health of UK for $11.55 million and 51 percent stake in Biomeda Group of Bulgaria in an all-cash deal worth Euro 5 million. Plethico Pharma's buyout of US-based Natrol for about $81 million and Strides Arcolab's acquisition of Italian firm Diaspa's fermentation assets, were some of the other buyouts.

"There can various reasons behind this slow down," says Sujay Shetty, Associate Director, PricewaterhouseCoopers. According to Shetty, investors are staying away because of litigations and the increasing cost of litigations. There are also uncertainties regarding Para IV which also effect the investors' decision. India also offers risks from generic spaces.

According to Utkarsh Palnitkar, Partner-Transaction Advisory Services and Leader- Policy Investment Advisory Services, Ernst & Young a large part of India pharma M&As is driven by cross border focus of India's pharmacos. In this context, global M&As as a whole has seen a fall in activity by almost 35 percent in the second half of 2007 mainly due to an increase in borrowing costs and the tightening of banking activities in underwriting large transactions.

"There is a need for greater consolidations both with big players as well as domestic players. However, it is difficult because of stock markets becoming stronger," suggests Shetty. "While the appreciation of the Indian currency has resulted in acquisitions becoming relatively less expensive, it also seems to have an adverse impact on companies that seek global consolidation of dollar revenues. This in turn might have resulted in a slow down or postponement of several decisions on large M&A transactions," adds Palnitkar.

On the domestic front, general appreciation in capital markets seems to have indirectly resulted in an increase in price expectations. However in the longer term, these changes are likely to be evened out by the ambition of India pharma companies to go global, opines Palnitkar.

"The Indian generic industry is growing at almost a rate of ten to 13 percent which is much more than the global industry which is growing at four to five percent. India is a growth market regardless of all the negatives and problems" - Sujay Shetty Associate Director PricewaterhouseCoopers

"A successful game plan requires a right mix of risk taking (valuation), risk mitigation (due diligence) and action orientation (post transaction integration" - Utkarsh Palnitkar Partner-Transaction Advisory Services and Leader- Policy Investment Advisory Services Ernst & Young

M&A benefits

However, inspite of some slow down in M&As in the pharma segment last year, the fact remains that the pharma industry is an M&A favourite. M&As prove beneficial for pharma companies as a growth strategy. It is more economical to buy out or merge with a premium than to invest in a start up which involves an element of uncertainty. There is also the benefit of scale of operations that can be achieved through M&A. "Building new businesses in new segments or geographies requires significant initial investments which might lead to a drag on the company's profits until the business reaches critical size," explains Palnitkar. M&A transactions also help achieve critical size in a shorter time frame, thus leading to faster return to shareholders. Larger companies are also likely to be better equipped to handle adverse impacts of regulations in an industry.

Besides, M&As also offer the biggest benefit of "time to market" factor. An M&A transaction helps pharma companies to get onto a launch pad for growth in strategically important and high growth markets. It also helps companies save significant time that might be needed to build green field businesses of similar scale.

Indian advantage

Easy availability of investment capital and increasing R&D capabilities are major factors attracting global players for M&As in the Indian pharma sector. "Consolidation in the India pharma space is imminent," says Palnitkar. The Indian market is huge. The country also offers a varied nature of diseases which works in favour of such deals as it attracts the interests of international companies.

The patent regime has also resulted in the need for new investments in R&D. "A large part of growth for the Indian pharma industry has been coming from its entry into regulated markets for generic pharmaceuticals. Lately, CRO and CMO related outsourcing has also been an area of significant growth. There are deals happening in the clinical research space. Indian companies are making R&D deals and restructuring. They need to convince the investors about their R&D pipeline and future plans. However, it is undoubtedly a risky investment but if even one molecule is developed, it will earn you a lot of money," says Shetty. There is also a new breed of companies focusing on becoming partners of choice to multinationals who seek to exploit Indian pharma's manufacturing advantage. Experts view the Indian vaccine manufacturing segment as a good example of upcoming opportunities from the global context.

However, analysts and industry experts also expect to see more and more acquisitions by Indian companies, especially in regulated markets of US and Europe in time to come. For domestic pharma companies it is the charm of the global pie. They have forayed into M&As in order to gain access to global markets. "Historically, this industry had grown and survived despite vast fragmentation. However, with the entry of global multinationals and their Intellectual Property (IP) protected product portfolio, Indian companies are bound to enter the race for survival which in turn is likely to result in consolidation," avers Palnitkar.

