Podcast |Editor's pick of the day: Aurobindo acquires Sandoz's dermatology and oral solids business for $900 million

Indian pharmaceutical companies have been playing in the big league for some time now. After Lupin bought US drugmaker Gavis $880 million in 2015; Cipla acquired US drugmaker InvaGen for $550 million; and Intas bought Teva’s generic drug business in the UK and Ireland for $764 million, comes another massive deal, overtaking the massive Gavis deal by Lupin in 2015.

India’s second-largest drugmaker Aurobindo Pharma on Thursday said it has entered into definitive agreement to acquire commercial operations and three manufacturing units from Sandoz, a Novartis generic division, in the US. The acquisition, Aurobindo’s largest ever, comprises Sandoz’s dermatology business and a portfolio of oral solid products along with commercial and manufacturing infrastructure in the US for $900 million.

This deal, and what it means for the pharma sector in general and to Aurobindo in specific, constitutes the crux of our Pick of the Day.

What’s the big deal?

Aurobindo Pharma has been in an expansion phase of late. Last year, Aurobindo Pharma inked a pact to acquire Portugal’s Generis Farmaceutica SA from Magnum Capital Partners for a consideration of €135 million. It also acquired four biosimilar products from Swiss firm TL Biopharmaceutical AG. In 2014, it acquired Actavis’s commercial operations in seven Western European countries.

Earlier this year in July, news emerged that Aurobindo had also inked a pact to acquire Apotex International Inc.'s businesses in five European countries for €74 million (Rs 593 crore).

The latest in this spree, and the biggest yet, is this Sandoz acquisition. This however is not its first major US acquisition. In 2014 it acquired nutritional supplement maker Natrol which was facing insolvency proceedings at the time. That acquisition turned around the fortunes of Natrol.

Coming to this deal with Sandoz, the transaction will be an all cash transaction which Aurobindo will finance through a fully committed debt facility, Aurobindo said in a statement. Aurobindo will raise a $900 million bridge loan from Japanese lender MUFG to fund the purchase.

The company had a net debt-equity ratio of 0.3:1, which will increase to 0.6 :1 after the transaction, Mint reported. Aurobindo and Sandoz will enter into a transitional services agreement to support the ongoing growth plans of the businesses being acquired by former. Aurobindo, which recently backed out of the race to acquire Mallinckrodt’s opioid business, was the only Indian drugmaker bidding for the Sandoz business.

The net sales of the acquired business were around $1.2 billion for the calendar year ended December 2017. The net sales of the acquired business for the first half of 2018 stand at $0.6 billion. Overall, the transaction will position Aurobindo as the second-largest dermatology player and the second-largest generics company in the US, by prescriptions.

It will also add approximately 300 products including projects in development as well as commercial and manufacturing capabilities in the US, complementing and expanding the group's portfolio and pipeline. Three manufacturing facilities at Hicksville and Melville, New York for dermatology, and Wilson, North Carolina for oral solids are also part of the acquisition. Aurobindo Pharma will get net free working capital of $225 million along with the acquisition.

The transaction is expected to be completed by end of 2019 subject to the clearance from US Federal Trade Commission (USFTC). "The acquisition announced today is in line with our strategy to grow and diversify our business in the US," said N Govindarajan, Managing Director of Aurobindo. "Acquiring these businesses from Sandoz will allow us to further expand our product offering and to become a leading player in the generic dermatology market," Govindrajan added.

"We expect a seamless integration of the acquired businesses with the rest of the Aurobindo group given the success we have achieved in our acquisitions to date. As we have done in some of our previous acquisitions, we will be focused on leveraging our Group's market leading vertically integrated and highly efficient manufacturing base to enhance the market position and medium-term profitability of the businesses we are acquiring," Govindrajan said.

The acquired generic dermatology portfolio covers topical antibiotics, gynaecological and dermatological antifungal agents, anti-acne agents, local anaesthetic analgesics, anti-itch, and a dermatological chemotherapeutic agent.

Current health of Aurobindo and Sandoz

Aurobindo Pharma’s revenues in FY2018 were close to Rs 16,500 crore and it reported profits of Rs 2,440 crore. The company’s total borrowings at the end of March, 2018 stood at Rs 4,482.5 crore. For the first quarter of this fiscal, Aurobindo had 1,387 crore rupees cash on books, and had a gross debt of 5,298 crore rupees. Currently US business contributes to around 45 percent of its revenue.

Bloomberg reports that analysts have been impressed with the company’s performance in the US. Analysts at Kotak Institutional equities said the company’s execution in the US had been superior. This was clear, they observed, from the consistent scale-up in the US despite broader pricing pressure, as well as a diversified, volume-led product basket across orals as well as injectables.

“The portfolio being divested generated sales of $0.6 billion in H1 2018 for Sandoz. After expiration of certain in-licensed product contracts, and rationalisations of acquired products that will not negatively impact profitability (but before the impact of any potential FTC-led divestments) the portfolio is expected to generate over $0.9 billion in sales for the first 12 months after completion of the transaction for Aurobindo,” a statement by Aurobindo Pharma said.

