A ‘Bigger Foothold’: What Does the Abbott-Piramal Deal Mean for Indian Pharma?

In May, U.S.-based Abbott Labs secured the top spot in India’s growing pharmaceutical industry with its US$3.72 billion takeover of Piramal Healthcare’s branded generics business. At the same time, hopes have receded of a wholly Indian pharmaceutical major emerging as a global player. According to Wharton faculty and industry experts, changing global business models and the resources needed to develop blockbuster drugs are propelling Indian companies to join forces with multinationals through strategic alliances or as targets for acquisitions.

The Piramal purchase offers “an incredible strategic platform,” according to Michael Warmuth, senior vice-president, established products, in Abbott’s pharmaceutical products group. Based in Abbott Park, Ill., Warmuth is responsible for growing his company’s global branded generics portfolio. The Abbott-Piramal combine reports to him, but he notes it will be run as a standalone business unit after the merger takes effect later this year. Abbott will pay US$2.12 billion upfront and four annual installments of US$400 million from 2011 for Piramal’s healthcare solutions business.

“We want to expand in emerging markets, and you can’t be taken seriously without having a strong or dominating presence in India,” Warmuth says. Emerging markets will in the next few years account for 70% of the growth in the global pharmaceutical industry, and India is “an important and critical part” of that, he adds. He expects Abbott’s Indian revenues to grow to US$2.5 billion in the next decade, up from the combined company’s current revenues of about US$500 million. Also, India’s US$8 billion pharmaceutical industry is poised to double by 2015, he adds.

Emerging markets will grow by 14% to 17% between now and 2014, compared with 3% to 6% in developed markets, according to an April 2010 report from IMS Health, a research services firm in Norwalk, Conn. The global pharmaceutical industry will add US$300 billion in revenues to reach US$1.1 trillion by 2014, the report stated.

The Abbott-Piramal deal is the latest in a wave of consolidation within the global pharmaceutical industry over the past few years. It is much smaller than two of 2009′s biggest M&A deals — Pfizer’s US$68 billion purchase of Wyeth and Merck’s US$41 billion buy of Schering-Plough. However, Abbott has valued Piramal’s formulations business at about eight times sales, which is almost twice that of what Japan’s Daiichi Sankyo paid for its US$4.6 billion purchase of a controlling stake in India’s Ranbaxy Laboratories in June 2008. “If you want the best companies you will pay a premium; however, we feel it was the right price,” says Warmuth of the Piramal acquisition. Incidentally, Daiichi Sankyo took a US$3.5 billion write-off on its Ranbaxy acquisition but has maintained it made the right decision.

Wharton management professor Saikat Chaudhuri says the relatively higher valuation makes sense for Abbott. “Sure, it is on the higher side, but we are also taking about a lot of potential in these markets and multiple synergies,” he says. “There are revenue synergies; the reach of generic drugs could be expanded globally, and Piramal’s sales and distribution network can be used to more effectively market drugs that are developed elsewhere. On top of that, India is a growing market.”

The valuation is appropriate, says Ajay Piramal, chairman of the group’s holding company Piramal Enterprises. “It is the best business available in India and has been growing at 25% [annually] in the last two years.”

Uneasy Amid the Top 10?

Globally, Abbott also faces the pressure of playing catch-up with its bigger rivals. It ranks eighth in the global pharmaceutical rankings with 2009 revenues of $30.7 billion, which is about half of industry leader Johnson & Johnson’s revenues of $61.8 billion for the same year. “Abbott has a unique challenge,” Chaudhuri says. “In terms of size, scale and scope, it is smaller than the other pharmaceutical players, and it is seeking ways to differentiate itself by gaining a bigger foothold in an up and coming market like India.”

Wharton professor of healthcare management Patricia Danzon agrees. “It’s a higher markup on a smaller base,” she says of the Piramal valuation, “and I can see a number of reasons for that. There are a limited number of Indian generics companies that are attractive, and there might be considerable competition for them. The U.S. pharmaceutical industry and other multinationals are looking to get into the branded generics space, and leading Indian companies are attractive — and Piramal is one of the leaders. So I don’t find it that surprising.”

Abbott has been operating in India for 100 of its 122 years, and has popular pharmaceutical brands including the antacid Digene and painkiller Brufen. Piramal’s pharmaceutical products span dermatology, anti-infectives and nutritionals, while Abbott India is focused on gastroenterology, pain, neurosciences and metabolic disorders, among other categories.

The Piramal group has agreed that for eight years after the deal’s closing, it will not enter the business of generic pharmaceutical products in India, or make or market them in emerging markets. It will, however, continue research in drug discovery through an affiliate company. Piramal Healthcare also retains custom manufacturing, over-the-counter consumer products, diagnostic medical devices and services and clinical research, among other activities.

