The Orchid Chemicals & Pharmaceuticals’ deal to sell its penicillin and penem API business (including its Aurangabad facility) along with an associated process R&D infrastructure (in Chennai) to US-based Hospira Inc. for $200 million (about Rs 1,120 crore) hasn’t excited the markets even as the deal has been done at attractive valuations and would eventually lead to a sizeable reduction in the company’s debt. Its stock, which was up five per cent intraday on Thursday, saw the gains diminish as the day progressed—it finally closed 0.6 per cent lower at Rs 111.10. While the deal will help the company deleverage, analysts are not too enthused by the road-map for the company, which from a formulations maker with its own marketing front-end has become a contract manufacturer.
The company is planning to use part of the funds (Rs 800 crore) to bring down its current debt (of Rs 2,200 crore) and to fund working capital needs and invest in newer businesses. The reduction in debt will help the company bring down its debt to equity ratio below one from the current level of 1.5 times. On the deal valuations front, analysts say the same is favourable. “The valuations are attractive for this kind of deal which normally are done at EV (enterprise value)/sales of 2 times,” says Sarabjit Kour Nangra of Angel Broking.
While the Aurangabad facility was contributing about Rs 450 crore or (24 per cent of consolidated FY12 sales), valuations (EV/sales) are pegged at 2.66.
Meanwhile, the stock which has taken a bit of hammering since the start of May losing 35 per cent on the back of poor performance over the last two quarters, is currently trading at PE valuations of 9-10 times FY13 estimated earnings, which is in line with other API manufacturers. Hence, there is little upside from these levels.
Timely deal
High debt and inadequate working capital availability meant that the company has had to dispose of assets to pay creditors, the last transaction being the $400-million sale of its cephalosporin formulations business to the same company three years ago. “A debt overhang coupled with the inability to raise equity has forced Orchid Pharma to sell its penicillin and penem business,” said Angel Broking’s analysts in a note. Analysts say the company was left with little choice since options such as tapping the equity markets (unfavourable conditions) and domestic institutions (high current loans, 14-16 per cent interest rate on its loans) were not viable. Moreover, given that the Aurangabad facility was manufacturing some of the older molecules which were at a mature stage, selling the same was the right decision, says a company spokesperson.
Operations under pressure
While the company will be able to fund future growth through this exercise, the near-term performance, especially on the sales and margin fronts, is likely to be under pressure. In the June 2012 quarter, lower price realisations and higher input costs dented the company’s revenues and margins. A sharp jump in interest costs and lower sales saw the company report a loss of Rs 46 crore. However, the deal, according to the company, should help save interest costs of Rs 100 crore a year. The company paid interest of Rs 72 crore in the June 2012 quarter and on an annual basis (Rs 280 crore) would have completely erased its gains on the Ebidta front, feel analysts. However, a good chunk of the gains would also get offset due to loss of revenues and profits from the outgoing business. Angel Broking’s analysts estimate that the sale of the unit will entail a loss of revenues to the extent of Rs 450 crore annually and Rs 100 crore on the EBDIT (earnings before depreciation, interest and tax) levels.
Outlook
The Hospira deal means that the company will exit from two (penicillins and carbapenems) of its four antibiotics businesses. The other businesses are cephalosporins and non-pencillin and non-cephalosporin antibiotics, which are expected to grow by 10-12 per cent in revenues. However, to drive future growth, going ahead, the company is looking at niche areas with high entry barriers (controlled substances, non-infringing processes/products). However, there will be an overhang on the stock as the Street will look for proof of the company’s ability to deliver in the chosen areas.
For the current fiscal, while the company spokesperson says that Ebidta margins will be around FY12 levels of about 20 per cent, analysts are sceptical and say that given lower sales and realisations the company is likely to report a margin of 15 per cent.
Angel’s analysts say, “The Ebitda (margin) post the deal is expected to be around 14-15 per cent and the EPS for FY2014 is expected to come down to Rs 12-13.”
