Sun acquires Ranbaxy Gain size at a cost of margin premium April 09, 2014 Surajit Pal surajitpal@plindia.com +91 22 66322259 Rating Accumulate Price Rs630 Target Price Rs646 Implied Upside 2.5% Sensex 22,702 Nifty 6,796 (Prices as on April 09, 2014) Trading data Market Cap. (Rs bn) 1,304.8 Shares o/s (m) 2,071.2 3M Avg. Daily value (Rs m) 3028.8 Major shareholders Promoters 63.65% Foreign 22.49% Domestic Inst. 5.74% Public & Other 8.12% Stock Performance (%) 1M 6M 12M Absolute 2.9 (2.4) 45.2 Relative (0.7) (16.0) 22.1 How we differ from Consensus EPS (Rs) PL Cons. % Diff. 2015 26.1 27.9 6.6 2016 28.6 31.9 10.5 Price Performance (RIC: SUN.BO, BB: SUNP IN) (Rs) 700 600 500 400 300 200 100 0 Apr 13 Jun 13 Source: Bloomberg Aug 13 Oct 13 Dec 13 Feb 14 Apr 14 Sun acquires Ranbaxy: Sun Pharma acquired Ranbaxy at an all stock deal of US$4bn, including equity value of US$3.2bn and debt of US$800m. Per deal, Ranbaxy to merge with Sun Pharma at a stock swap ratio of 0.8:1. This implies 16% dilution in Sun Pharma with addition of 478m shares at Rs.457/share to Ranbaxy. Additionally, Sun would also assume contingent liability of US$850mn in forex derivatives which were bought by Ranbaxy at US$/Rs42 44 in 2006 07. The duration of the derivative contracts is set to expire in 2016 with expiry of contract US$35mn/month. Merged entity to be domestic behemoth with 9.2% market share: Sun Pharma, post merger, will have market share of 9.2%, with few overlaps in CVs and Diabetetology. The merged entity has reached in a dominant position with its presence in top 4 cos in each of the to 10 therapeutic areas. The Top 10 therapeutic areas contribute 90% of Indian Pharma market. Sun s US Derma business to be major gainer: With acquisition of Ranbaxy, Sun Pharma to be number one in generic derma while it ranks number three in branded Derma business in US. Absorica s sales of US$100mn and sales team of 50 reps in US to be source of major synergy due to branded Derma business in DUSA and Taro Pharma. Drugs in anti acne, Actinic Keratosis and anti fungal to be Sun Pharma s key specialty business in US Derma post acquisition. Valuation Maintain Accumulate with TP Rs.646: While Sun Pharma management believes to achieve US$250m synergy in three years, we believe that Ranbaxy s single digit EBITDA margin, forex derivatives, high consultancy costs and high tax rate to be strong hangover in near term. FDA s approval in Nexium and Diovan could provide benefits of US$300 400m net income in short term. We maintain Accumulate and target price at Rs.646. Key financials (Y/e March) 2013 2014E 2015E 2016E Revenues (Rs m) 112,999 160,380 176,583 195,703 Growth (%) 14.8 41.9 10.1 10.8 EBITDA (Rs m) 48,962 71,690 78,579 87,088 PAT (Rs m) 35,732 53,423 53,987 59,197 EPS (Rs) 34.5 25.8 26.1 28.6 Growth (%) (21.3) (25.2) 1.1 9.6 Net DPS (Rs) 5.0 2.5 2.5 2.5 Profitability & Valuation 2013 2014E 2015E 2016E EBITDA margin (%) 43.3 44.7 44.5 44.5 RoE (%) 26.2 31.4 25.2 22.4 RoCE (%) 25.9 30.7 24.8 22.0 EV / sales (x) 5.4 7.7 6.8 6.0 EV / EBITDA (x) 12.5 17.3 15.4 13.4 PE (x) 18.3 24.4 24.2 22.0 P / BV (x) 4.4 6.9 5.5 4.5 Net dividend yield (%) 0.8 0.4 0.4 0.4 Source: Company Data; PL Research Event Update Prabhudas Lilladher Pvt. Ltd. and/or its associates (the 'Firm') does and/or seeks to do business with companies covered in its research reports. As a result investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of the report. Investors should consider this report as only a single factor in making their investment decision. Please refer to important disclosures and disclaimers at the end of the report
