Structural shift in global pharma driving Lupin's M&A plans

After an exciting FY15 with stellar returns, Lupin suddenly finds itself being surrounded with question marks over its earnings potential in the current year.

That's because it faces structural long-term challenges as well as near-term headwinds in the US, which is its largest market. Lupin has reported below estimated earnings for the last three successive quarters.

In the March quarter, it surprised the market with a marginal decline in sales compared to the corresponding period in the previous year, as approvals for new products were slower and consolidation among buyers (large pharmacy chains) led to pressure on pricing.

Lupin chief executive officer (CEO) Vinita Gupta says while the near-term challenge of receiving US FDA approval for new products is expected to ease in the coming quarters, the long-term structural challenge of building capabilities in complex generics is what investors will watch out for.

"Slower approvals by US FDA, which impacted the industry in general, impacted our growth in FY15. Average approval timelines for the industry have increased to 42 months. FDA is working towards a more efficient review of applications and we expect the approval timeline to reduce to 12 months by 2017," she says.

Going by the slowdown in revenues and weak outlook, Lupin expects organic growth to be in the range of 10-15 per cent in FY16 as new product launches have been delayed.

Religare Institutional Research believes the 12 per cent year-on-year decline in Lupin's US business to $211 million was due to slower ANDA approvals (13 in 2014 calender against 20 in 2013), a high base (led by higher sales of Cymbalta and Niaspan in the year-ago period) and channel consolidation (price erosion of 10-12 per cent in the base portfolio versus the usual 5 per cent erosion).

Lupin's managing director Nilesh Gupta believes the firm will be able to grow organic revenues by 15 per cent.

Lupin says it is following a two-pronged strategy to address challenges. Though launch of key products have been delayed to the second half of FY16, Lupin remains optimistic about approvals. While Vinita Gupta says the worst could well be over, the Street is not entirely convinced.

Given the delays, the company is expecting to step up acquisitions this year to aid revenue growth, help build capabilities and enter new markets. Lupin intends to become a $5-billion company over three years and $1 billion sales will be through acquisitions.

So far Lupin's acquisitions have been small but this could change given its inorganic revenue target. Lupin is concentrating on acquiring companies in geographies where the potential for growth is higher. Lupin is also concentrating on building capability in complex technologies.

Explains Gupta, "Our focus continues to be on brands and complex generics." The acquisition of Mexican drugmaker Laboratorios Grin last year and Brazil's Medquimica marks its entry into Latin America, a $70-billion pharma market and one which has growth potential.

Strategically, acquisitions like Nanomi, a Netherlands-based injectable platform company, is what will give Lupin capabilities it needs in complex generics. Complex generics are the future, but require higher investments unlike the copycat drugs that Indian companies have so far been manufacturing. Analysts believe Lupin can look at acquisitions of up to $1.5 billion given its balance sheet strength.

Lupin is also building strong capabilities in the inhalation business and has created a strong research facility in Florida for development of drugs to treat respiratory ailments.

Building capabilities in complex generics is crucial as nearly half the drugs that will go off patent by 2020 will be biologics and require complex capabilities if generics players wish to make biosimilars. Several biologic drugs, adding up to $81 billion in sales, are set to go off patent by 2020, providing both an opportunity and challenge for Indian players. It costs a generics company $2-3 million to take a small molecule to approval stage, in contrast, a biosimilar requires a minimum investment of $75-250 million.

The rush for this market explains Pfizer's $17-billion buyout of Hospira in February. Korea's Samsung, too, has invested $2 billion in biopharmaceuticals.

Brian Tempest, former CEO of Ranbaxy and a global consultant to large institutional investors, says: "It would be interesting to see what kind of returns these companies make on biosimilars. In the near-term, product approvals is a big issue for Indian companies as the pipeline is packing up."

Korean companies have jumped into the space and Celltrion and Samsung are the biggest of them and want a third of the market.

These opportunities will require Indian generics players like Lupin to sink in substantial amounts of money in research. These are big molecules that require sophisticated manufacturing and handling systems.

While Lupin remains interested in the injectible and inhalation segments, Gupta says "We would like to be a fast follower than a trend setter. Given the increase in the complexity of the business, our R&D costs will remain elevated at 10-12 per cent of sales."

The Street is seemingly taking cognisance of the structural changes faced by India's pharmaceutical sector.

On Lupin, Kotak Institutional Equities says in a note, "Beyond the near-term approvals, we believe progress on key technology areas such as topicals (FY16 filings), nasals (FY16 filings), LA injectables (FY17 filings) and particularly pressurised metered drug dose inhaler (pMDIs) (FY17 filings), and DPIs (FY17 filings) will be critical to sustain the medium-to-longer term growth momentum."

Given the changing dynamics in the global industry, Gupta acknowledges that Lupin's strategy is also undergoing a major shift.