Zydus Wellness buys Heinz India: All you need to know about the deal

What will Zydus get?

Apart from the four iconic brands, Heinz India's business comprises two large manufacturing facilities in Aligarh and Sitarganj and teams devoted to operations, research, sales, marketing and support.

Heinz India also has a strong network of over 800 distributors and more than 20,000 wholesalers covering 29 Indian states. The acquired brands, in the year ended March 2018, earned revenues of Rs 1,130 crore.

How will Zydus fund the deal?

The transaction is proposed to be financed by a mix of equity and debt. Select leading private equity firms have committed to partnering with the company for the transaction by way of equity support.

The exact contours of the financing are not known as yet. The net worth of Zydus Wellness stood at around Rs 700 crore and it had cash of Rs 177 crore, which is not enough to fund the acquisition.

The company will have to rely on its parent Cadila Healthcare's balance sheet to fund the transaction. There are indications that Cadila will pump in Rs 1,000 crore to fund the deal.

As on September 30, Cadila Healthcare owned a 72.08 percent stake in Zydus Wellness.

Is the valuation cheap?

Heinz India, for the 12 months ended June, had sales of Rs 1,150 crore, with an earnings before interest, tax, depreciation and amortization (EBITDA) of Rs 225 crore.

This means Zydus will be paying an enterprise value of four times the company's sales or around 20 times its EBITDA.

To be sure, there are no similar deals to benchmark the valuation. But analysts reckon it is reasonable when compared to the valuation of GlaxoSmithKline Consumer Healthcare (GSK ).

GSK, which derives around 75 percent of its revenues from Horlicks, has an EV to sales of 5.7 times and EV to EBITDA of 28.5 times.

Notably, Kraft Heinz was earlier expecting its India business to fetch at least $1 billion, but had to settle for a much lower valuation.

What is at stake for Zydus

For Zydus, the acquisition will help increase its revenue threefold to around Rs 1,700 crore. In FY18, Zydus' net sales stood at Rs 513 crore and its net profit came in at Rs 134 crore.

Zydus markets brands such as sugar substitute SugarFree, skincare product EverYuth and butter substitute Nutralite. The company bought Nutralite in 2006 from Carnation Nutra-Analogue Foods.

The deal gives Zydus a headstart because it could start selling products in the space without having to build brands and distribution.

Zydus, given its pharmaceutical DNA and focus on research and development, can take cues from its rival Abbott's pediatric nutritional health drink brand Pediasure.

Abbott's Pediasure has a market share of little over 1 percent, but it is fast growing and commends premium pricing compared to other competitors, as it focused on pediatricians to push its product.

Most importantly for Cadila Healthcare, like other Indian drug makers that are facing price controls, competition and threat of generic substitution in the domestic formulation market, the deal provides relatively safer diversification.

Challenges

GSK is the market leader in the Rs 7,000 crore domestic health food drinks segment, with Horlicks holding a 49 percent market share. It is followed by Mondelez's Bournvita at 11 percent and Kraft Heinz's Complan at 7 percent.

But the segment isn't growing.

In recent times, players like Nestle, Danone and Patanjali have also entered the space with brands like Milo, Protinex, and Power Vita, respectively.

This has intensified competition and is putting pressure on margins.

"The HFD category has been struggling to grow as fast as some of the other food and beverage categories in India (6 percent sales CAGR in FY12-17 vs 16 percent for F&B)," said Ambit Capital in its recent report.

Consumers are increasingly demanding scientific evidence to back the claims these companies make while promoting their products as health drinks.

Also, malt-based health drinks are coming under scanner of health activists for excessive use of carbohydrates that are linked to childhood obesity.

The slow growth or lack of visibility of future growth is forcing incumbents to exit the segment.

Market leader GSK has put its consumer business in India for "strategic review" by end 2018. Horlicks alone contributed around three-fourths of the company's sales of Rs 4,208.57 crore in FY17.