Cure for an Ailing Industry? Pharma Multinationals Seek a Panacea in Indian AcquisitionsPublished February 01, 2010 in Arabic Knowledge@Wharton
"Sanofi-Aventis Scans India for Acquisitions"; "Glaxo Eyes Piramal, Dr. Reddy's Labs"; "MNCs Eye Indian Pharma": If these and other recent headlines are any indication, India's pharmaceutical companies are in play for multinational suitors. According to some industry observers, more acquisitions are almost certain once valuations improve -- whether for diversification, exposure to emerging markets or other purposes.
"Pharmaceutical, health care and biotechnology was one of the busiest sectors on India's Deal Street in 2008," according to Bundeep Singh Rangar, chairman of IndusView Advisors, an India-focused cross-border advisory firm. "At US$5.57 billion, it was second in terms of total value, marginally below telecommunications, which had total transactions worth US$5.78 billion." The pharma sector had 57 deals, second only to the 102 deals in the IT and IT services sector, Rangar adds.
In June 2008, the acquisition of Ranbaxy Laboratories -- India's biggest drugmaker at the time -- by Japanese firm Daiichi Sankyo set the ball rolling. At US$4.6 billion, it was the largest of India's deals for the year. Since then, the Dabur Group, which operates in the wellness space, sold a 73% stake in its Dabur Pharma prescription business to Singapore-based Fresenius Kabi for US$200 million. Perrigo, an over-the-counter firm based in the U.S., picked up an 85% stake in Mumbai-based Vedants Drugs & Fine Chemicals for US$12 million. Wockhardt, based in Mumbai, hawked its nutritional supplement brands Farex, Protinex and Dexolac to U.S.-based Abbott Laboratories for US$130 million and its animal health division to Vetoquinol of France for US$40 million. And Sanofi-Aventis of France acquired Hyderabad-based vaccine major Shantha Biotechnics for nearly US$800 million.
"The strategy in India in the past has been around a smaller number of products," says Chris Viehbacher, CEO of Sanofi-Aventis. The company's management in India "is now focusing more on the base business and has accelerated our growth rate from about 7% per year to around 15% to 16%," he notes. "Vaccine is clearly an area where we were in deficit -- pretty much everybody is. And that is why Shantha was so important." The company is still on the takeover trail. "There will be more shopping on the horizon," Viehbacher told Bloomberg News in late September. The objective, he said, is to build the company's "vaccine, biotechnology and non-prescription-medicine businesses, as well as expand in emerging markets."
The Economic Times reports that a team from Sanofi, which had US$42 billion in revenues last year, visited India recently and held talks with Mumbai-based Piramal Healthcare and the privately held, Bangalore-based Micro Labs. GlaxoSmithKline (GSK), which had US$45 billion in revenues, is widely reported to be looking to acquire a 5% stake in Dr. Reddy's Laboratories; it already has a marketing deal in place. Pfizer, meanwhile, has struck alliances with Aurobindo Pharma and Claris Lifesciences. "A lot of other proposals of the same kind are floating around, some of which involve second-tier companies" including Torrent Pharmaceuticals, Unichem Laboratories, Shasun Chemicals and Orchid Chemicals & Pharmaceuticals, according to business magazine Business India. "The promoter families of quite a few Indian drug companies are open to the idea of selling to a multinational company but are waiting for valuations to improve." Says Karan Singh, partner at Bain & Co. India: "Some of the big deals being spoken about haven't gone through because of valuations. But they will."
Four Important Trends
Why has Indian pharma come under the takeover lens? Singh notes that four important global trends are driving MNCs' strategies: "First is cost optimization, for which you need to create a flexible business model. The second is getting into businesses that are different -- vaccines, for instance. The third is the pursuit of profitable growth, for which you need to focus on emerging markets, which give you good margins. Finally [there] is the move into generics, for which many companies have to look at inorganic growth."
