Indian pharma companies have notched up some aggressive global buys recently but the sector’s experience with cross border M&As has been mixed. Are they on the right track this time? And how will companies deal with the possible backlash from employees as they rightsize to maximise benefits from such deals? By Viveka Roychowdhury
The deal making path is certainly not smooth. The aborted Pfizer – Allergan merger, which was dubbed Phallergan, proves that even the biggest of big pharma is not immume to roadblocks. But aborted and failed deals are not going discourage corporates from planning, strategising, finalising and even fantasing about a dream deal that will jettison them ahead of their peers.
In fact, EY’s Firepower Index and Growth Gap Report 2016 predicted that focused acquisitions and divestitures will become paramount this year, specifying that deals targeting narrower therapeutic battlegrounds, emerging and exciting scientific opportunities, geographic strongholds and strategic gaps will drive the M&A agenda. Even though the report was released before Phallergan was called off, the EY report’s predictions are in line with other industry analyses. As deals drive more deals, competitors are forced to respond but since few large companies have the financial wherewithal to pursue transformative acquisitions, targeted M&A and divestitures have and should continue to pick up the slack.
There are a number of signs that this is already happening. After Pfizer and Allergan decided not to say ‘I do’, a GlobalData report in early June commented that an upcoming merger agreement between Pfizer and Anacor, worth around $5.2 billion, would help both companies leverage their strengths in the atopic dermatitis space.
Pharma companies in India have had their fair share of successes and lemons. Far from being a dream of a deal, the Daiichi Sankyo-Ranbaxy saga will probably go down as a case study in the ‘how not to do a deal’ section. While the promoters of Ranbaxy got a good valuation when they sold out, Daichii Sankyo paid the price for insufficient due diligence. Ranbaxy’s peers seem keen not to make the same mistakes when they acquire assets overseas. (See box: Fallen heroes)
Hailed as a milestone deal in 2008, the Daichii Sankyo – Ranbaxy merger was hailed as a badge of honour for the pharma industry in India and a win – win for both companies. The erstwhile promoters of Ranbaxy Laboratories, Malvinder and Shivinder Singh and their family, sold their entire stake of about 35 per cent in Ranbaxy for $2.4 billion to Daiichi Sankyo, allowing them to focus on their hospital business. The main driver for the Japanese partner was access to the huge Indian market.
But today, the Daiichi Sankyo-Ranbaxy deal will probably be remembered for all the wrong reasons. The merged entity had to deal with repeated raps from the US FDA for serious non – compliance issues which finally resulted in a consent decree and a $500 million penalty. Five years after the deal, in November 2012, Daiichi Sankyo filed an arbitration case in Singapore, alleging that certain former shareholders of Ranbaxy ‘concealed and misrepresented certain critical information concerning US Food and Drug Administration and Department of Justice investigations at the time of Daiichi Sankyo’s purchase of shares of Ranbaxy in 2008.’
The Japanese firm decided to cut its losses and sold out to Sun Pharma in April 2014. The $4.2 billion merger/ acquisition between Sun Pharma and Ranbaxy was completed in February 2015, and a month later Daiichi Sankyo sold out its remaining nine per cent stakes of Sun Pharma shares it had obtained during the acquisition. Thus ended its short-lived Indian presence.
On May 6 this year, three and a half years after filing the arbitration case in Singapore, the International Court of Arbitration of the International Chamber of Commerce awarded a judgement in favour of Daiichi Sankyo, asking the former promoters of Ranbaxy to pay damages of Rs 2,562.78 crores. Daiichi Sankyo would see this judgement as a vindication of its stand but Ranbaxy does not seem to be giving up without a fight. A statement from the Ranbaxy side
indicated that it was exploring further legal options to challenge this decision.
Maneesh Chandra of ZS Associates agrees that given that Daichii Sankyo had already faced the brunt of the problems, the worst was probably behind them. But the Japanese company still decided to sell out. Sun Pharma got Ranbaxy at a good price, so automatically at the point of purchase itself they were able to give a good deal to their shareholders in terms of value. But whether they can derive better business value, is still a big question.
In search of synergies
In spite of the increasing levels of complexity due to tax regualtions and currency fluctuations, the search for synergies continues. Of late, the complexion of deals involving pharma players from India has been diametrically opposite to the mega Daiichi Sankyo – Ranbaxy and Sun Pharma-Ranbaxy buyout/ mergers. The latter one seems to have spurred other big Indian pharma companies into an almost desperate race to close the gap in rankings and revenues. But are they going deeper with their due diligence? As acquirers, their recent buys seem more doable and deal complexity too has ratcheted to a new level but its still to early to tell for sure.