While Indian pharma space is becoming more globally oriented by the day, Palnitkar feels that the trend will continue to grow. "India has become a center of focus for multinationals who seek to get a share of India's strategic growth advantages. Global generic companies with high costs of manufacturing are beginning to look at India as an attractive option to mitigate their risks. In this context, the global generic multinationals are likely to find Indian generic pharma companies attractive as prospective acquisition targets," says Palnitkar. Shetty agrees with this analysis. According to Shetty, the country's generic industry is a major strength of the Indian market. "The generic market will always attract pharma companies because the need for cheap and quality life saving drugs will continue in developing nations and this is a huge market. The Indian generic industry is growing at almost a rate of ten to 13 percent which is much more than the global industry which is growing at four to five percent. India is a growth market regardless of all the negatives and problems," he says.

It is also expected that a large part of India's deal space will be covered by companies seeking to fund their aggressive growth strategies in Indian and international markets. The industry is, therefore, likely to see a large number of private equity related deals centered on capital infusion to meet growth requirements.

Funding advantage

Interestingly, the funding environment of Indian market also supports the pharma industry here. Experts expect the funding environment in pharma to continue to remain robust. According to Shetty, there is lot of money in the Indian market. "There is multiplicity of investors in the Indian pharma market. There are local investors, private investors and retail investors to pour in money," says Shetty. Agrees Palnitkar. "It will not be an exaggeration to say that Indian pharma companies have come of age in their experience of tapping financial markets to meet their funding requirements. In addition to the traditional capital market and private equity markets, companies have started exploring various innovative funding options such as Foreign Currency Convertible Bonds (FCCBs), Alternative Investment Markets (AIMs) listings and Global Depositary Receipts (GDRs) as an effective route of funding their growth requirements," says Palnitkar.

Liberal funding environment has also resulted in encouraging possibilities like increased focus on innovation and R&D spending in the country. Consequently, Indian pharma companies are now also willing to explore funding options that are specific to their R&D streams such as R&D focused private equity investments, R&D de-mergers and subsequent listing etc.

Right steps in right direction

Making an M&A successful is no child's play. While doing an M&A transaction per se might be an ego booster for many businesses, it is critical for companies to have clarity on their long term objective for such a transaction. For example, companies might want to get strategic entry into a specific geographic region or might want to acquire companies only to attain size in top line etc.

Irrespective of the objective, the bottom line is that the transaction should be value accretive to shareholders. "A successful game plan requires a right mix of risk taking (valuation), risk mitigation (due diligence) and action orientation (post transaction integration)," according to Palnitkar.

According to Shetty, while going for an M&A a company must look into cultural issues, (especially in case of overseas acquisitions), it should have greater insight into management bandwidth with stronger management professionals, should check on the regulatory issues and have proper technical understanding.

In case of cross border or overseas M&As in the pharma industry, experts suggest, one needs to be aware of the intricacies of doing a transaction in another country especially since the laws governing the pharma sector differs from country to country. For instance, the laws relating for pharma pricing, pharmacists substitution, dispensing, pharma labor and trade unions etc need to be closely studied and evaluated before taking the plunge.

Minimising risks

According to Palnikar, the three most important challenges in closing a successful M&A deal are right valuation, complete and effective due diligence and post closing integration. While each of these challenges is interlinked, they need to be addressed in a manner so as to reduce risks of loss while maximizing value from the transaction.

"The right valuation helps in mitigating the risk of over paying for a business," avers Palnitkar. The benefits of a transaction can only be felt over a period of time when the transaction has been completed and the team works towards achieving the original objective of the transaction.

This is where integration plays a vital role. However, there are instances where deals have been considered to be unsuccessful despite the right valuation and due diligence since integration was not smooth and up to the mark.

As 2008 unfolds, one major strategic acquisition on the cards is the delayed Sun-Taro deal, awaiting shareholder approval. No doubt Indian pharma players have many more cards up their sleeves. Experts maintain that it might be next to impossible to find the ideal transaction but the essence lies in minimising risks and maximizing benefits.

sushmi.dey@expressindia.com