"With growth expected to taper off in the U.S. and other developed countries, emerging economies like India are expected to drive future expansion," says Pratik Kadakia, practice head (chemicals and energy) at Tata Strategic Management Group (TSMG). The Indian pharmaceutical market had estimated revenues of US$17 billion in fiscal 2008, he notes. "The domestic formulation business, which was US$8 billion, is estimated to grow at over 12% annually to reach US$14 billion by fiscal 2013." The key growth drivers in the domestic market, according to Kadakia, are "increasing per-capita income, growing insurance penetration, better health awareness, higher government expenditure, adherence to IPR (intellectual property rights) norms, and shifts in disease profiles." Also, the country "has established itself as a leading player in generics manufacturing as well as contract research and manufacturing. This is of interest to MNCs, which are currently facing a relatively low pipeline of new innovator drugs. Increased pressure from governments in several developed countries to reduce health care costs has also forced large pharma companies to look at enhancing their generics portfolio."
Sujay Shetty, associate director of the pharma life sciences practice at PricewaterhouseCoopers (PwC), agrees that getting access to India's domestic market and adding generics to portfolios are two primary drivers behind the increasing number of takeovers by MNCs in the pharma sector. "Until recently, India was not an important market for big pharma companies because it accounted for only a very small percentage of their global revenues. But over the next 10 years, India is expected to become a multibillion-dollar market, among the top 10 markets globally." Indeed, Rangar of IndusView notes, "Consumer spending on health care [in India] increased from 4% of gross domestic product in 1995 to 7% in 2007, and is expected to rise to 13% by 2015." However, Shetty adds that tapping the Indian market will require a tailored approach. "Cost efficiencies are important, price points are important. There are lots of poor people and different disease profiles."
On the generic front, Shetty points out that "earlier, generics used to be the lower end of the game, the bottom of the barrel. But those days have changed. Now there is a big drive for generic substitution wherever possible, because the prices collapse by 90%. All the big pharma players want to take a bigger role in generics. They realize that having generics in their portfolio gives them an extra arrow in the quiver while dealing with policymakers globally.... One way is to acquire Indian drugmakers that have proven skills in manufacturing, can keep their operations lean and have cost-effective generic development methods."
"Expansion by global pharma companies into emerging markets like India becomes imperative as about US$103 billion worth of patented drugs will go off patent in the next few years," Rangar says. "This will further hit the already sagging fortunes of such companies. Thus they are trying to augment their revenues by acquiring or aligning with companies in the generics business. The acquisition of Ranbaxy is an apt example in this context."
The industry itself isn't necessarily looking to sell out. According to an October 10 report in Businessworld, the Indian Pharmaceutical Alliance, a lobby of 12 top home-grown drugmakers, was seeking the government's help to prevent acquisitions by foreign companies, through funding to protect and promote the industry and through tackling such issues as patents and price controls.
A Fragmented, Vulnerable Market
The Indian market is vulnerable because it is fragmented. At the end of 2008, according to pharma research firm ORG IMS, the top five companies had a combined market share of only 22%. Cipla Ltd. had the largest, having ousted Ranbaxy from the top spot, yet its share was only 5.3%. The top 20 companies had a total market share of about 57%. Globally, the 10 largest companies account for about 40% of sales.
According to Espicom Business Intelligence, a market information provider based in the United Kingdom, India is the world's fourth-largest producer of pharmaceuticals by volume, accounting for around 8% of global production. In value terms, India's production accounts for around 1.5% of the world total, ranking India thirteenth. Espicom highlights the Indian pharmaceutical industry's fragmentation. "While there are around 270 large R&D-based pharmaceutical companies in India, including multinationals, government-owned and private companies, there are also around 5,600 smaller licensed generics manufacturers, although in reality only around 3,000 companies are involved in pharmaceutical production. Most small firms do not have their own production facilities, but operate using the spare capacity of other drug manufacturers."
"The intense competition in a highly fragmented market is posing a great challenge," says Rangar. "The stage is set for the next phase of growth accompanied by consolidation." Adds Shetty of PwC: "India is one of the most competitive markets in the world, primarily because it is very fragmented. No one enjoys dominance and that is unlikely to change in the near future."
