Double whammy

The maiden M&A deal for Ahmedabad-based Torrent Pharma and possibly the last mega deal in calendar 2013 has not gone down well with the Street. Given that in the past a majority of M&As have failed to deliver on their promised synergies and, instead, impacted shareholder return, the market seems to be viewing the biggest-ever domestic pharma M&A with scepticism. “In the past, we have observed that large M&As have taken longer than expected time to realise synergies (the Zydus Cadila-Biochem acquisition is a clear example),” mentions Alok Dalal of Motilal Oswal.

The biggest grouse seems to be over the seemingly expensive valuation that Torrent has paid and also that it will end with a levered balance sheet. As for Elder, the sale has effectively left it with practically nothing on its plate, except for reducing its leverage.

Not surprisingly, then, since the deal was announced on December 13, the share price of Torrent sank from around Rs 500 level to Rs 480, and that of Elder has fallen from ₹ 325 to ₹ 268 within a week.

A new formulation

Torrent's therapy mix before and after acquiring Elder's 

portfolio

Elder Pharma sold its branded formulations business, which accounted for 95% of its revenues, to Torrent for ₹ 2,004 crore. While the company doesn’t disclose its branded formulations business revenue, analysts estimate that these brands bring in around ₹ 500 crore, valuing the deal at four times its revenue. “A valuation of 3.3X-4X FY13 sales in our opinion appears to be steep,” adds Dalal of Motilal Oswal. The sale entails transfer of 30 brands across women’s healthcare, pain management and dietary supplement categories. Post sell-off, the residual businesses of anti-infectives, exports and in-licensed products are not expected to fetch the lucrative margins the branded products did. Since no earnings estimates are available, the stock, which trades at 7X its FY13 consolidated earnings, is likely to see a further de-rating with the most profitable part of its business being sold.

For Torrent, the deal will catapult its ranking to 12th place from the current 17th in a highly fragmented domestic drug market, according to IMS Health data. But the buyout will bloat its debt from the current ₹ 913 crore to ₹2,600 crore by FY15 as the company plans to raise over ₹ 1,000-1,200 crore in fresh debt and fund the rest with internal accruals. As a result, debt-equity is expected to be around 1.30X from nil, while the acquisition is expected to be EPS-accretive only in the third year. Consequently, analysts have given a thumbs-down. “In the medium term, immediate cost push concerns would outweigh the synergy benefits,” says Rahul Sharma of Karvy Broking, which has a sell rating on the stock with a target of ₹ 455, 6% lower from current levels.

What could be also of concern for analysts is whether the goodwill of around ₹ 1,600 crore that Torrent Pharma will take on its balance sheet will see an impairment just as it had happened in the case of DRL with regard to Betapharm.