Hospira deal to be Rs 7-8 EPS accretive: Orchid Chemicals

Shares of Orchid Chemicals were on the rise after the pharmaceutical company sold its penicillin and penem business to US-based Hospira Inc for USD 200 million.

Speaking about the deal, K Raghavendra Rao, CMD of Orchid Chemicals informed that the proceeds from the deal will be to the tune of Rs 1,150 crore. Out of it, 80% will be used to pare down the company’s debt portion.

Rao said that the company’s current debt stands at around Rs 2,100 crore, which includes working capital of around Rs 600 crore and foreign currency loans of around Rs 800 crore, Rs 700 crore of rupee debt.

He explained, “the entire rupee debt will be repaid and a part of the working capital will also come down because a part of the business will not be with us. So we will be left with total debt including working capital of around Rs 1,300 crore or so, which will be less than 1:1 from the shareholders’ perspective in terms of debt equity ratio.”

Rao added that this deal would be EPS accretive. “At EBIT level, we will lose about Rs 70 crore or so but we are saving Rs 120 crore on interest charges. So it is Rs 7-8 EPS accretive on net-net basis,” he said.

Below is the edited transcript of the interview

Q: What would be the proceeds from this deal? How much of it would go into debt reduction?

A: The proceeds will be approximately Rs 1,150 crore because we need to make a small adjustment for the working capital position as well. So we will get between Rs 1,100 crore and Rs 1,150 crore of the proceeds in a couple of months. 80% of it will go to pare down debt because we have debt to the tune of Rs 200 crore in the balance sheet.

The debt has three components; one is dollar debt, which we have taken as external commercial borrowing (ECB) to replace the Foreign Currency Convertible Bonds (FCCBs) few months ago. We will keep that debt and working capital but we will payoff the rupee debt so that we will be light on interest cost as well as the debt will come down by half and the debt equity will be below 1:1 after this deal.

Q: What is the current debt position and what will it be post the utilization of the proceeds?

A: The current debt is around Rs 2,100 crore, which includes working capital of around Rs 600 crore and foreign currency loans of around Rs 800 crore, the balance of around Rs 700 crore is rupee debt. So the entire rupee debt will be repaid and a part of the working capital will also come down because a part of the business will not be with us.

So we will be left with total debt including working capital of around Rs 1,300 crore or so, which will be less than 1:1 from the shareholders’ perspective in terms of debt equity ratio.

Q: How much would your annual interest cost come down because of this deal?

A: It will come down between Rs 110-Rs 120 crore at the minimum because we are repaying high cost rupee debt. So, the annual savings will be between Rs 110 crore and Rs 120 crore in terms of interest saving.

Q: Would that make this deal EPS accretive even adjusting for the EBITDA loss because of the division, which is going out?

A: Yes, it is definitely EPS accretive. We were making two products in the carbapenem category and one product in the penicillin category in Aurangabad on cost-plus-margin basis as part of the agreement with Hospira based on the previous deal. That is the portion, which they will be manufacturing by themselves now.

So the margin portion of it on the cost-plus contract will go off, that portion represents around 23% of total business. Last year, we did about Rs 450 crore of that business. So at EBIT level, we will lose about Rs 70 crore or so but we are saving Rs 120 crore on interest charges. So it is Rs 7-8 EPS accretive on net-net basis.

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Q: Was it a difficult business to let go off because it came with a fairly significant assured margin. Did you have to do it for the balance sheet? Was it not part of the original plan?

A: Not really. You have to be smart enough to get in and get out of certain businesses at the right point in time. We thought that it made sense for them to have some backward integration for the antibiotic fortification and it made sense for us because we have been anyway doing at cost-plus-fixed rate margin.

By releasing so much of cash into the system now, I can go light on assets and high on turnover with new verticals going forward. All the ratios will improve because 26-28% of my net assets are gone but I will be back to the same sales position and profitability position in the next year.

Within a year, if I am catching up on the P&L but I am light on assets, all the ratios will improve. So it’s a good deal for Orchid.

Q: Any more deleveraging that you need to do or do you contemplate any more asset sales in the near term to bring down debt further?

A: I do not think so because if you see the balance sheet, post this deal, we will be left with foreign currency loans of about USD 160 million, which have maturity going up to February 2019, they have moratorium also for the next 1-1.5 years or so. In terms of the tenure of the loan, it is five-seven years ahead and the balance that I have is on the working capital.

So, I do not need to pare down any debt because there is no debt that they need to repay. I do not think any asset sale or any other transaction will be done from deleveraging point of view because I am comfortable with less than 1:1 debt equity ratio and some foreign currency loan and working capital on the balance sheet.

Q: How is the basic business doing now? Your revenues were down 9% in the last quarter even finance cost aside, which reduced your operating bottomline quite significantly, even your topline looked sluggish?

A: When we had to repay the foreign currency bonds, USD 167 million was to be repaid and raised only USD 97 million in the form of ECB, I pulled the balance of USD 70 million from the cash on the balance sheet and the internal generations and things like that.

So it put strain on the total working capital of the company, which this deal will address now. I will use that cash after repayment of about Rs 800 crore or so to the banking system balance from the operations.

So we were tight on working capital and stretched balance sheet is one of the reasons where the capacity utilization was not so great.

Also, there was pricing pressure in some of the products that resulted in 9% drop. But I am confident of making it up in the rest of the business because except for those three products, we are into all other products that we have been doing earlier.

The cephalosporin business, non-antibiotic business and all dosage form business except injectables are with us. So, we should be able to grow significantly in double digit percentage next year.

Q: Earlier, you had indicated that this year you will end with sales between Rs 2,180 crore and Rs 2,280 crore. After this deal, this will need to get pared down. But when do you see yourself getting back to that Rs 2,200 crore kind of level?

A: We will be back between Rs 2,100 crore and Rs 2,200 crore for sure next year itself.