“They infiltrated our borders; now they have taken our money in broad daylight,” was the outburst from a Hyderabad-based pharma industry veteran, on the IPO of Gland Pharma, which is currently trading 50% above its issue price of Rs.1,500. After the Galwan skirmish, the frostiness in Sino-Indian relations has also cast a shadow on Chinese investments in India. The 60-year-old former executive believes the government should not have let the Chinese-owned Fosun to list the injectables maker. “They already have a backdoor entry in the drugs business and now you have let them take our money as well,” berated the gentleman to Outlook Business. The Rs.65 billion IPO was the biggest in the domestic pharma space after that of Eris Lifesciences in 2017, Laurus Labs in 2016 and Alkem Laboratories in 2015.
Notwithstanding the ‘nationalist’ undertone, Gland was always an outlier compared to other Indian pharma companies. Established in 1978, Gland was founded by PVN Raju, who had pioneered Heparin technology (anticoagulant used to decrease the clotting ability of blood) in India in the ’60s, and set up the country’s first pre-filled syringe unit for low-molecular-weight heparin in 1998. Also, unlike Indian pharma players which were making it big in generic APIs, Gland stuck to just one business — injectables. Also, a majority of Gland’s business originated from the US and other developed markets.
While the homegrown biggies garnered all the attention, Gland hit the headlines when PE giant KKR picked up 35% stake in 2013, valuing the company at $650 million. Four years later, the Shanghai-based Fosun Pharma acquired 74% — the largest-ever buyout of an Indian business by a Chinese entity — for $1.2 billion. Fosun wanted to acquire 86.08% but the Cabinet Committee on Economic Affairs objected, resulting in Fosun settling for 74%. Since the government in July 2016 had eased regulations stating that FDI of up to 74% in existing pharmaceuticals companies would fall under the automatic route, the takeover went through finally in mid-2017.
When KKR bought into the company, Gland had revenue of Rs.7.70 billion and Rs.1.58 billion in profit, and by FY17, when Fosun took control, both revenue and profit had doubled to Rs.14.80 billion and Rs.4.13 billion, respectively. Post the takeover, the company’s strong financial performance continued with sales hitting Rs.26.63 billion and net profit nearly doubling to Rs.7.73 billion. Post the IPO, Fosun holds 58%, while the Raju family holds 10%. Interestingly, the Ramalinga Raju family, erstwhile promoters of Satyam also hold 3.87% stake. But, those shares are held under an escrow account of the Enforcement Directorate which is investigating the Rs.140-billion Satyam fraud.
With just 2x oversubscription, the IPO got tepid response from retail and HNI investors, but the post listing performance could have left investors wringing their hands in disappointment. While the cloud over the Chinese connection could have clouded investors’ perception about the company’s future, for now, Gland seems to be in a sweet spot. “Though in the past we have had wars and border skirmishes with China, nothing as drastic as a trade barrier has ever materialised. The economic reality (globally and for India) is that you cannot cut your nose to spite your face,” says an industry consultant. The observation is not misplaced given that Gland continues to be a preferred injectables supplier to global pharma companies.
To begin with, injectable is a sterile drug administered into the body using a needle and syringe or through an IV (Intravenous) set. The global injectable market has been estimated at $432 billion in 2019, having grown at CAGR of 10.1% over 2014 to 2019. Injectable is the second largest form of drug delivery after oral solids (tablets, capsules, etc) and it has grown faster than the overall market, increasing its share from 32% (by value) in 2014 to 39% (by value) in 2019 (See: Growth stack).
Gland over the years has straddled the entire injectable value chain, including contract development, in-house development, dossier preparation and filing, technology transfer and manufacturing across a range of delivery systems. With seven manufacturing units (four at Hyderabad and three at Visakhapatnam), the company has created a portfolio of products across therapeutic segments such as anti-diabetic, anti-infectives, anti-malaria, anti-neoplastics, blood-related, cardiac, gastro-intestinal and hormones through delivery systems comprising liquid vials, lyophilized vials, pre-filled syringes, ampoules, bags and drops. The company is expanding its development and manufacturing capabilities in complex injectables such as peptides, long-acting injectables, suspensions and hormonal products as well as new delivery systems such as pens and cartridges.
