Why investors gave a thumbs down to Ipca Labs’ Unichem acquisition?

Analysts believe Ipca Labs would have been better-placed had they committed this growth capital to secularly growing within the India market.

Pharmaceutical company, Ipca Laboratories announced plans to acquire a stake of up to 60 percent in Unichem Laboratories on Monday. However, the deal, aimed at providing Ipca a point of re-entry into the US market, has failed to evoke confidence among investors, going by the slump in the company’s stock price.

Several concerns emanated from the acquisition deal put in place by Ipca, including an unfavourable risk-reward balance, which prompted investors to dump the stock. Consequently, shares of Ipca Labs nosedived around 16 percent in two sessions to slip to its lowest level in 52 weeks on April 26.

The drugmaker plans to acquire a 33.38 percent stake in Unichem Labs at Rs 400 per share, aggregating to around Rs 1,034.06 crore. An additional stake of up to 26 percent will also be bought through an open offer priced at Rs 440 per share. The price that Ipca is set to pay for this acquisition, valued at 2.4x TTM (Trailing 12-month) FY23 sales, is the major point of contention among stakeholders and analysts alike.

Paying a heavy price

Analysts view the deal as expensive, a concern that is aggravated by the fact the Unichem has reported a net loss for the first nine months of FY23.

In an attempt to calm investor nerves, Ipca Labs highlighted in a conference call on Tuesday that it may monetise Unichem’s 3.5 acres of land in Jogeshwari, Mumbai, and a GST refund of Rs 280 crore. The company also guided to deliver 16-17 percent revenue growth with Rs 170-180 crore revenue and Rs 30 crore EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortisation) within two years of the acquisition.

However, the affirmations by the company failed to move the needle for the Street as analysts do not anticipate the company’s monetisation plans making much of a difference.

Talking about the expensive acquisition, Abdulkader Puranwala, AVP, ICICI Securities, believes that even the monetisation of assets would not help take the burden off Ipca’s shoulders as the amount received through the process would go into Unichem’s balance sheet.

When it comes to the Street’s major disappointment over the deal, Puranwala pointed the finger towards Ipca’s capital allocation strategy. He feels the acquisition is not sitting well with the Street as the company went down the path of inorganic growth in the unbranded generics business, primarily based out of the US and Europe market. The segment is facing several headwinds.

Puranwala believes the Street would have cheered for Ipca had it opted for an acquisition within the domestic branded generics market.

Along similar lines, IIFL Securities also believes that due to the limited accretion from the deal and an inferior business mix, the acquisition doesn’t make much strategic sense. The brokerage firm also backed the view that Ipca would have been better-placed had they committed this growth capital to secularly growing within the India market.

Also Read: Ipca Labs hits fresh 52-week low as Unichem acquisition spoils mood for second day

A fund manager, who did not wish to be named, also questioned the need for Ipca to go headstrong into the US market at a time when other players with a presence there are facing profitability issues.

Analysts also believe that amid the challenges and uncertainty associated with the US market, such an expensive acquisition deal will only become margin-dilutive for Ipca Labs.

Broking firm JM Financial also stated in its report that the deal would delay the much awaited strong margin recovery for Ipca as it will stumble upon the current capital allocation decision, consequently leading to further consensus downgrades.

What else spoils the mood?

On top of the concerns mentioned, Unichem’s plain-vanilla portfolio and the lack of regulatory checks from the US Food and Drugs Administration since February 2020 leaves a lot more work for Ipca to put in place to achieve higher profitability.

Motilal Oswal Financial Services highlighted that the acquisition would enable Ipca’s re-entry into the US generics market and aid synergy through cross-selling of the portfolio in the export market. Despite the advantages, the firm believes that increased competition in the oral solids US generics market and a lack of US FDA inspections at Unichem’s sites since February 2020 also puts the outlook for the US generics business at risk.

Also Read: Ipca to acquire 33.38% stake in Unichem Laboratories for Rs 1,034 crore

MOFSL has also downgraded Ipca to ’neutral’ on expectations of a limited upside from current levels. The brokerage has assigned a target price of Rs 760 for Ipca, reflecting an upside potential of 2.5 percent from Tuesday’s closing price.

IIFL Securities also stated that facility inspections would be a key risk going ahead, especially in an environment of tightened regulatory scrutiny by the US FDA.

All hopes on domestic business

Even though many of the red flags around the future of Ipca Labs are concentrated around the expensive acquisition deal, the underlying optimism for its domestic business remains intact.

“Ipca’s core business remains strong — domestic formulations should sustain outperformance aided by ~30 percent addition to its salesforce in FY23,” analysts at Nuvama Institutional Equities stated in a report.

The analysts at Nuvama believe that the active pharmaceutical ingredients (API) business has troughed out. They also showed optimism in the company’s confidence to deliver mid-teen growth, with the UK leading the recovery in the European market.

Nuvama is among the few brokerages that continue to hold a ’buy’ call for the stock. It will await the deal’s closure before altering its numbers.

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