Sun Pharma s acquisition of Ranbaxy in all stock swap deal would create fourth largest generic company in the world with US$4.2bn sales and US$1.2bn EBITDA. Per agreement, Ranbaxy to merge with Sun Pharma and its shareholders would receive 0.8 shares of Sun Pharma against 1 share of Ranbaxy. Sun Pharma s acquisition would provide edge to its size of sales in US, India and ROW markets. With this acquisition, Sun Pharma to be ranked top in generic dermatology and ranked number three in branded dermatology business in US. The company also would be ranked top in domestic market with 9.2% market share. With acquisition of Ranbaxy, Sun Pharma s US sales to be US$2.2bn, India sales to be US$1.1bn and ROW sales to be US$0.9bn. The joint entity will have 445 ANDAs in markets with 184 ANDAs in pipeline in US. Sun would gain major access in ROW markets with few overlaps in Romania, South Africa, Russia, Malaysia and Brazil. The joint entity would however inherit USFDA s ban on four major plants Dewas, Poanta Sahib, Mohali and Toansa. All the four manufacturing facilities are included in Consent Decree (CD) signed between Ranbaxy and US FDA to achieve remediation for the plants. Sun Pharma s debt would be increased to US$800m and contingent liability with exposure of US$850m to forex derivatives. Overall, we analyse Sun Pharma s benefits vis à vis cost (qualitative and quantitative) of the acquisition in short term and long term: Revenue Contributions Exhibit 1: Ranbaxy Exhibit 2: Sun Pharma Exhibit 3: Merged Entity ROW 50 US 29 India 23 ROW 17 US 60 ROW 31 US 47 India 21 India 22 Source: Company Data, PL Research Source: Company Data, PL Research Source: Company Data, PL Research April 09, 2014 2
Short Term benefits Approvals for Ranbaxy in Nexium (May 2014) and Diovan could lead to a net income of US$400 500m in most optimistic scenario, assuming API supply to be sourced from Sun Pharma. In case API is sourced from third party, we expect net income to be shared by 50% in Nexium and Diovan. We expect INR35.6 EPS from one off opportunity in Nexium and Diovan, assuming sharing of net income with third party API supplier Reduction of headcounts in sales reps could reduce cost of sales of Ranbaxy for domestic market Domestic market share of 9.2% could increase better pricing power and impart synergy through complimentary expansion of networks Addition of Ranbaxy s derma products including Absorica, Ximino and 13 brands bought from BMS. Sun Pharma also gain marketing team of 50 reps in US to synergy for Derma business in Taro and DUSA s franchise Short term negatives Increase uncertainty in financial performance with MTM value of forex derivatives (US$850m) and debt (US$800m) Increase leverage with US$800mn would reduce availability of cash (US$1.3bn) for international acquisition Reduce revenues in APIs as Ranbaxy voluntarily stopped production and global export of APIs from Toansa plant post US FDA s import alert on the plant. Also, there would be increase in production costs of Ohm Labs (Ranbaxy s US subsidiary) as supply of APIs from Toansa for internal consumptions to be stopped post US FDA ban Additional consultancy costs for remediation in Toansa and Mohali to be increased from Q1FY15. We believe that Ranbaxy currently incurs 3 4% of EBITDA margin on account of consultancy costs to achieve US FDA compliance for its four plants Cost of severance package for the joint entity post merger of Ranbaxy in Sun Pharma Operating margin (EBITDA) of the merged entity to be decreased to 28% 30% vs. Sun Pharma s EBITDA margin of 44%. Tax rate of merged entity to be increased as Ranbaxy s normalised tax rate is 20% while Sun Pharma s normalised tax rate is 15% 17% April 09, 2014 3