Unlike other pharma players who focus on generic APIs and have injectables on the side, Gland derives its entire business from injectables. Anshul Saigal, head-portfolio management services, Kotak Mahindra AMC, which has a p and healthcare fund as part of its Rs.20 billion PMS AUM, sees merit in the company’s positioning. “It’s a unique business. Unlike normal tablets, where there is always a certain impurity level, in injectables, that impurity level has to be far, far low. Also, the technology of injecting formulations in vials is not easy and is limited to only a few companies.” As a contract manufacturer, Gland sells to over 60 countries, with a chunk of the business coming in from the US at 67%. In India, apart from the B2B business, it also sells directly to hospitals.
Rahul Jeewani, analyst, IIFL Securities, points out that Gland has created a niche for itself in the B2B generic injectables segment, with the company having strong relationships with several large global injectable players such as Sagent Pharmaceuticals, Apotex, Fresenius Kabi, Athenex Pharmaceutical and several other players including Indian companies such as Dr Reddy’s. “Given its non-exclusive contracts with multiple partners, the B2B model allows Gland to garner 25-30% market share in several of its molecules, thereby driving economies of scale at product level,” elaborates Jeewani.
Although Gland’s B2B business operates across IP-led, technology transfer and contract manufacturing models, majority of Gland’s products are marketed under the B2B IP-led model where profitability is relatively better compared with technology transfer/CMO models, given that Gland owns/co-owns the product dossier and has a profit share arrangement on the product (See: Cash niche).
Explaining the uniqueness of its R&D business, Kunal Mehta, analyst, Vallum Capital Advisors, says: “Under this model, money is earned in three stages: In the first stage, Gland gets a small fee for entering into a licensing agreement along with milestone payments tied to completion of specific product development stages. In the second stage, when the product is ready for commercial launch, Gland earns another milestone margin per unit dose and in the third stage, when the product is finally sold to the end user, it gets 30% share of the profit.” But, the critical part in the deal is that Gland owns the R&D technology and is able monetise costs by selling to more than one customer. “Simply put, if Gland spent Rs.50 million on R&D, it will be able to get Rs.20 million each from four-five clients and that allows it to more than cover R&D costs.” Not surprising that Gland’s R&D cost as percentage of sales is low at 3.5%.
That apart, Gland has another edge in high quality control.
Best in class
While Indian pharma has made it big in generics, over the past five years, it has been caught in the crosshairs of the US Food and Drug Administration (FDA). In 2019, according to reports, Indian companies were handed 19 warning letters of the 41 issued by the FDA, the most in four years. Warning letters are issued if the companies fail to take corrective action after the FDA raises observations in Form-483, detailing the quality controls that need to be rectified. Among other players, the letters were issued to even leading companies such as Lupin, Aurobindo, Glenmark, Strides Arcolab and Zydus Cadila.
Given the nature of the business, the generic injectable market is characterised by high capital investments and operational costs coupled with relatively higher compliance requirement owing to the sterile nature of the products. This is where Gland scores. Its manufacturing facilities have been approved by the FDA, Medicines and Healthcare Products Regulatory Agency and other regulators. Mehta says, “Over the past two decades, Gland hasn’t got any FDA warnings. Though past performance is no guarantee of the future, Gland has invested heavily in quality control.” Of the 3,791 people across its facilities in India, one-third works on quality assurance and control. The emphasis on strict quality compliance is not without reason. Ranjit Shahani, former MD and vice-chairman at Novartis India, says, “Any adverse observations from the US FDA means one and half years are lost for a pharma company.”
No wonder, entry barrier in the injectable business is so high that 32% of the market (by value) is captured by a single company. 70% of the US generic injectable market (by value) has three or less than three companies compared with five or more than five for oral solids generics, states an ICRA report. Approximately 65% of the drug shortages in the US are on account of quality manufacturing/delays or capacity constraints, thereby making it one of the critical success factors. “While there is always the threat of competition, because of strict regulations Gland is part of a club where not everyone can enter," adds Saigal. Though Dr Reddy’s injectables make up for 25% of its revenue, “it took four years to get its injectables plant out of FDA warning,” points out Mehta.
