The Sun – Ranbaxy Deal


This is what has happened. Shares of Sun Pharmaceutical Industries on Monday were up 2 percent in morning trade after it agreed to buy its troubled peer Ranbaxy for $4 billion (with debt) in an-all stock deal, thereby ending the latter’s ill-fated six-year control by Japan’s Daiichi Sankyo. As per the deal, in simplest terms, shareholders of Ranbaxy will receive 0.8 share of Sun Pharma for each share of Ranbaxy.

The combination of the two will create the fifth-largest generic pharma company in the world and the largest pharmaceutical company in India and leave Daiichi Sankyo with a significant stake in the combined entity. The combined entity will have operations in 65 countries, 47 manufacturing facilities across 5 continents, and a significant platform of specialty and generic products marketed globally, including 629 ANDAs (Abbreviated New Drug Applications) and will result in increased leadership in key emerging markets like Russia, Romania, South Africa, Brazil & Malaysia.


DAIICHI SANKYO CO. LTD: Daiichi Sankyo is Japan’s fourth-biggest drug maker by revenue. Daiichi bought Ranbaxy in 2008 in a cash deal valued at $4.6 billion, believing the latter’s dominance in cheap generic medicines and developing markets would help the firm grow. However this did not happen. In the last six months, the deal has already lost 40 percent of its value due to Ranbaxy’s regulatory problems with US Food and Drug Administration (FDA).

Now that Sun Pharma has acquired Ranbaxy, Daiichi is relieved of the burden of managing Ranbaxy’s problems. Post the Sun Pharma deal, Daiichi will still hold 9 percent stake in Sun Pharma, thereby becoming the second largest shareholder in the company but is likely to sell its stake eventually.

As per the investor presentation, Daiichi Sankyo, which holds 63.4 percent stake in Ranbaxy, has agreed to vote shares in Ranbaxy in favor of Sun Pharma’s acquisition and the transaction is expected to close by December 2014, pending shareholder, court and regulatory approvals and other customary conditions.

RANBAXY: Ranbaxy is banned from exporting drug ingredients to the US. Earlier this year, the US Food and Drug Administration banned Ranbaxy from manufacturing and distributing drugs to the US market from its Toansa facility in Punjab. This is the company’s fourth facility to face such a ban, others being Poanta, Dewas and Mohali. To add to its miseries, along with the acquisition news, Ranbaxy announced that it received a subpoena dated 13 March (why this was not disclosed earlier is something that should bother shareholders) from the US Attorney for the District of New Jersey asking for information about its Toansa facility that recently received an import alert from the US FDA.

But things change now for Ranbaxy. This is the end of the road for Ranbaxy as it exists but it perhaps is the best outcome for the company and its shareholders, given the circumstances. Ranbaxy is a company with a very bright future in the US generics market, with a size-able drug pipeline and some big product launches in the waiting, but for frequent run-ins with the US drug regulator.

The fact that these glitches continued even after a new management was in control was a big surprise for investors. It is now up to the new owners to ensure that the plants become and remain compliant with US FDA norms.

SUN PHARMA: Sun Pharma’s chairman Dilip Shanghvi has acquired a reputation for acquiring companies in trouble at a good price, and then turning around their operations. Sun Pharma has a proven track record of creating significant long-term shareholder value and successfully integrating acquisitions into its growing portfolio of assets.But Ranbaxy will certainly be a big challenge.

The merger will see Sun Pharma’s revenue jump by a healthy 40% but its operating profit will rise by a meagre 7.5%, based on pro forma 2013 financials. Its operating profit margin will decline from 44.1% to 29.2%. Thus, the merger will have a negative effect on its performance in the near term. Pro forma financial statements are designed to reflect a proposed change, such as an acquisition, or to emphasize some figures when a company issues an earnings announcement to the public.

In terms of size, Sun Pharma will now have a pro forma 2013 revenue of Rs.25,911 crore and an operating profit of Rs.7,577 crore, with a net profit of Rs.1,710 crore. Ranbaxy’s profits have been hit by provisions related to inventory write-offs and foreign exchange-related provisions.

So, what does Sun Pharma hope to gain from this acquisition? Sun Pharma has said it expects to get $250 million, or Rs.1,550 crore, in merger-related synergies by the third year after the acquisition is completed. That is fairly significant and these savings should be from sales growth, procurement and supply chain efficiencies. But this merger is not really about scale and its benefits.

In the Indian market, the combined entity’s portfolio becomes much larger, covering more therapeutic areas. The challenge is that Ranbaxy’s margins have been relatively lower and that is unlikely to satisfy Sun Pharma. The company management has said they will work on improving its margins. In the US market, the priority will be to resolve all of Ranbaxy’s FDA-related troubles to ensure that every major generic product in Ranbaxy’s pipeline makes it to market. These are crucial factors, in addition to their efforts to grow their combined business in Europe and emerging markets, to ensure this acquisition works out in Sun Pharma’s favour.

SHAREHOLDERS: Ranbaxy’s share is evenly placed based on the merger ratio and no further gains are likely to accrue to its shareholders. Ranbaxy’s shareholders will now become Sun Pharma shareholders. They can choose to stay invested if they believe that Sun Pharma will be able to make a much bigger and better combination, or exit at this point.

Sun Pharma’s shareholders may blink at the immediate effect of equity dilution of 16.4% and the effect on its profitability in the near term. This is reflected in the stock market reaction to the announcement: On Monday, Ranbaxy’s shared declined by 3.1%, while Sun Pharma’s share faced some volatility but closed with a decent gain of 2.7%.”

There is also the matter of uncertainty on what further lies ahead for Ranbaxy’s regulatory troubles and how soon Sun Pharma can resolve them. Running counter to these fears should be Sun Pharma’s ability to make this acquisition work in the long run. The company’s successful track record in turning around acquired companies should give investors some hope that it can pull off the same magic at Ranbaxy as well.

All in all, this merger looks like a win win situation for all parties involved.

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