Long term benefits Restructuring of Ranbaxy s operation along with efficient supply chain management to gain US$250m synergy in three years Key drugs from Ohm Labs could be produced in Sun Pharma s India plant to increase profitability. Site transfer of low margin products from ohm Labs could address capacity constraints in the plant Higher possibility of re approval of Mohali, Toansa and non sterile division of Dewas by US FDA. Approval of 15 ANDAs (as we believe) applied from Ohm Labs since 2009. We expect few more shared exclusivity could be possibility in long term Reduction in consultancy costs and streamlined operation could lead to increase operating margin Long term negatives In our view, Ranbaxy is unprepared in its product pipeline for addressing issues pertaining to patent cliff period post 2015 16 Three year patent exclusivity of Absorica to be expired in 2015 and likely to be genericised with launch of Mylan s generic. Currently, Absorica s sales are US$100m per annum While operating margin of Ranbaxy could be increased to 16 18%, the operating margin could not be matched with Sun Pharma s 44% EBITDA margin given the nature of products in Ranbaxy We believe that strong compliance lacunae in Poanta Sahib led to Ranbaxy s investment in Mohali for US market. This implies that Sun Pharma s expectation of US FDA approval for Poanta Sahib plant may come a cropper Dewas Plant is one of the oldest plant of Ranbaxy and profitable products such as Penems and Cipro were filed from sterile division of the plant. We believe that early relieve from Consent Decree could be possible only for non sterile division of Dewas plant while approval of Sterile division could take longer time to receive approval Average track record of resolution in CD takes 5 7 years for generic cos while patent holder cos takes 7 9 years. With the history of resolution achieved in CD, we expect Sun Pharma may regain compliance in Dewas in 2016 17 while Mohali and Toansa may receive earlier approval in 2016 Post approval of Mohali plant from US FDA in 2016, ANDA applications from Mohali plant would not be commercially viable Ranbaxy s single digit operating margin and net loss could reduce EPS of Sun Pharma in FY15E FY16E while increase sales by US$1.7bn. This implies lower ROI which may lead to reduction in premium valuation to peers April 09, 2014 4
Income Statement (Rs m) Net Revenue 112,999 160,380 176,583 195,703 Raw Material Expenses 20,733 30,953 31,962 35,422 Gross Profit 92,265 129,427 144,622 160,281 Employee Cost 15,345 19,246 25,251 27,986 Other Expenses 27,958 38,491 40,791 45,207 EBITDA 48,962 71,690 78,579 87,088 Depr. & Amortization 3,362 4,104 4,688 5,396 Net Interest 432 463 477 558 Other Income 3,881 5,239 5,396 5,558 Profit before Tax 49,050 72,361 78,810 86,693 Total Tax 8,456 10,854 15,762 17,339 Profit after Tax 40,595 61,507 63,048 69,354 Ex Od items / Min. Int. (6,939) (42,264) 9,061 10,157 Adj. PAT 35,732 53,423 53,987 59,197 Avg. Shares O/S (m) 1,035.6 2,071.2 2,071.2 2,071.2 EPS (Rs.) 34.5 25.8 26.1 28.6 Cash Flow Abstract (Rs m) C/F from Operations 33,629 55,891 50,681 63,738 C/F from Investing (26,351) (2,468) (11,106) (11,328) C/F from Financing (6,713) (7,263) (6,994) (13,211) Inc. / Dec. in Cash 565 46,160 32,581 39,199 Opening Cash 17,527 20,691 66,851 99,431 Closing Cash 20,691 66,851 99,431 138,630 FCFF 11,667 31,152 34,822 40,953 FCFE 11,057 31,280 35,281 41,490 Key Financial Metrics Growth Revenue (%) 14.8 41.9 10.1 10.8 EBITDA (%) (3.8) 46.4 9.6 10.8 PAT (%) (21.3) 49.5 1.1 9.6 EPS (%) (21.3) (25.2) 1.1 9.6 