Apollo plans to hive off pharma business to unleash growth for new entity

For the past three years, Apollo Hospitals Enterprise’s plan to raise around Rs 7.5 billion through rights issue from foreign investors to reduce debt and fund expansion had been struck due to regulatory hurdles. But last month, the group found a  remedy that will greatly benefit its pharma business. 

Apollo announced that it would hive off its pharma arm into a separate entity to unleash growth and comply with foreign investment norms. The Foreign Investment Promotion Board had asked Apollo to restructure its pharmacy arm into a separate business to meet the regulatory guidelines for multi-brand retail. 

“We have foreign investors in Apollo Hospitals Enterprise, which does not allow us to keep the pharmacy business in the current structure,” said Akhileswaran Krishnan, chief financial officer of Apollo Hospitals.

Apollo, however, had been toying with the idea of hiving off the pharmacy business and bringing in a strategic partner to unlock its potential since 2008, and the timing seems right to do so now. The front end of the business — standalone stores, people and dispensing of products — will now be housed in a separate company called Apollo  Pharmacies.

With a large network of over 3,000 outlets, the pharmacy business is a significant pillar of Apollo Hospitals’ financial growth, accounting for nearly 40 per cent per cent of its total revenue in 2017-18. In the new structure, Apollo Hospitals Enterprise’s stake in the pharmacy arm will shrink to 25 per cent, with the option to buy back the shares when needed.

The separate company, Apollo Pharmacy, will be restructured as a subsidiary of Apollo Medicals Pvt Ltd in which investors have picked up a 74.5 per cent stake for Rs 1.06 billion; Apollo has infused Rs 350 million; and nearly Rs 3.87 billion would come via bank borrowings. 

This structure has helped the new entity in price discovery. The entire pharmacy business, including the back-end, is valued at around  Rs 50 billion. The back-end comprises exclusive supplier for Apollo Pharmacy and online pharmacy operations.

Shobana Kamineni, executive vice-chairperson, Apollo Hospitals Enterprise, who will continue to lead the pharmacy business, told Business Standard that the decision was taken not just to comply with the FDI norms but also to unlock the potential of the pharmacy arm and to have a sharper focus on the business.

The new investors — Jhelum Investment Fund, veteran investment banker and chair of DSP BlackRock Hemendra Kothari and Enam Securities — will have a board seat in Apollo Pharmacies. Enam Securities will hold 44.7 per cent; Jhelum Investment Fund will have 19.9 per cent; and Khotari 9.9 per cent share. 

With funds in place, Apollo Pharmacy wants to now move quickly into e-commerce, where it has not marked its presence so far, and bridge the gap between online and offline.

“In the future, we would  look at strategic or new equity investors; IPO could also be explored,” said Kamineni. However, if FDI into multi-brand business is allowed, she says, it could help the company secure funds with ease.

In the immediate future, Apollo Pharmacy has set a  target to increase the number of outlets to 5,000, from the current 3,167, over the next five years, and reach Rs 100 billion in revenue. At the same time, it has set a target to enhance the share of private label business from the current over six per cent to over 12 per cent.

Organised pharmacy retail accounts for less than five per cent of India’s $15-billion domestic pharmaceutical market, which is estimated to grow at a CAGR of 10-12 per cent  over the next decade. The growth is being driven by increase in disposable incomes, demand for quality products, higher incidence of chronic diseases, growing awareness of diagnostics and preventive care and greater accessibility through generics.

Apollo Pharmacy itself has grown from 170 outlets in 2004-05 to 3,167 outlets by the end of September2018. The pharmacy has operations across 400 cities in 20 states, and serves 0.3 million customers annually.

Kamineni, who will continue to lead the business with her team, has set her sights on around 20 per cent of the total pharma revenue from online channels. Current revenue stands at around Rs 43 billion. 

ResearchAndMarkets.com, an online market research data platform, estimates, the e-pharmacy market to grow at a CAGR of over 20 per cent, crossing the $3-billion mark by 2024, from $1 billion currently.

The new structure has advantages for the parent, Apollo Hospitals, as well. Of the Rs 8.50-billion capital employed in pharmacy, nearly Rs 5 billion will move to the new company, which in turn will reduce the debt burden of Apollo Hospitals and increase the value of the back-end business. 

“For Apollo Hospitals, this will mean that it can utilise the proceeds towards growth and enhancement of the other existing businesses. It will enhance the strategic flexibility to build a viable platform solely focusing on each of the businesses and enable dedicated management focus, resources and skill set allocation to each business, which will in turn accelerate growth and unlock value for shareholders,” the management said in a conference call  last month.

There are, however, some concerns about loss of revenue for the parent entity. But the management believes the impact on Ebitda will be only for a short term. Although in the immediate future, Apollo Hospitals earnings will shrink by Rs 400 million, in the longer run, the move is expected to strengthen Apollo Hospital's book. In the current format, since only the retail end of the pharmacy business has been separated, Apollo Hospitals will continue to have 85 per cent of pharmacy business Ebitda and 90 per cent of its cash flows.

Also, as the front-end pharma business expands, the back-end, which continues to be with Apollo Hospitals, will benefit as well.