However, the industry veteran quoted earlier, points out that unlike other diversified branded generic players, Gland does not have a brand of its own and, hence, does not rank up to the ilk of Dr Reddy’s. Shahani, though, believes otherwise. “You don’t have to do everything, either you are good in API, OTC or injectables. Besides, in injectables there aren’t too many competitors.” Concurring with Shahani, Saigal says, “It’s a question of your focus and capability. Gland wanted to grow big in injectables. Similarly, Divi’s chose to become big in complex APIs and not get into generics but Dr Reddy’s chose to become bigger in the generics market.”
Gland may have its share of critics, but the fact remains that its core strength in injectables has helped it beat major pharma players in financial metrics. In terms of revenue, Gland ranks way below in the pecking order, but in terms of growth and profitability it stands out. For instance, Dr Reddy’s FY17-20 revenue CAGR, though on higher base, was 12%, and Gland clocked revenue CAGR of 16%. But in terms of profitability, over the same period, Gland clocked 36% CAGR (See: The outlier). “Focus and diversification are two distinct strategies. Mindless diversification that brings you average Ebitda is no good,” opines Shahani.
For now, Gland is sitting pretty given that fresh capacity is not coming up in a big way and, more importantly, injectable products account for more than 50% of overall US drug shortages. Jeewani points out that key Indian companies that have created a sizeable injectables portfolio for the US market include Aurobindo, Gland Pharma, Sun Pharma and Dr Reddy’s. Gland is unique among these companies as it operates only as a B2B player, as opposed to having its own front-end. Based on IIFL’s analysis, Jeewani estimates that 25 of Gland’s products are in the US shortage-list versus 33 products for Aurobindo.
Although the overall US generic injectables market has clocked 13% CAGR over the past five years, Indian players such as Gland have grown at 18-20% CAGR over FY17-20, due to their low base. Assuming end market sales of $550 million for Gland’s products (US revenue is $250 million and it recognises 45-50% revenue share in its B2B molecules), Gland’s revenue per commercialised injectable product works out to $6.4 million. “This indicates that Indian players have similar product complexity and operating efficiencies in their injectables portfolios versus global peers,” explains Jeewani.
Gland along with its partners has filed 267 ANDAs in the US, of which 52 ANDAs are pending for approval. Of these pending ANDAs, 60% are owned by Gland (See: Future bounty). The new US launches from this pending pipeline would drive near-term revenue growth for Gland. Additionally, the company intends to leverage its US product portfolio for new launches in other markets. “We expect Gland’s overall revenue to grow at 20% CAGR over FY20-23, led by 18% growth in the US business, 17% growth in India sales,” says Jeewani. Though injectable products have 2x margin as compared to oral solid products, the discontinuation of the MEIS export incentives scheme by the Indian government could impact Ebitda margin by 200 basis points.
Another plus for Gland is that it is debt free and generates the best return ratios among the pharma pack (See: Leader’s legacy). It has been a net cash company for the past four years and as of March FY20, the cash of Rs.13.25 billon accounted for 32% of Gland’s total assets. Despite the higher cash, Gland has managed to generated RoE of 21% in FY20, led by high Ebitda margin of 36% and net fixed asset turnover of around 2.4x.
According to IIFL Securities' FY22 estimate, at its current level of Rs.2,250, the stock is trading at 34x. Given that earnings have grown 41% in FY19 and 70% in FY20, analysts believe there is more headroom. Jeewani expects FY23 earnings of Rs.80/share, which translates into current multiple of 28x. After the run-up post listing, Mehta sounds circumspect. “Even if one assigns the average FY23 multiple of 20x, at which prominent and high cash-flow generating pharma companies are trading at, the fair value of Gland should be Rs.1820. Hence, the current valuation is definitely factoring in a lot,” feels Mehta.