Indian companies can hope to become truly global pharmaceutical companies only through drug discovery, says Piramal. “No Indian company has done that in the last 60 years. Now, Piramal on its own has that opportunity.” Piramal Healthcare focuses on oncology, metabolic disorders, inflammation and anti-infectives. Increased funding expands the scope for drug research, but that alone is not enough; other pieces have to fall in place, Piramal notes. “Time is limited. You have to create a whole organization, and that takes time. [The the Abbott-Piramal deal] puts drug research on a faster track.”

Springboard to Global Markets

According to Warmuth, the Piramal acquisition, at least initially, is purely for Abbott’s plans to grow its Indian business. “Piramal’s 350 products [are] clearly our interest, and we could build on and accelerate that,” he says. “We have no plans immediately to export Piramal products [to third-country markets] but we will evaluate that. You won’t be at all surprised that if we evaluate that.”

In fact, 10 days before the Piramal acquisition, Abbott announced a licensing and supply deal with Indian pharmaceutical company Zydus Cadila. It allows Abbott to commercialize two dozen Zydus Cadila drugs in 15 emerging markets. The collaboration includes medicines for pain, cancer and cardiovascular, neurological and respiratory diseases, with product launches beginning in 2012. The Piramal and Zydus Cadila deals are consistent with Abbott’s purchase in September 2009 of Belgian drug company Solvay for about US$7 billion, Warmuth says. Abbott bought Solvay in its quest to enter emerging markets in Asia and Eastern Europe, and to add drugs for hypertension and Parkinson’s disease, besides vaccines.

Abbott and other Big Pharma companies face the twin challenges of slow growth in the developed markets and maturing product pipelines that are getting harder to replenish with newer, blockbuster drugs, according to Chaudhuri. “Essentially, the global pharmaceutical industry players have all been trying to diversify their business,” he says. “In earlier waves of M&A deals, they would try and buy major pipelines of blockbuster drugs. In the past few years, they have realized that those pipelines are running dry, and are trying to diversify.”

Unlike other pharmaceutical acquisitions that have been targeted at buying Indian generic capacity to service Western and emerging markets, the Abbott-Piramal deal is primarily focused on the domestic market, according to Mumbai-based business magazine Business India.”The deal is intended to consolidate Abbott’s toehold in India; it is recognition of the fact that growth in healthcare will come from emerging economies,” the magazine said in an editorial. “Big Pharma will stay big only by selling its wares in India and China.”

India certainly offers a large and growing domestic market with rising incomes and increasing health insurance coverage, says Danzon. However, she cautions that “it is most effective for drugs that are moderately priced…. The potential to expand with very high priced specialty products is seriously limited.” In fact, she sees a bigger agenda for Abbott. “I don’t think these sorts of mergers are driven primarily by a desire to sell in India,” she says. “It’s about getting access to manufacturing capabilities and a portfolio of products that can be sold in other emerging markets.”

Abbott would get Piramal’s manufacturing facilities in Baddi in Himachal Pradesh state, and about 5,000 employees, bringing the combined entity’s workforce to about 7,000. Warmuth says Piramal’s manufacturing standards and capabilities meet global regulatory standards. He doesn’t expect to face the kind of problems Daiichi Sankyo found itself in after its Ranbaxy acquisition, when the U.S. Food and Drug Administration charged the Indian company with numerous violations on quality and safety fronts, and banned some of its drugs.

“There are risks, but I would expect MNCs doing acquisitions in India to partner with companies that do have facilities approved by the FDA or the EMEA (European Medicines Agency),” says Danzon. “Some of the benefits of having those low-cost locations allow them to export their drugs to the U.S. or other developed countries. That is one reason pharmaceutical multinationals are doing deals with the relatively small number of well established Indian companies that have met international standards in manufacturing.”

To be sure, Abbott competed with other suitors for Piramal Healthcare’s branded generics business, which according to media reports included Pfizer, Sanofi-Aventis and GlaxoSmithKline. Several other deals occurred over the past one year. Sanofi-Aventis bought Shanta Biotechnics, a vaccine maker in Hyderabad, for about US$788 million. Earlier, the Dabur Group had sold a 74% stake to Fresenius Kabi of Singapore for about US$200 million. The industry has been buzzing with talk of Big Pharma companies like Pfizer and GlaxoSmithKline courting Indian companies like Cipla, Dr. Reddy’s Laboratories and Torrent Pharmaceuticals.

Changing Business Models — and Commitment

All the same, the West continues to dominate pharmaceutical innovation, and companies in India and other emerging markets could play a supportive role, according to Danzon. “Indian companies don’t have the capital required to go into that area of innovation; biotech and pharmaceutical innovation is capital intensive.”