Cost considerations are also driving MNCs' interest. India "offers the benefits of low-cost R&D, a domain in which it is estimated to capture a 10% to 20% share of the world's business by 2020 from less than 1% currently," Rangar notes. "Globally, pharmaceutical companies are shifting their outsourcing activities to Asian markets, with India emerging as one of the most attractive destinations," according to an August 2009 report by the Organization of Pharmaceutical Producers of India (OPPI) and Ernst & Young (E&Y) titled, Taking Wings: Coming of Age of the Indian Pharmaceutical Outsourcing Industry. "India is a fast-growing custom manufacturing outsourcing destination with a growth rate of 43% that is [three times] the global market rate," the report states. "This is driven by its ability to create a differentiating cost value proposition powered by its lower manufacturing costs, skilled manpower and strong technical capabilities."
The report rated India highest in terms of cost-efficiency attractiveness among six destinations including China, Eastern Europe, Puerto Rico, Singapore and Ireland. "India's cost efficiency is driven by its low manufacturing cost, which is only 35% to 40% of the cost of manufacturing in the United States, supported by its low installation and manpower cost," according to the report. "In drug discovery and development services, India is emerging as a hot spot, growing at around 65%. India offers significant cost arbitrage in end-to-end R&D with potential savings of 61% as compared to the United States."
Another E&Y study, developed with the Federation of Indian Chambers of Commerce and Industry (FICCI), says India enjoys significant cost arbitrage in the conduct of clinical trials, which includes infrastructure, patient recruitment, manpower, data management and processing costs. "The cost of these activities in India is typically 40% to 60% lower than in developed countries and around 10% to 20% lower than in other emerging economies," says the study, Report on Compelling Reasons for Doing Clinical Research in India. At least eight of the top 10 pharma companies internationally are tapping such allied services in India. The sector is growing by 21% annually in India, compared with 7.5% globally. According to Espicom, the U.K.-based market information provider: "With low-cost manufacturing, high-quality research and manufacturing facilities, and educated personnel, the Indian pharmaceutical industry presents both a competitive threat and partner opportunities."
A Growing Affluent Market
MNCs have another reason to eye India. The FICCI-E&Y study says that high-value drugs from MNCs could produce up to US$8 billion in sales by 2015. The population in India's highest income class is expected to grow to 25 million in 2015 from 10 million today, so more people will be able to afford high-value patented drugs. "MNCs are increasingly restructuring their operations with global parents increasing their equity stakes in their Indian affiliates," the report says. Companies such as Bristol-Myers Squibb and Merck that had exited the Indian market have staged a reentry. "Lifestyle disorders will make people more vulnerable to ailments such as cardiovascular diseases and diabetes," says Rangar of IndusView. "Secondly, medicines will become more affordable to a larger number of people as the size of India's 300 million middle class is rapidly increasing and income levels are also going up."
Affordability is at the forefront of debate. "We need to think how such deals affect our poor people and whether [the deals] can block access to drugs at a reasonable price," opposition leader L.K. Advani said in the Lok Sabha, India's lower house of Parliament, at the time of the Ranbaxy takeover.
"But the entry of MNCs does not necessarily mean more expensive medicines," says Kadakia of TSMG. "It could lead to the introduction of patented drugs for lifestyle diseases. But India will continue to need affordable medicines, particularly for acute ailments. These are typically served by generic medicines which are affordable and, in certain cases, their prices are regulated by the government. While we can expect patented medicines to be launched in India, particularly due to growing confidence in Indian IPR laws, affordable generic medicines will continue to comprise a very significant section of the market."
"There is always a fear that if MNCs come and dominate the pharma market they will raise prices," says Shetty of PwC. "In fact, that is why India has developed its own homegrown pharma industry by adopting a process-patent route as opposed to a product-patent route. In India, the cost of medicines going up matters in terms of aam admi (common man) policies. But drug pricing is still controlled by the government so, hypothetically, even were the MNCs to dominate, I don't think they would have pricing power."
Kadakia says that pharma takeovers elicit so much attention because health care is of key importance everywhere. "Health care and pharmaceuticals will continue to be of strategic interest for the country. The pharmaceutical industry will continue to be watched and followed keenly by the media as well as the government, unlike several other sectors." That is why industries such as advertising and market research have become almost 100% foreign-owned without a murmur, while pharma takeovers have a host of critics.
