Sun Pharma- Ranbaxy merger: Is it a win-win deal?

In one stroke Sun Pharmaceuticals has doubled its size in a cashless transaction by acquiring one of India’s largest pharmaceutical company – Ranbaxy. 

 

Having a consolidated turnover of Rs 11,326.32 crore (March ending 2013), Sun Pharma acquired a larger company Ranbaxy with a turnover of Rs 12,410.43 crore (March ending 2013). The transaction done at a valuation of 2.2 times sales of Ranbaxy will make Sun Pharma the largest Indian pharmaceutical company by a wide margin. 

 

Sun Pharma took more than 30 years to achieve (inception in 1983) its present turnover and a single day to achieve the same turnover through this acquisition. The beauty of the transaction lies in the fact that a bigger sized company has been acquired without paying anything for it (in absolute rupee terms). The deal is a cashless share swap one where Ranbaxy shareholders get 80 shares of Sun Pharma for every 100 shares they own. 

 

 

Even though Sun Pharma is smaller than Ranbaxy in terms of sales, market values the company much higher than Ranbaxy. Sun Pharma is valued in the market at Rs 122,128 crore while Ranbaxy attracts a valuation of only Rs 19,070 crore. Ranbaxy’s trouble with US FDA has affected its valuation and operations severely. Over the trailing four quarters, Sun Pharma has overshot Ranbaxy posting a cumulative turnover (consolidated) of Rs 15,108.79 crore as compared to Rs 10879.63 crore by Ranbaxy. 

 

Without getting too much into financials and valuations, let us look at the deal from the perspective of each of the three stake holders – Daiichi Sankyo, Ranbaxy and Sun Pharma.

 

Daiichi Sankyo:
 

Daiichi had acquired 34.8 per cent of Ranbaxy from its promoters, the Singh brothers for $2.4 billion in 2008. However, after taking into account the open offer of 20 per cent to its non-promoter shareholders, the company ended up paying $4.6 billion. The deal was struck at a share price of Rs 737 per share. 

 

Sun Pharma’s acquisition values the entire Ranbaxy at $3.2 billion at a price of Rs 457 per share. Daiichi’s 63.4 per cent stake in Ranbaxy (post open offer) is thus being valued at $2.03 billion, a loss of over half its money invested. However, since it is not a cash pay-out, Daiichi still has some hope of recovering its money if Sun Pharma is able to unlock the value of Ranbaxy shares. The company’s investment is now on a much stronger wicket, which can be seen from the nearly 4 per cent rise in Daiichi’s stock in Tokyo after the announcement. 

 

Daiichi was clearly looking lost post its acquisition of Ranbaxy with the company repeatedly pulled up by the US FDA for malpractices and manufacturing and operational issues. By selling its stake at a huge loss (even after consider the 30 per cent currency depreciation), Daiichi has indicated its helplessness in controlling the situation. 

 

Ranbaxy:
 

Ranbaxy is now in the hands of one of the sharpest brains in the Indian pharmaceutical industry. The company will however, lose its identity post the merger and will no longer be traded as Ranbaxy. However, the company now has a better chance of unlocking its value than as a standalone company. 

 

Ranbaxy had lost considerable brand equity in the US, European and even to some extent in the Indian markets. Further, the company’s manufacturing units were barred from selling their products in the US. However, the acquisition will now give Ranbaxy’s sales outlets in the US a chance to source from Sun Pharma’s manufacturing units. It was the manufacturing units of Ranbaxy that were barred not the brand. Ranbaxy can in a short time pull back its lost market share by leveraging on the strength of Sun Pharma’s presence in the US market.

 

Sun Pharma:
 

Sun Pharma stock has cautiously moved higher on announcement of the deal. There will be anxious moments over the short term as the issues pertaining to Ranbaxy’s US FDA are tackled. However, Sun Pharma’s history of handling contentious issues; be it handling of its US acquisition Caraco or its Israeli acquisition of Taro gives confidence that the company will be able to address all concerns. Most of the issues that have come up have already been addressed and penalties have been paid for. Daiichi has in fact, agreed to indemnify Sun Pharma and Ranbaxy on the latest subpoena issued by US Attorney of District of New Jersey with issues related to Ranbaxy’s Toansa facility.

 

The potential for value unlocking is huge. Apart from the synergies of procurement and supply chain, Sun benefits from increased product portfolio and market reach. 

 

Only a year back Ranbaxy was bigger in terms of turnover but was one-sixth in terms of valuation. Analysts’ consensus expectation of profit growth from Sun Pharma in the next fiscal (2015) stands at around 12 per cent; while for Ranbaxy it stands at 50 per cent (on account of lower base and monetisation of certain US opportunities). In which case, concerns of Ranbaxy are clearly overdone. In fact it will be Ranbaxy which will be driving Sun’s profit growth in the short term. 

The near distress valuation of acquisition leaves a huge potential upside for Sun Pharma shareholders to capitalise on, especially since the acquisition has come with a minimal impact on the balance sheet.