Consider for example, Lupin’s acquisition of assets in the US (Gavis Pharmaceuticals, Novel Laboratories, VGS Holdings and one share of Novel Clinical Research) through bridge financing of $880 million from JP Morgan Chase Bank in July 2015. Touted as one of the largest offshore acquisitions by a company from the Indian pharma sector, the deal reportedly created the fifth largest pipeline of ANDA filings with the US FDA, addressing a $63.8 billion market, with over 45 First-to-Files (FTFs).
The way Lupin derisked its financing was interesting but not completely novel. Analysing the financials backing this deal, Anil Khanna, Partner, Tai Pi Advisors says, “Lupin took the debt in US market, in the foreign currency, gave corporate guarantee backed by the parent company, since US subsidiaries balance sheet wasn’t big enough to justify such a big loan. Much earlier, Wockhardt has also taken a similar route. This route enables the Indian company to take a low cost foreign currency loan and also avoid all the risks on account of currency movement or the change in business movement. These deals were valued at 16 times EBITDA multiple. Again some analysts felt it was a high price!” (For more analysis, read his article in this issue, Pharma M&As – value creator or a value destroyer?, pages 18-21)
Other big pharma companies from India have forged deals similar to Lupin’s, buying assets, either manufacturing facilities or research leads, in the US and other western markets. Sun Pharma continues to rationalise different parts of the merged entity. For instance, it has shut down or sold some of its global manufacturing plants (Ireland, Ohio, Philadelphia and Illoinois) in a bid to synergise operations.
Deeper due diligence
So, is there a foolproof strategy to ensure deals do not go sour, especially when they are cross border transactions with higher levels of complexity? Manisha Shroff, Associate Partner, Khaitan & Co., who advised Lupin on the Gavis Pharmaceuticals – Novel Laboratories – VGS Holdings – Novel Clinical Research transaction said that the deal process for such a deal is not very different from a pure domestic deal. However, she does list a few action points. “Depending on the jurisdiction involved, it is advisable to focus on certain diligence work streams more than others. For instance, if the target involves plants for western jurisdictions, technical and GMP compliance diligence is very important,” she said.
“Additionally, for plants located outside of established industrial areas (as we have in India), higher categories of environmental due diligence may be called for,” Shroff pointed out. For companies looking at targets overseas, Shroff highlighted that “employment and pensions is another aspect which is tricky in several developed jurisdictions and something that Indian companies may not face in India.”
Thus as big Indian pharma companies look to grow their global footprint, they need to consider that big ticket deals would be more difficult to manage. For example, when Dr Reddy’s Laboratories (DRL) bid for Germany’s fourth largest generic firm, Betapharm in 2006, it was then the largest outbound deal by an Indian pharma company. But DRL’s plans went haywire when the German government announced a switch to a tender-based process soon after the deal. Sun Pharma too faced a prolonged battle with hostile stakeholders in its attempts to buy controlling stakes of Israeli Taro Pharma. Though it entered into an option agreement in 2007, it took three years to acquire a 69 per cent controlling stake in Taro Pharma.
Shroff agrees that “bigger deals tend to have several moving parts” like various operational matters, finance, tax and accounting workstreams, etc. which creates the possibility for slippage and creating wider crevices for deal process to fall through. Which is why she stresses that “it is key that one does their homework properly. The more challenges you can identify in advance, the easier and smoother the ride.” She also advises that it is very important to ensure that all acquisition teams retain sight of the bigger picture and remain aligned on the direction of movement.
From paper to practice
Maneesh Chandra, Principal, ZS Associates, a consultancy involved with a variety of projects including sales force optimisation, takes a slightly contrarian view when he says, “The track record of mergers in the global pharma industry, considering all the big M&As that happened in the 1990s, has been extremely mixed. Especially when it comes to (achieving) complementarities in transactional mergers from a business perspective. In my opinion, some of the
complementarities are good only on paper.”
The people factor
If deal making as a trend is set to increase, it is sure to impact the pharma workforce. Mega mergers could see contraction in the number of job positions, as the merged entity strives to derive maximum synergies between workforces. A perceived dearth of positions could see the sector losing key talent to other sectors, especially in the sales and marketing functions.
For instance, the Sun Pharma – Ranbaxy merger created one of the largest sales forces in India but Sun Pharma’s moves to optimise this field force through transfers etc has met with stiff opposition from the Federation of Medical and Sales Representatives Association of India. There are reports of medical representatives going on mass casual leave to protest these measures.
While deals are signed in boardrooms, they need to be executed across the rank and file of the company. And this is why Shroff stresses that communication between senior management and staff level is crucial and spells out that in order to retain employee morale, appropriate communication should be employed to give them context on why are they changing hands, and what lies in store for the future.
Would future mega mergers face a backlash and be opposed even before they get to the drawing board? And would the perceived post-merger job uncertainty deter young talent from considering this sector or even cause an exodus of existing talent from the pharma sector to greener pastures? As Khanna points out, “The acquisition of Piramal by Abbott and that of Ranbaxy by Sun Pharma had culture and people issues. Both Ranbaxy and Abbott had an ‘MNC way of working’, which made integration difficult. Likewise, many Ranbaxy people chose to quit rather than opting to work with the merged entity.”