The criticisms notwithstanding, MNCs obviously are attracted to India. From the Indian point of view, it makes sense to join hands or sell out. Intense competition is one reason. A patent regime established in 2005 that limits the industry's ability to introduce new generic drugs is another. "With the increasing need for capital to sustain momentum, a number of Indian pharmaceutical companies will find it difficult to pursue the growth path on their own," Rangar says. "Such companies will be ideal candidates to join hands with strong multinational companies."
Indian companies face other problems, too. Exports, mainly of generics, have become an increasingly important business component. But some Western countries are setting up what are perceived as non-tariff barriers. For example, the U.S. Food & Drug Administration has taken action against several companies; early this year, it banned 28 of Ranbaxy's drugs, saying the company had falsified data and test results in approved and pending drug applications. Also, several shipments of generic drugs destined for Latin American countries have been seized in European ports. A Dr. Reddy's consignment of losartan, used to lower blood pressure, was seized in transit to Brazil by Dutch customs officials. The U.S. multinational DuPont holds the patent for losartan in the Netherlands. Several such seizures have occurred that the Indian industry considers illegal because the drugs were in transit and not meant for sale in any European market.
Indian Companies 'At a Crossroads'
"Indian companies are at a crossroads," says Singh of Bain. Because of the increasing competition, "winning in commodity generics in developed markets will be difficult. Today, valuations are fantastic. So divest. If you do not divest, you have to invest. But for that you need resources. Ranbaxy and Shantha got very rich valuations, some three to five times sales. So India promoters are asking themselves: Why shouldn't I cash out?"
The "rich" valuations Singh talks about raise a different issue: Are MNCs paying too much? Consider what happened to Daiichi after the Ranbaxy purchase. At the time of the acquisition, BusinessWeek wrote: "Japan's Daiichi Sankyo makes Ranbaxy Laboratories an offer it can't refuse." The Singh brothers, Malvinder and Shivinder, sold their 34% stake to the Japanese major for US$2 billion. Daiichi paid a similar sum in an open offer to ordinary shareholders; it now owns 63.9% of the company. At the end of the year, the Japanese company was licking its wounds. It had to write down US$3.84 billion after Ranbaxy shares plunged 66% on the Bombay bourses, in line with the rest of the market. Four years of Daiichi's profits were wiped out. That doesn't seem to have fazed others. "Japan's largest and oldest pharma giant, Takeda Pharmaceutical, is keenly eyeing Ahmedabad-based Torrent Pharmaceuticals as a possible acquisition," The Times of India reported soon after the Ranbaxy takeover in July 2008.
Takeda and Daiichi are looking to the future. When the Indian pharma industry itself looks to the future, what does it see? Just a few years ago, Indian companies seemed to be on the takeover trail. "The roles have now reversed in the Indian pharma M&A space," says the daily Business Standard. "In the growth years of 2005 to 2008, companies like Wockhardt, Dr. Reddy's and Ranbaxy were busy shopping abroad to expand their global footprint. In 2007-08 alone, Indian drug companies made 14 acquisitions abroad at a cost of US$1.3 billion." Some deals have gone wrong. Wockhardt is selling off because it borrowed too much to fund acquisitions and ended up with financial problems. Sun Pharma is still fighting a legal battle over its bid for Taro of Israel. The experiences of some others -- Dr. Reddy's with Betapharm of Germany for one -- have not turned out well: The company has had to write off around US$300 million on account of this German subsidiary.
"There has been a reduction in outbound M&A," Shetty notes. "For one, the capital availability has gone down significantly and two, some of the high-profile cases -- Dr. Reddy's with Betapharm -- have proved to be not very easy. They have not been earnings-accretive.... But there will continue be a hunt for acquisitions overseas, though the sizes of the deals will be down and the players will be a lot more cautious."
Is it the end of the Indian pharma MNC? No, says Singh. "Indian generic MNCs will come up. Sun Pharma is trying. So is Dr. Reddy's. They could become generic MNCs. Companies that have ambitions are not going to give up. This is just a pause."