The acquisition will be on debt-free and cash-free basis and will be made through its wholly-owned subsidiary, Aurobindo Pharma USA Inc. Through this deal, Aurobindo will acquire a well-established commercial infrastructure with a fully-dedicated dermatology sales force along with a state-of-the-art manufacturing facility with specialized capabilities in creams, ointments, lotions, topical solutions and topical suspensions.

Analystspeak

Bloomberg quoted an analyst of a domestic brokerage who requested anonymity saying that the deal looks good but the balance sheet gets stretched which has always been a main concern for Aurobindo.

According to a Kotak Institutional Equities report Aurobindo Pharma is well positioned to gain volumes in US orals and injectables, while gradually moving up the complexity curve. “We believe the market has been largely ignoring Aurobindo’s superior execution in the US, as demonstrated by its consistent scale-up in the market despite broader pricing pressure,” it added.

According to a note by Rakesh Nayudu of Haitong, “The deal adds massive scale, the oral solids and dermatology businesses will see progressive pricing pressure, but the deal value looks very accretive despite not so great outlook on the segment, and given Aurobindo’s own manufacturing base in India, they should be able to extract cost synergies from this.”

Surajit Pal – AVP, Analyst, Pharma at Prabhudas Lilladher spoke to the Economic Times about the acquisition. On being asked if the company was doing the right thing by committing about a billion dollars on an acquisition at a time when markets have been worried about their total debt positioning, he said, “There are two ways to look into it. One, they are looking for brands - be it US or Europe. The mid to long term prospect depends on whether they want to get into brand replacement - be it OTC or acquisition of other companies. As far as debt is concerned, we should look at net debt to equity ratio which at 0.35 to 0.37 is pretty good. Every year, around $150 million goes on average payout and despite that, if they maintain or reduce debt-equity ratio, that is pretty good. They are getting into that direction and they want to increase the presence in terms of sales and reach.”

Stock market reaction

Today, at the end of trading hours, the Aurobindo stock ended up 5.7 percent to close at Rs 802.5 on the NSE. It hit an intraday high of Rs 827.45, also its 52-week high.

What do brokerage houses say?

Brokerage houses remained bullish on the stock after this acquisition and raised target price up to Rs 915, implying 20.5 percent potential upside from Thursday's closing levels.

Brokerage: Credit Suisse | Rating: Outperform | Target: Rs 840 | Return: 11%

Aurobindo acquired high-concentration portfolio from Sandoz. Acquisition is attractive on financial parameters and at this size, we expect overall mid-single digit growth.

We have maintained Outperform rating on the stock with increased target price to Rs 840 from Rs 700 per share.

Brokerage: ICICI Securities | Rating: Buy | Target: Rs 915 | Return: 20%

The acquisition is at 1x (after adjustment) of sales which is one of the cheapest among recent deals. The reason for the same is the negative growth trajectory the portfolio is witnessing over the last few quarters owing to generic pricing pressure in the US. This deal is also a part of parent Novartis’s broader game plan of exiting from non-core generics globally.

For Aurobindo, however this augurs well as this offers a footprint in the Derma segment in the US and in a way it fills the portfolio gap especially for derma (generics + branded). There will be significant debt addition nonetheless, but looking at the broader picture of synergy and earlier history of successful acquisitions, we believe the company is well poised to manage this added burden.

Aurobindo possesses one of the best enduring ecosystems among peers (vertically integrated model, lower product concentration) to withstand the volatility in the US generics space. We have rolled over estimates to FY21 to capture the synergy of this deal. We have also upgraded currency expectations. Accordingly, new target price arrives at Rs 915 based on 15x FY21E EPS of Rs 61.2.

Brokerage: Elara Capital | Rating: Buy | Target: Rs 836 | Return: 10 percent

Sandoz acquisition seems to be transacted at attractive valuations (1x sales and 5x EBITDA), which will give Aurobindo higher scale ($2.3 billion of consolidated US sales) and diversification in US (derma portfolio). Although the generics cycle in the US is going through a tough environment, we see Sandoz acquisition as value-accretive.

We will incorporate Sandoz deal post closure of transaction and clarity from FTC on divestments. The incorporation of Sandoz business will increase our FY20E EPS by 15-20 percent, if we assume transaction closes by FY19-end.

Strong US business and an emerging EU (transitioning from negative OPM into the double digits) show drivers are in place. The EIR receipt for Unit IV in April 2018 and gErtapenem launch will aid in injectables sales in the US in FY19. We retain Buy with a target price of Rs 836 on 18x FY20E P/E.

Brokerage: Motilal Oswal | Rating: Buy | Target: Rs 910 | Return: 20%

The company guided for sales of $900 million and a company-level EBITDA margin for the first 12 months post completion of the transaction (likely in Q1FY20). Accordingly, the deal turns out to be at an attractive valuation of around 1x EV/sales and around 4.3x EV/EBITDA.

The acquisition would add around 300 products and enhance manufacturing capabilities in the US.

We expect incremental PAT of around $92 million on a 12-month basis from this deal. We raise FY20 EPS estimate by 20 percent to Rs 59 to factor in this acquisition. We value Aurobindo at a 12-month forward P/E of 15x (unchanged) and revise target price to Rs 910 (prior: Rs 750). Re-iterate Buy.