Recruiters, quite understandably, prefer to take the ‘glass half full’ approach. Mayank Chandra, Managing Partner, Antal International, agrees that across sectors, takeovers and mergers do have an effect on HR indicators like the appraisal system and the job markets. This is true for the pharma sector as well. “It is usually observed that the appraisal process becomes stringent immediately post a takeover/ merger process, simply because with numbers on its side the company doing the takeover can afford to separate the wheat from the chaff rigorously. Naturally, the employees, especially those who are performing roles that can be overtaken easily by another in the same company and the underperformers start looking out, thus feeding the job market,” he reasons.
Similarly, during the initial post merger/ takeover phase, he points out that initially there are less roles available due to consolidation. However, Chandra of Antal International stresses a positive long term view, because “in the long run such corporate activity creates many vacancies due to the companies’ expansion plans.” He also refutes the charge that the pharma sector is losing talent. He has, in fact, observed that both candidates as well as companies, prefer to remain within the same sector due to the technical competencies and nature of the sector, especially in sales and marketing roles.
When synergies start breaking down
History is proof that all deals do not have a happy ending. “The track record of mergers in the global pharma industry, considering all the big M&As that happened in the 1990s, has been extremely mixed, says Chandra of ZS Associates, especially when it comes to (achieving) complementarities in transactional mergers from a business perspective. In his opinion, some of the complementarities are good only on paper.
Analysing the Sun Pharma-Ranbaxy merger further from a product portfolio point of view, his first point is that while Ranbaxy had a broad set of anti infectives, Sun Pharma has a broad set of cardiovascular and speciality products. “With such a broad portfolio, where is the opportunity to offer this basket of products to the same set of physicians? More sales people from the same company calling up the same set of doctors may not translate into synergies. At a certain scale, some of the synergies and complementarities start breaking down,” is his argument. Conceding that the Sun Pharma got Ranbaxy at a good price, he questions whether they can now derive better business value.
Secondly, he mentions how chance is an important factor in such deals. For instance, Ranbaxy’s strong presence in the emerging markets (EMs) today does not make too much sense because all the EMs, except for India, are not doing that great. Any dependencies that the Indian companies had on foreign markets, becomes more pronounced with the situation in the US. An ICRA report released in June foresees that moderating growth from the US market and macroeconomic concerns in EMs will be key challenges for the Indian pharma sector. Growth in revenues from the US will slow thanks to the relatively moderate proportion of large size drugs going off patent, increased competition, generic adoption reaching saturation levels, regulatiory overhang as well as a high base effect catching up with the sector. CAGR of revenue growth from the US during FY11-15 for ICRA’s sample set was 33 per cent which dropped to 15 per cent in FY2016, and ICRA has indicated that this slide will continue.
A new sunrise
Has the deal with Ranbaxy also resulted in Sun Pharma’s own fall from grace? Chandra of ZS Associates narrates how many of the senior executives and CFOs in other big Indian pharma companies used to be envious of Sun Pharma’s high EBIDTA. For many CFOs, Sun Pharma’s financials were the benchmark of a healthy balance sheet and they would give their eye teeth to emulate this role model. But today, they are no longer in awe as the merged entity’s EBIDTA
is nowhere near past levels. So, Sun Pharma has in a way surrendered this ‘sweet spot’. Sun Pharma fans could argue back that this is a fallout of the changing dynamics of the business and in fact Sun Pharma’s present strategy will once again prove to be the right one in years to come.
Right now, Sun Pharma is in the process of getting the basics right by organising themselves, putting together a structure and function in a holistic way but Chandra of ZS cautions that sometimes when these kind of mergers take place, they suck up so much time and attention of the senior management that they are not able to put time and effort into the new opportunities the merger offers.
According to him, there is an over invest of time into getting the two organisations to work together. To prove his points, he harks back to two examples of big global pharma mergers. Around 2001-2002, two UK-based companies, Glaxo Wellcome and SmithKline Beecham merged into GlaxoSmithKline (GSK). Another example of a merger of equals is Sweden’s Astra and UK’s Zeneca merger in 1999. The Glaxo Wellcome-SmithKline Beecham merger took a very long time to consolidate as it was across two different locations. According to Chandra, 13-14 years down the line, staff within some of these companies are just beginning to feel like one team. Of course, given the pace of business today, no acquirer will today wait this long to derive benefits. While he agrees that Sun Pharma has been successful in its past deals, he points out that most of these transactions have been acquisitions of much smaller companies rather than the merger of equals that is now under way.
As Sun Pharma’s consolidation continues, the company is sure to remain in the news for some time, with competition tracking each move closely. Let’s hope this merger finds its true place in the pharma M&A playbook.