Will The Next Teva Be From India? Global Scale, Product Mix, And A Strong Balance Sheet Can Trigger Big M&As By Indian Pharma

MUMBAI - News reports of Teva Pharmaceutical Industries Ltd. CEO Shlomo Yanai's recent visit to India sparked rumors that the company may have finally set its sights on the Indian market via a joint venture with Cipla Ltd. But even as the world's largest generic company toys with the idea of entering the sub-continent, leading analysts predict that the next Teva - referencing its multi-fold growth in the last six years - could soon emerge out of India.

In a detailed report issued June 15, Credit Suisse analysts Anubhav Aggarwal and Michael Faerm mapped a range of factors including global market dynamics for generic drugs and expansion strategies of frontline Indian companies both in mature and emerging markets, and then compared the Indian firms' product mix with leading global players and their M&A trends. The analysts deduced that Indian companies may be best suited to enlarge their global footprint and forecasted that if they pursue large-scale acquisitions, they could reach the size of Teva, which posted sales last year of $16.1 billion.

Following Teva's Footprints

Credit Suisse highlighted similarities of scale between leading Indian companies like Sun Pharmaceutical Industries Ltd., Dr. Reddy's Laboratories Ltd. and Lupin Ltd. to Teva and reasoned that the Indian companies are now at a similar scale to what Teva was a decade ago. Teva's larger acquisitions, which took the company to the next level, were made only in the last decade.

The one point that may distinguish Teva and Indian companies, according to the two analysts, is that the core focus of India pharmas may continue to be the generic drugs business, unlike Teva's gradual tilt toward innovation in the way it developed the blockbuster multiple sclerosis therapy Copaxone (glatiramer).

"Indian generics have been less acquisitive and less focused on innovative R&D versus global peers. We see no strategy change towards innovative R&D, but expect acquisitions for Indian generics to accelerate given increased scale of 2.5 times over five years, stronger balance sheets and higher management bandwidth with professional CEOs. Historically, the market has rewarded Teva's inorganic strategy, with market capitalization growth being similar to sales growth of 22% in the past 18 years," the analysts wrote.

The reference to "professional CEOs" in the report is notable. Over the last few years, many Indian companies switched to a professional management structure, a remarkable departure from a past history of family ownership and organization control.

For example, a few years ago Lupin's board decided to rope in Kamal Sharma as managing director, and founder Desh Bandhu Gupta moved up to occupy the chairman's position. Sharma worked in Lupin for several years, then moved to RPG Life Sciences Ltd. and returned to Lupin to occupy the senior level position. Though not officially confirmed, sources suggest that Sharma was put in the position on the insistence of Citigroup Venture Capital. CVC had stepped in and bought equity against funding to bail out Lupin at a time when the company was neck deep in debt.

For reasons different from Lupin, last year Sun Pharmaceutical hired Kal Sundaram as its CEO. Prior to joining Sun, Sundaram held senior leadership positions for GlaxoSmithKline PLC in key Asian markets including India. Sun's mandate for Kal was to grow the emerging markets portfolio.

Sun has moved aggressively in that direction via an alliance with Merck & Co. Inc. to work on a range of self-developed and differentiated products (Also see "Merck Establishes JV With India's Sun Pharma To Develop Novel Combinations Of Branded Generics For Emerging Markets" - Scrip, 11 Apr, 2011.). Thus far, Sun has been very restrictive in its geographical presence, focusing mostly on India and the U.S.

The promoters of Dr. Reddy's Laboratories have also recently spoken about hiring an independent and professional CEO to run its operations and bring in greater professionalism into the system.

Equity Dilution An Option For Global Deals?

Although there are major perception issues, promoter-driven ownerships in India may not stand as a big hurdle for M&A as only a few acquisitions by Teva have involved equity dilutions, according to Credit Suisse.

The analysts noted the wide variation in equity holdings held by promoters of Indian companies. Dr. Reddy's promoters, for example, hold only about 26% stake in their company, Sun Pharma promoters own 64% and Cadila Healthcare Ltd. founders hold as much as a 75% stake of their listed stocks. Late last week, Zydus Cadila acquired Nesher, the generics arm of the troubled drug maker KV Pharmaceutical Co. for $60 million in an effort to bolster its presence in the $7 billion controlled-release and controlled substance market in the U.S. (Also see "Lure Of Niche Drugs Lead India's Cadila To Buy Troubled KV Pharma's Generic Arm For $60 Million" - Scrip, 20 Jun, 2011.).

The Credit Suisse analysts believe that equity holding may not be a deterrent to doing large-sized deals, but if a company like Dr. Reddy's faces a situation to dilute equity for a big strategic deal, the company founders may not be in the best position to dilute below what they hold.

While not dismissing the idea of large buyouts where promoter stake is low, the analysts said, "The only drawback could be that the acquisitions need to be spaced out enough to maintain leverage ratios below the threshold." Sun Pharma, the two analysts noted, could be best placed for large acquisitions both in the U.S. and emerging markets.

Sun Shines The Most

Sun has the potential to make acquisitions to the tune of $1.5 billion given its current net cash of $860 million. "This ties-up with its management's stated objective of going for acquisitions in both the U.S. and emerging markets," the analysts said.

According to Aggarwal, scaling up in the U.S. and the higher exposure to emerging markets augurs well for Indian companies as they can adjust to the markets in view of the "strong branded generics experience" they have in India.