“It is like a reality check for Indian pharmaceutical companies,” says Chaudhuri, referring to the financial resources and expertise in newer-age drugs based on biologics research. He visualizes how an Indian pharmaceutical entrepreneur might weigh the pros and cons of growing globally in today’s environment: “If you have the scientific base and the resources, say a few billion dollars, then maybe we can talk. [Otherwise,] why toil and struggle with this, given how health care reform is on the anvil in many countries and cost containment pressures will be even greater?” He adds: “Let’s go to something that is booming,” referring to Piramal retaining select portions of its business including diagnostics and contract manufacturing facilities.

Chaudhuri acknowledges those new realities, but with a patriotic tinge. “I am disappointed, and there is some patriotic sentiment in that,” he says. As Ranbaxy, Dr. Reddy’s Labs and other Indian drug makers made inroads into developed markets with generics, he adds that he expected some of them to become true global pharmaceutical players, much like Infosys and Wipro Technologies in IT Services.

“Indian firms that had the potential and were leaders in generics have not been able to pull it off,” says Chaudhuri, adding, “Ranbaxy was the first [to sell out].” But he also sees why that is the case: “It requires a lot of commitment. I don’t see any of these promoters interested in the long haul, unlike Azim Premji (who heads software services major Wipro Technologies) or Ratan Tata (head of the Tata Group, whose recent triumphs include several international acquisitions and the Nano small-car brand). These other players are not even interested in doing that. They don’t seem to have that type of desire.”

Along with desire, the rules of the game for Indian companies changed dramatically after India strengthened its patent laws in 2005 to comply with the World Trade Organization’s rules on intellectual property rights. The earlier regime recognized patents on pharmaceutical processes but not on pharmaceutical products, allowing companies to reverse-engineer copies of the branded and patented drugs of western companies.

“Their old model can’t work anymore, so if they want to go into the R&D side, they need the capital and the expertise the MNCs can bring,” Danzon says. “At the same time, from the standpoint of the MNCs, with the drying up of R&D productivity in the U.S. and developed markets and their search for other sources of innovation, [acquisitions like that of Piramal are] a cost-effective way to bring in a portfolio of branded generics. It makes a lot of sense if they can pull off all the integration issues.”

Regulatory Detours

However, companies like Abbott and others getting into new generic drug markets must be watchful of the changing lay of the land there as well, according to Danzon. “In many countries, branded generics command relatively high prices and margins, and are really like branded drugs, sold through sales forces and marketed to physicians.” However, in the U.S., unbranded drugs dominate the generics market, which is intensely price-competitive and one where decisions are taken by pharmacists, and not physicians. “You have to be very skilled at it to survive and have very good controls on cost processes,” she adds.

The takeaway for Abbott and others eyeing the global generics business is that “other countries will eventually evolve towards the cheaper, branded generics model,” according to Danzon. Against that backdrop, “it doesn’t make sense” to pay high prices for generics companies. Also, a couple of acquisitions of generics companies in recent years have “turned sour” as regulatory agencies changed the rules of the game in favor of lower-cost drugs, she adds.

Danzon points to Dr. Reddy’s Laboratories’ 2006 acquisition for US$570 million of German generic drug maker Betapharm of Germany as one that was caught in the midst of regulatory changes. “Right around that time, the German generics market was transforming from a physician-driven, fairly high priced market to one that was in direct contracts with insurance companies,” she says. A big chunk of Betapharm’s valuation was for its sales force, but with generics companies, “price is a key factor; you don’t need a big sales force.”

Danzon adds that the emerging business plan for generics companies is essentially around selling to pharmacists, not physicians. “That transition is the next evolution for generics. For consumers, the great value in generics is getting it cheaper.” In the branded generics model, the prices could be as much as 30% lower than the originator drug, whereas in the U.S. model, they can be 80% or 90% lower, she explains. “All countries are trying to control their health care spending, and one way they try to do that is by expanding the use of generics,” Danzon says. “And they get much more bang for their buck if they get cheap generics.”

A key differentiator here is that unlike in the U.S., the regulatory regimes in many countries including India do not require generic drugs to be bioequivalent to the originator products; they require them to have roughly the same active ingredients, according to Danzon. But that is also changing, she says. Mexico, for example, is in the process of changing its regime to require generics to be bioequivalent, she says. “That means putting a lot of domestic companies out of business, so politically and economically, it is a tough thing to do in an emerging market.” Abbott may have to confront that if and when the rules change in India.

Warmuth is unfazed by the imponderables he may face in Abbott’s India quest. “A lot of things make me stay up at night; there will always be concerns,” he says. “With Piramal, it is about how we take full advantage of the opportunity. It is not so much a concern about the downside, but about how we maximize the opportunity.”

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