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Tax efficiencies and treaties help M&A
February, 22nd 2007
Consolidation in the pharma space is clearly here to stay and India's M&A juggernaut is not likely to slow down soon. MR HITESH GAJARIA, PARTNER, BSR & CO, CHARTERED ACCOUNTANTS.

Not many believe that accountants can make some of the best matches of businesses, that is, going by what Arun Gandhi did for the Tatas, and Gautam Doshi, in Reliance. "The recent involvement of CAs (chartered accountants) in M&A (mergers and amalgamations) and takeovers clearly proves that CAs in industry are now not stuck only to finance and accounts. They are giving best business consultancy services and helping managements take major and vital decisions," acknowledges Mr Sunil Talati, the President of the Institute of Chartered Accountants of India.

To know how accountants study the M&A field, Business Line interacted with Mr Hitesh Gajaria, Partner, BSR & Co, Chartered Accountants. As `Sector Head - Pharmaceuticals', he focuses on international tax and transfer pricing issues too, apart from watching the deal terrain.

"Before the mega deals of Corus, Novelis and Hutch were announced, Indian pharma companies had stolen the thunder in the Indian M&A space with acquisitions worth $2.5 billion in the last couple of years," notes Mr Gajaria. "Most of these acquisitions were strategic and were primarily driven by consolidation pressures in the pharma generics space globally, helped in no small measure by easy access to capital."

Excerpts from the interview:

First, a primer on global generics consolidation.

Globally, the generics pharma industry is in major consolidation mode driven by increased competition, mounting pricing pressures and dwindling margins, on the one side, and the desire for geographical diversification and market share growth, on the other.

Major consolidation deals in the recent past include Teva-Ivax, Actavis-Alpharma, Barr-Pliva, Andrx-Watson and Hospira-Mayne. Teva alone made acquisitions of over $11 billion in the past 2-3 years, which include major deals such as acquisition of Sicor for $3.4 billion in 2003 and Ivax for $7.5 billion in 2005. The acquisition of Ivax made Teva the undisputed No.1 in the global generics space.

Actavis acquired Alpharma's generic business for $810 million and Amide Pharmaceuticals for $600 million in 2005. The acquisition of Amide helped Actavis to launch its products in the US, the world's largest market for generics pharmaceuticals. The acquisition of Alpharma made Actavis one of the five largest companies in generics worldwide in terms of revenue.

On the pricing pressures in the industry.

With competition hotting up in the global pharma space, companies are facing severe pricing pressure and price erosions, especially in the US, France, the UK and Germany. In the US, the largest generics market in the world, off-patent drugs are facing severe pricing pressure on the back of an increasing number of players and the launch of authorised generics by innovator companies.

Previously, a generic drug used to command about 35-40 per cent of the patented drug's price on account of limited players. However, the scenario has completely changed today, with the entry of small- and mid-sized companies; the price erosion in many cases exceeds 85-90 per cent of the patented drug's price!

Where does India stand in the value chain?

Global pharma players are looking at low cost destinations such as India to maintain their competitiveness. The best example of this is US-based Mylan Laboratories' 71.5 per cent stake in India's Matrix Laboratories for $736 million.

This acquisition gives Mylan access to low-cost resources and operations in India, which is definitely becoming an integral part of the global pharma value chain.

On Indian companies acquiring businesses abroad.

India pharma companies are rapidly ramping up their presence in the global pharma space through the inorganic route, and are increasing their horizons beyond domestic boundaries and trying to establish their foothold in the global pharma market. They are adopting inorganic growth strategies rather than setting up their own manufacturing facilities and distribution networks to hasten their presence in newer markets, expand their product portfolios and consolidate their market share. Indian companies have primarily succeeded in acquiring many companies in Europe, whereas significant acquisitions in the US still remain a distant dream, primarily due to very high valuations.

How are the valuations?

Soaring. Some acquisitions that have taken place at the higher end of the valuations cycle include Dr. Reddy's Labs' acquisition of Betapharm and Ranbaxy's acquisition of Terapia. Also, the ongoing race for acquisition of Merck's $2.5 billion generics business, valued at more than $5 billion, in which Indian pharma majors have also evinced interest along with global giants, is proof of the ambitions of Indian companies to consolidate their position in the global pharma space.

Your take on the competition in the industry, closer home.