As far as the U.S. market, the analysts suggest that a large proportion of that market remains untapped by Indian companies. "In the US market, volume share of Indian generics has quadrupled in the past five years to 17%, though their combined scale is still one-third of their top five peers," the authors said.

The present U.S. pipeline of Indian companies is strong, and market share gains could continue for Indian generics over the next four to five years. In the medium term, the analysts said, global peers may address a larger basket of the U.S. market and Indian firms may opt for acquisitions or joint ventures to plug portfolio gaps.

Aggarwal singled out Sun for its strong Indian franchise and a sound balance sheet, which may provide flexibility to acquire scale in the U.S. and emerging markets. "Past acquisitions have been highly accretive for Sun and the promoter group has a high stake of 64% in the company," the analysts wrote.

Having battled for four years to gain clear control of the Israeli firm Taro Pharmaceutical Industries, last quarter Sun turned up strong performance in the U.S. driven to a large extent by Taro's products (Also see "Sun Finally Gains Control Of Taro As Founders Relent; Charts Out Aggressive Investment And Growth Plans" - Scrip, 22 Sep, 2010.). Sun has traditionally grown through a blend of strong organic expansions and acquisition of distressed manufacturing sites and brands within India and overseas.

Indian Companies Shy Of Big Deals

The Credit Suisse analysts noted that global generic companies are more acquisitive and focused on developing a branded business in the U.S than compared to their Indian rivals. Promoter-driven ownership of Indian firms, less-than-encouraging results in past large scale acquisitions, and higher levels of organic growth are cited as key reasons for them to be less willing to seek large deals.

Also, among the bigger deals done by Indian companies, most have not been able to realize the goals that were set at the time of lining up the acquisitions, best exemplified by Dr. Reddy's.

The Hyderabad-headquartered company struggled with its $560 million acquisition of Germany's Betapharm as the market switched from branded generics to a pure generic model just a year after the deal, upsetting its calculations of value accretion and plans to grow further in the European market. Though the prospects look much better after an overhaul of the business, Dr. Reddy's had to write off millions of dollars and the senior executives have acknowledged to investors that the deal strained the company's performance (Also see "Launch Delays In U.S. Dampen Dr. Reddy's Q1 Earnings But Money Starts Flowing From GSK Deal; Analysts Confident On Future Outlook" - Scrip, 23 Jul, 2010.).

Similarly, Sun engaged in long litigation with Israeli firm Taro as the founder family contested the acquisition value that was initially agreed upon. Jubilant Life Sciences Ltd., largely operating in research and manufacturing services, has not been able to fully utilize its CRAMS assets Hollister Stiers and Draxis Pharma in the U.S.

Aggarwal and Faerm suggested that new product opportunities within the U.S. market are steadily declining, and that: "It is critical to address product/technology gaps and we expect acquisitions/joint ventures to accelerate in such cases."

Watch Sun, Lupin, Dr. Reddy's

Currently, Sun, Dr. Reddy's and Lupin are the preferred firms in Credit Suisse's view that can garner capabilities to scale up. "They have a strong franchise in India, an established presence in key emerging markets such as CIS, Latin America and Japan, are diversifying from commodity generics in the U.S. market towards niche products and technologies such as biosimilars and have a strong balance sheet which provides flexibility to acquire scale in the U.S. and EMs."

Dr. Reddy's has the most advanced biosimilar pipeline from India and is the largest Indian player in the profitable CIS market in the former Soviet Union. Lupin, the analysts said, has been the most successful in its emerging markets expansion so far, emerged as the largest Indian player in the U.S. by volume and continues to invest in niche opportunities.

In Generics, Bigger Is Better

Drawing from Teva's history of acquisitions, Aggarwal said Indian companies have a few important takeaways to note. Teva's acquisition strategy is driven by market share gains in key geographies, access to niche specialty products and acquisitions that become accretive within one year. In close succession, between 2005 and 2011, Teva made acquisitions to the tune of $32 billion bagging large companies like Ivax, Barr, Ratiopharm, Cephalon and Taiyo of Japan ( (Also see "Teva Buys Japanese Generics Company For $460 Mil." - Scrip, 16 May, 2011.) ).

It is only in the last decade that Teva went for large acquisitions, which besides scale were also aimed at broadening its technology capabilities to include injectables, respiratory, oral contraceptives and biosimilars, in part aimed at shifting the company's revenue mix to geographies outside of the U.S.

Indian companies started in the U.S. market in the late 1990s and early 2000s and scale wise - sales and total assets - are now similar to what Teva was in 2000.

"We admit that the comparison may not be applicable in toto, but if Teva's growth path is any indication, increased scale of Indian generics can now support large acquisitions," Credit Suisse said. The analysts underlined the need to have a wider network of distribution to increase reach in the U.S. generics market. "As the difference in the market shares of the top two players increase, namely Teva and Sandoz, the operating margin for the market leader also increases," the report said.

While the opportunities may exist for gaining size in the global generics market, a few Indian promotors like Malvinder Singh of Ranbaxy Laboratories Ltd. appear to have succumbed to tremendous market pressures and exited the pharmaceuticals business (Also see "A Closer Look: Why Are Indian Pharma Promoters Diversifying Into Other Sectors?" - Scrip, 18 May, 2011.).

- Vikas Dandekar ([email protected])