Profitability EBITDA Margin (%) 43.3 44.7 44.5 44.5 PAT Margin (%) 31.6 33.3 30.6 30.2 RoCE (%) 25.9 30.7 24.8 22.0 RoE (%) 26.2 31.4 25.2 22.4 Balance Sheet Net Debt : Equity (0.3) (0.3) (0.4) (0.5) Net Wrkng Cap. (days) 303 199 228 260 Valuation PER (x) 18.3 24.4 24.2 22.0 P / B (x) 4.4 6.9 5.5 4.5 EV / EBITDA (x) 12.5 17.3 15.4 13.4 EV / Sales (x) 5.4 7.7 6.8 6.0 Earnings Quality Eff. Tax Rate 17.2 15.0 20.0 20.0 Other Inc / PBT 7.9 7.2 6.8 6.4 Eff. Depr. Rate (%) 4.4 4.9 5.0 5.2 FCFE / PAT 30.9 58.6 65.4 70.1 Source: Company Data, PL Research. Balance Sheet Abstract (Rs m) Shareholder's Funds 149,897 190,359 238,288 291,426 Total Debt 2,597 2,724 3,183 3,720 Other Liabilities 17,188 22,286 28,267 35,105 Total Liabilities 169,683 215,369 269,737 330,251 Net Fixed Assets 50,771 54,667 59,979 64,583 Goodwill 11,330 12,330 12,330 12,330 Investments 24,116 18,584 19,690 21,018 Net Current Assets 75,010 119,649 166,083 218,921 Cash & Equivalents 40,587 66,851 99,431 138,630 Other Current Assets 64,376 87,335 103,665 117,848 Current Liabilities 29,953 34,537 37,014 37,558 Other Assets 8,456 10,140 11,656 13,400 Total Assets 169,683 215,369 269,737 330,251 Quarterly Financials (Rs m) Y/e March Q1FY14 Q2FY14 Q3FY14 Q4FY14E Net Revenue 34,822 41,921 42,866 41,499 EBITDA 15,306 18,284 19,751 20,074 % of revenue 44.0 43.6 46.1 48.4 Depr. & Amortization 978 1,005 1,050 1,072 Net Interest 219 117 67 60 Other Income 954 1,196 1,602 1,487 Profit before Tax 15,063 18,358 20,236 20,429 Total Tax 1,511 2,760 2,438 3,473 Profit after Tax (12,761) 13,623 15,311 14,668 Adj. PAT 12,413 13,623 15,311 14,668 Key Operating Metrics Formulations 106,538 154,869 170,409 189,040 India Formulations 29,657 36,775 43,394 50,771 US Formulations 61,538 97,614 102,893 109,477 ROW Formulations 15,344 20,480 24,121 28,791 APIs 7,549 7,614 8,651 9,553 Source: Company Data, PL Research. April 09, 2014 5
Prabhudas Lilladher Pvt. Ltd. 3rd Floor, Sadhana House, 570, P. B. Marg, Worli, Mumbai 400 018, India Tel: (91 22) 6632 2222 Fax: (91 22) 6632 2209 Rating Distribution of Research Coverage % of Total Coverage 60% 50% 40% 30% 20% 10% 0% 52.7% 25.9% 20.5% 0.9% BUY Accumulate Reduce Sell PL s Recommendation Nomenclature BUY : Over 15% Outperformance to Sensex over 12 months Accumulate : Outperformance to Sensex over 12 months Reduce : Underperformance to Sensex over 12 months Sell : Over 15% underperformance to Sensex over 12 months Trading Buy : Over 10% absolute upside in 1 month Trading Sell : Over 10% absolute decline in 1 month Not Rated (NR) : No specific call on the stock Under Review (UR) : Rating likely to change shortly This document has been prepared by the Research Division of Prabhudas Lilladher Pvt. Ltd. Mumbai, India (PL) and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of PL. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, PL has not independently verified the accuracy or completeness of the same. Neither PL nor any of its affiliates, its directors or its employees accept any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient's particular circumstances and, in case of doubt, advice should be sought from an independent expert/advisor. Either PL or its affiliates or its directors or its employees or its representatives or its clients or their relatives may have position(s), make market, act as principal or engage in transactions of securities of companies referred to in this report and they may have used the research material prior to publication. We may from time to time solicit or perform investment banking or other services for any company mentioned in this document. April 09, 2014 6