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M&A the main driver for value unlocking in Indian pharma
December, 06th 2007

India has currently more than 120 formulation players with sales greater than $10 million. While the larger players continue to enjoy EBITDA margins of 18-20 per cent, there are many Indian companies which struggle to make even 10-12 per cent.

Mr Navroz Mahudawala, Associate Director, Transaction Advisory Service, Ernst & Young.

Generics is the old story in the great Indian pharmaceutical space. The new kids on the block are contract research and manufacturing services (CRAMS) providers.

The emphasis is on future leaders rather than established captains, and the rapid expansion plans charted by these emerging breeds make them a perfect fit for private equity players, who are hot on heels to get their slice of the growing pie.

Naturally, funding is less of an issue for these smaller companies, says Mr Navroz Mahudawala, Associate Director, Transaction Advisory Service of Ernst & Young (E&Y).

In an exclusive interaction with Business Line, over the e-mail, he also talks about the change in strategies of pharma MNCs (multinational corporations) present in India and why Europe is where all the M&A (mergers and acquisitions) action could be for Indian drug makers.

Excerpts from the interview:

How do you view the existing funding environment as far as the pharmaceutical industry is concerned?

We expect the funding environment in pharmaceuticals to continue to remain robust. Many PE (private equity) funds, especially the recent entrants, have either none or limited pharma exposure. Its a sector that is difficult to ignore considering the inherent competitive strength of India.

CRAMS continues to be the favourite area within pharma, largely driven by the sheer size of opportunity and benchmark-listed success stories like Dishman and Divis. Also, its an area wherein a large global fund could add substantial value to entrepreneurial companies. We expect at least 5-6 CRAMS businesses being funded in the next 12-18 months.

API (active pharmaceutical ingredients) also holds promise; however domestic formulations could be an area of challenge as valuations herein are almost at an all-time low.

Biotech holds promise; however most business plans in this space are still at VC-stage and hence do not figure on the radar of many PE funds.

There seems to be some amount of slowdown in overseas M&A. What kind of geographies do you expect Indian corporates would target going forward?

To some extent, it was expected after the frenetic pace of deal making witnessed in 2005 and 2006.

While the top 3-4 companies are integrating the companies they acquired, the mid-sized players have consciously stayed away due to fancy valuations prevailing in various geographies.

One clearly needs to factor in the stagnant valuations of the Indian pharma sector on the bourses.

It is difficult to envisage an Indian company acquiring an overseas business at 12 (x) EBITDA (earnings before interest, taxes, depreciation and amortisation) when its own valuations here are 8 to 9 (x) EBITDA. Europe would continue to be a favourite geography for most Indian companies.

What kind of inbound deals do you expect in the next 2-3 years?

We will definitely witness some acquisitions in the API space by overseas generic companies. Also, there is a strong appetite for regulated market-approved assets; however, there are few keen sellers.

How do you view domestic sector consolidation? There has been limited activity in the domestic industry; however there is constant talk of an imminent consolidation.

Domestic M&A has been a challenge, in spite of impending consolidation in the domestic formulations sector. However, the recently concluded deal wherein Dabur Pharma sold its entire non-oncology business to Alembic could be a signal for restructuring.

There are not many European and Asian companies keen on establishing a base in the Indian formulations market. This could potentially reduce the valuation expectation gap and make sellers keener. M&A will undoubtedly be the main driver for value unlocking in this sector.

In todays market, there are at least a couple of dozen buyers and negligible sellers in this space. This could potentially change.

Lets examine some of the strategic rationale. India has currently more than 120 formulation players with sales greater than $10 million. While the larger players continue to enjoy EBITDA margins of 18-20 per cent, there are many Indian companies which struggle to make even 10-12 per cent.

Promoters of smaller companies are increasingly becoming aware that growth from volumes alone would be a challenge in the future. Marketing in domestic formulations has become a competitive function.

Many Indian companies have dabbled in the regulated market; and the results in most cases have not been too encouraging.

Regulated-market presence requires sustained investments for a period of 4-5 years with minimal cash inflows a fact that many smaller companies are not used to. Some of these factors would also make many companies do a strategic rethink.

Another shift, which we could witness, is the change in the strategies of MNCs in India. While these have been sceptical acquirers till date, growth pressures would make them take a different stance.

They could be willing to experiment with more India-oriented portfolios as well as take on additional assets if the deal requires them to. This may not be as much out of strategic intent as it could be out of pure market diktat.

Do you believe buyouts could happen in this sector by private equity investors?

The domestic formulations sector seems to be ripe for buyouts to occur. Actually, PE-led buyouts could provide the ideal option for many managements that would be keen to explore the option of divesting a large stake (including control), while however wishing to run the business on a day-to-day basis for the next few years.

In fact, certain family-run businesses, which have historically suffered due to inherent systemic inefficiencies and limitations of management bandwidth, could benefit greatly from induction of an aggressive buyout fund.

Bio: Mr Mahudawala, a chemical engineer by graduation is a chartered financial analyst (CFA) and PGDBA. His focus is on the health sciences and chemicals practice of E&Y in India. He has more than 10 years of investment banking experience.

Prior to joining E&Y, Mr Mahudawala worked for around 4 years with KPMG Corporate Finance as an AVP. His previous corporate finance experience includes stints at Lazard India and India Advisory Partners. For a year, in 2000 that is, he also co-promoted Internet entrepreneurial venture

Mr Mahudawala has worked on diverse assignments, such as M&A, advisory, valuations, debt restructuring, entry strategies and financial advisory. Besides chemicals and pharmaceuticals, he has also been involved in M&A transactions in areas of FMCG and textiles.


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