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Why PE cos pay 'strategic' premium for Indian pharma?

Mumbai: Call it a smart pickings in an otherwise dire macro environment and then paying a scarcity premium for it. With four large deals in two months and counting, bulge bracket private equity players KKR, Carlyle, Apax, Advent are seemingly out with their shopping bags scouting for good pharma bets in the country. From Ra-Chem to Emcure and possibly even Granules India, the scope and deal flows are only expected to rise this year.“PE funds have significant dry powder and have always been keen on sectors such as pharma which are seen as defensive, have a steady cash flow and are usually higher ROCE businesses," said Utpal Oza, Head, investment banking, Nomura India. “They are happy to pay a significant control premium for pharma assets as control transactions are far and few, especially in the absence of strategic competition.”Data from the recent deal flows also suggest that many of these financial investors are also willing to pay more than strategics (see chart). Historically, the preference has been more in favour of selling out to industry peers since transition is faster and handholding limited --- Daichi-Ranbaxy-Sun Pharma, Piramal-Abbott, Torrent’s acquisition of Unichem and Elder or even Gland and Fosun -- unless the value difference is tangible. From the current trend it seems that indeed is the case. However, many still believe the eventual exits of these control PE investments will likely be to such strategics.76881776For PE players the numbers reflect future growth prospects in a sector with a long tail of companies and future scope for consolidation. “These are fair multiples compared to the peer comparables in the listed space like Torrent, Alkem, Ipca and also reflect the work that needs to be done to position the company for future growth. India has an attractive branded formulations market that is worth around $20 billion, growing at a CAGR of around 9 -10%,” feels Prashant Kumar, MD, KKR. “It makes India’s pharmaceutical industry one of the top three markets globally. This growth is mostly driven by chronic and sub-chronic therapy areas, making it the key verticals for growth amongst established players in the industry.”DEFENSIVE BETSA variety of factors is at play. Pharma as a sector is performing much better "relatively" compared to other sectors with a majority of companies at least doing 70-85% of their monthly revenues (that they were doing pre-covid) and in specific pockets like APIs there is outperformance. India also stands to emerge as a clear alternative to China going forward & the domestic API industry should do much better. “This sector also has the least leverage amongst the Indian manufacturing sectors,” says Navroz Mahudawala, Founder, Candle Partners, a boutique investment firm. “Unleveraged/less leveraged balance sheets help buyout funds in generating better returns by using the company balance sheet in future. Also for future expansion, debt could be used without equity dilutions.” According to a study done by the firm on pharma trends between 2010-2020, the large cap universe is at net debt / EBITDA of 2.1 (x) and the mid cap universe is at 1.5 (x). Average Debt / Equity levels of the sector are around 0.33 (x). With limited inorganic activity seen in the last 12-18 months & with prudency in capex, these ratios are expected to get maintained going forward. THE EXIT FACTOR" The pharmaceutical sector in India always gives a good return for PE funds compared to any other sector. At the same time, strategics are having a tough time globally and rarely spending time for acquisitions in India,” argues Ravi Penmetsa, Managing Director, Gland Pharma who sold hi company first to KKR and then China’s Fosun.KKR which invested $200 million in Gland in 2013, made a return of more than 3 times and an internal rate of return (IRR) of close to 30%, while the past exits by PE have seen an average IRR of 15%. ChrysCap's exits from Mankind Pharma with 10-fold gain; from Eris Life with 4X return and Apax Partners' exit from Apollo Hospitals with 3-fold gain are some of the many multi-baggers that people rely upon."The Indian promoters also have been proactive in partnering with global PE funds with significant ownerships to leverage on their global networks to grow their companies in the rapidly evolving and increasingly competitive markets," adds Bhavesh Shah, MD, Equirus Capital.Carlyle for example, wants to capitalise their expertise from owning several global contract research organizations and pharmaceutical ingredient manufacturers like Albany Molecular Research, PPD and Ambio, to identify global trends and add value to Piramal Pharma. “We also will leverage our operating partners who have been former CEO of Pfizer or the former CFO of GSK to guide the business,” Neeraj Bharadwaj, MD of Carlyle Asia Partners, told ET. The firm also has similar wide exposure in the animal health space through multiple investments in the last two decades that helped edge past competition to acquire Sequent.KKR too views JB Chemical as a platform with strong domestic brands in therapy areas like gastro, cardiac, and anti-infectives, and a large field force of medical reps that compliment the local API manufacturing to build further. “The idea is to leverage the strong India foundation and target both domestic and international markets that have branded formulations. JB’s cash flows will also help the company in going after bolt on acquisitions,” adds Kumar.WHERE ARE THE STRATEGICS?With a wave of consolidation across Big Pharma globally -- deals worth about $300 billion last year and $265 billion in 2018 -- global generic players Mylan, Teva have their own growth challenges in the US/EU markets. "International strategic players are not interested in minority joint ventures and have little appetite for expensive buyout transactions," feels Oza. “We will definitely see domestic pharma consolidation as key leading players will now increasingly use M&A to increase their domestic market share.” Even domestic drug manufacturers have played a passive role in 2020 as there was a single acquisition involving Dr.Reddy's Labs acquiring a portfolio of 62 brands in multiple therapy segments of Wockhardt for Rs.1850 crore."Domestic to domestic acquisitions have been more towards acquiring complementary businesses to strengthen position in specific markets or brand baskets with significant market leadership; with a view to play out synergies on a larger combined platform (DRL – Wockhardt, Torrent – Elder)," believes Equirus’ Shah.Several industry players therefore believe the PE rush may be more of a coincidence and several of the deals have been cooking over last 12-18 months and may not necessarily reflect a trend. Compared to global standards, the consolidation landscape in India is still sporadic and large deals have been less than even one annually! Post Abbott Piramal deal a decade back (May 2010) or the Sun-Ranbaxy one, other notable large deals have been handful. But that also gives a unique edge to the funds who continue to believe that the local industry will continue its double digit growth. ICRA puts that 10-13 per cent in 2020-21.Till then the race to who buys best seems to continue.