With Elder, Torrent springs out of a price bind

The deal to acquire 30 Elder brands will hit profit, but will boost market share and revenues as the drugs acquired are out of price control

Torrent Pharmaceuticals' Rs 2,004-crore acquisition of Elder Pharma's 30 brands will result in momentous changes for both companies. Elder will lose the cream of its business. Analysts expect it to henceforth focus on its business abroad. For Torrent, which draws a large chunk of its revenues from overseas, the acquisition will increase its share of the domestic market and expand its presence to newer therapeutic segments. Torrent's current market share is 2 per cent and it is placed 17th on the pecking order - the acquisition will raise it to 2.7 per cent and improve its rank to 12th. The gains in some key segments will be more dramatic: from 0.4 per cent to 6.2 per cent in vitamins, minerals and nutrients, and women's healthcare (rank will jump from 45th to 3rd), and from 0.9 per cent to 2.7 per cent in pain management (rank to improve from 27th to 11th).

ELDER’S JOURNEY

• Founded in 1981 by first-generation entrepreneur Jagdish Saxena
• Has brands like Shelcal, Chymoral, Carnisure
• Acquired Dubai-based NeutralHealth PLC UK in 2010
• Raised stake in Bulgarian subsidiary to 100 per cent in 2012
• Had accumulated debt of Rs 1,300 crore
• Operating margin dropped 100 bps to 14.8 per cent in FY13 owing to high interest cost
• Recorded 9 per cent rise in turnover in March 2013 to Rs 1,454 crore
• Appointed Ernst & Young and Nomura Securities in mid-2013 to find a buyer
• Sold domestic branded formulation business to Torrent Pharma in Dec ‘13 for Rs 2004 crore
• Will now focus on in-licensing, anti-infectives and exports business

However, the deal is likely to have a sizeable impact on the company's profit before tax (Rs 619 crore for 2012-13). Ranjit Kapadia of Centrum Broking reckons the hit on account of higher annual interest outgo could be at least Rs 110 crore. That's because the Rs 2,000-crore deal will increase Torrent's current debt (around Rs 913 crore as of September) as the company plans to fund it through a mix of debt and internal accruals. Since it has cash of around Rs 800 crore on its books, analysts feel it will have to contract debt of Rs 1,000-1,200 crore. At 11 per cent interest, this could drain its revenue by at least Rs 110 crore every year. Torrent has said that its total outstanding debt would be around Rs 2,600 crore by 2014-15, and the acquisition is expected to be cash-accretive by the second year and EPS-accretive by the third year.

That apart, analysts say Torrent has got hold of products which aren't under the government's restrictive price-control regime and are unlikely to come under it anytime soon. "The company will be able to increase prices by 10 per cent every year. For that matter, a price rise is expected soon after the deal is closed in the first half of 2014," Kapadia says.

Torrent's acquisition needs to be seen from the perspective of the Drug Price Control Order of 2013. It has brought the prices of 348 essential medicines under control and has recommended cutting the margins for wholesalers and retailers from 10 and 20 per cent to 8 and 16 per cent, respectively. As wholesalers and retailers want their margins to be maintained at the old levels, this means companies have to squeeze it out of their profits. This has led to friction between pharmaceutical companies. The two factors together have caused a serious loss of business. According to PricewaterhouseCoopers, growth in India's domestic pharmaceutical market slowed to 9.8 per cent this year from 16.6 per cent in 2012.

Therefore, Indian companies need to redesign their product portfolio keeping in mind the price controls. Torrent was quick to recognise this, and had mentioned in its 2012-13 annual report: "Given the developments, companies need to focus on driving productivity through brand building and customise (their) marketing approach to suit different customer segments. Medium-term growth would be driven by therapy expansion and new product introduction." This is where the deal with Elder fits in.

As of now, in the domestic market, Torrent has a strong presence in the chronic segment (cardiology and neuropsychiatry, among others) - it accounts for as much as 66 per cent of its domestic revenue. Elder's portfolio of 30 products has strong brands like Shelcal, a popular calcium supplement brand in India with annual sales of around Rs 160 crore. It contributes 32 per cent of Elder's domestic revenue. Pain management brand Chymoral too has a strong market share of 85 per cent. "Not much immediate additional expenses need to be incurred to promote these brands. Even the manufacturing would be done by Elder for three years," says a source in the company.

Production plans
According to the deal, Elder would continue to manufacture and supply the products at its manufacturing facilities for Torrent for three years. The transaction will also involve the transfer of employees engaged in sales, marketing and operations of the India business. Analysts say that this is a win-win situation for both companies. "While the manufacturing plants remain with Elder, it will now have lower personnel costs. Also, Torrent gets the benefit of outsourced manufacturing that saves cost," says an analyst adding that the contract is also likely to be renewed at the end of three years. When asked this question, Torrent says: "The arrangement also allows Torrent to manufacture part of the volumes at its identified facilities. Meanwhile, Torrent will evaluate various options to source these products once the three-year period ends and shall suitably decide. It will not be possible to give an exact idea at this point."

As for Torrent, while its employee costs will increase (a field force of 1,100 is likely to be transferred to Torrent from Elder), its sales are expected to grow too. Torrent says that it expects revenues to get a boost of 18-20 per cent. And most of Elder's 30 products that have come to Torrent enjoy a high profit margin. Kapadia says Torrent's overall margins are in the range of 20-23 per cent and, if the company manages to achieve good volumes for Elder's products, its margins might not come under much pressure. The share of domestic sales in its overall revenue is likely to increase from 32 per cent now to around 40 per cent in about two years' time. Another plus is that the deal will increase the number of Torrent stockists from around 1,700 to around 4,000.

Looking overseas
There is also the possibility that Torrent might take some of these products to international markets, especially the emerging markets, in the future. "It is comparatively easier to get product registrations in developing countries in Southeast Asia and Africa. There is a huge potential for products like Shelcal in markets like Bangladesh, Sri Lanka and Myanmar. Elder already sells some of its products in Nepal. Torrent's task will be easier if Elder has already registered some of these products in overseas markets," says an analyst. Torrent, on its part, says there are no plans to take these products overseas. An e-mail query to Elder did not elicit any response.

There is some gain in it for Elder too. Alok Saxena, managing director and chief executive of the company, had said at the time of the deal: "This path-breaking domestic consolidation by Torrent addresses our recent challenges and will significantly help Elder de-leverage its balance sheet. We will now focus and grow our in-licensing, anti-infectives and exports businesses." The Mumbai-based company had accumulated debt of around Rs 1,300 crore after multiple overseas acquisitions. Elder had already announced restructuring plans to clear its debts, and Sanofi and Novartis were in talks with Elder's management for an acquisition. Elder had revenues of Rs 1,454 crore in the year ended March 31, 2013.