The domestic pharma industry in India is highly fragmented with over 24,000 manufacturing units, leading to intense competition and high pricing pressures. In such a competitive situation, only players with lean cost structures can survive and grow. Acquisition and subsequent integration provides opportunities to ramp up the scale of operations and enjoy economies of scale.

On Indian presence in new markets.

The domestic pharma industry is rapidly integrating with the global one by de-risking revenue streams. Our companies are focusing on other markets and just not relying on one or two prime markets. It has become imperative to establish a worldwide presence. For instance, the primary objective of Ranbaxy's acquisition of Be Tabs, a leading generics player in South Africa, was to enter the high growth South African market. Dr Reddy's acquired Betapharm, the fourth largest generics player in Germany, to catapult itself into a significant position in that pharma market.

Is research capability a key factor in a target?

Acquisition of assets and expertise is a key driver of deals in the contract research and manufacturing space. Companies can acquire strong research expertise and boost their capabilities through consolidation. This is the strategic reason for Dishman's acquisition of Solutia Pharma, and Nicholas Piramal's acquisition of Avecia Pharma.

What are the innovative funding models in pharma M&A?

With ease in regulations and ample liquidity in the global financial system, Indian companies have been using FCCBs as their chief acquisition currency. Most of the companies are looking beyond the traditional debt-equity funding models and using a variety of instruments such as FCCBs, GDR/ADRs, and private equity. For instance, an Indian pharma major is also reportedly working with a consortium of private equity investors for the acquisition.

It has put in place a unique funding model whereby it will not make any investments at the beginning, and only take care of the management for a percentage share in the profits and increase its stake slowly every year.

On tax considerations.

Various tax regimes in the developed world encourage M&A activity by offering favourable tax efficiencies not only in their domestic tax legislation but also through the vast tax treaty networks that they have put in place.

Use of international holding company, intellectual property rights holding company, and tax efficient financing structures encourage leveraged buy-outs. Set off of interest and losses due to fiscal consolidation is now becoming important factors to shorten payback periods and minimise cash outflows via taxation.

The future, as you see it.

Players are daring to think big and are vying for larger acquisitions on the back of rising confidence of managing large and complex deals and past experience. Private equity players who have been on the other side of the table for many past deals are now teaming up with Indian pharma companies for their global pursuits.

To conclude, consolidation in the pharma space is clearly here to stay and India's M&A juggernaut is not likely to slow down soon. On the contrary it will only gain more momentum, and the size of the deals and the modes of acquisitions will get more innovative and creative.

What are the strategic imperatives for acquisitions?

Strengthening the value chain, improving the competitive position, entering new markets, expanding the product portfolio, building expertise in new therapeutic areas, and acquiring assets, are some of the compelling strategic considerations. These are the same for Indian as well foreign generic players.

On trends in overseas acquisitions by Indian pharma companies.

With healthcare expenditure rising continuously in Europe, those governments are strongly promoting generics business, leading to high growth opportunity in the world's second largest pharma market. Also private equity investors are exiting from profitable investments made by them in European pharma companies offering Indian companies attractive buy-out targets. Not only the large players, but also small- and mid-sized players have built up a huge war chest for domestic and global acquisitions.

There has also been a recent trend of pharma companies acquiring front-end pharmaceutical marketing companies to strengthen their distribution network and improve their global competitiveness. For example, Dabur Pharma recently acquired Thailand-based pharmaceutical marketing company and long-term associate Biosciences Co. to strengthen its distribution network in Thailand.

On consolidation of market share.

Indian pharma giants like Ranbaxy and Dr Reddy's have for long adopted the strategy of capturing market shares faster via inorganic acquisitions rather than only relying on organic growth.

Ranbaxy has closed eight acquisitions last year, of which the major deals include acquisition of Terapia for $324 million and Be-Tabs for $70 million. Terapia is the largest generic player in Romania, making Ranbaxy a leading player in that market. Be-Tabs is the fifth largest generics player and the largest penicillin manufacturer in South Africa. At present, Ranbaxy is targeting to become the world's third largest generic player through acquisition of Merck's generics business.

Similarly Wockhardt acquired Pinewood Laboratories for $150 million. Pinewood is the largest and fastest growing branded generics pharmaceutical company in Ireland and this acquisition gives Wockhardt a larger footprint in Europe spread over the UK, Ireland and Germany.

Many small- and mid-sized players are now trying to replicate Ranbaxy and Dr Reddy's growth models.

(Some of the major deals that have taken place in the recent past are shown in the table.)

D. Murali

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