Time for pharma to make acquisitions in US, says Sanjiv Kaul

Indian pharmas are not seized by border tax implications as risk could be high under Trump

Indian pharma exporters’ profit margins have shrunk following increased approvals for generic drugs in the US. While increasing competition has led to price erosion, consolidation of distribution channels in the US has put more pressure on pricing. Sanjiv Kaul, partner at home-grown private equity fund ChrysCapital, has spent over 40 years in Indian pharma, including a 27-year stint in leadership roles at erstwhile Ranbaxy Laboratories. He spoke to Abhineet Kumar on what he is advising to his portfolio companies, including Intas Pharmaceuticals where ChrysCapital has re-invested. Edited excerpts: 

How has the valuation of pharma companies in the US corrected in the past two to three years? 
 

It is a good time for Indian pharma to make big acquisitions in the US as the price-to-earnings multiple for generics business has come down to 7.5, a 10-year low, against the median of 14. However, the enterprise value-to-Ebitda multiple is 9, which is in line with the 10 years’ average and indicates that operating margins are still good. It benefits from debt leverage, which is at an all-time high. Sales multiple is also at an all-time low.

What is the correction in this period specifically to specialty pharma companies in the US?

Major contributing factors are the pricing pressure on account of increased GDUFA (Generic Drug User Fee Act) approvals, buyers consolidation, and United States 

Congress’ clampdown on price increases. Against an average five per cent price erosion in the past five years, almost all generic players in the US expect to see 12-15 per cent of price erosion in their base business in 2017. 

I expect it to be north of 10 per cent in 2018, too. The market has already factored in this drop in enterprise valuations. 

Typically, the generics price erosion follows a six to seven years’ cycle. We last saw a similar happening of price erosion in excess of 10 per cent in 2011 that lasted for two years. Prices should bounce back in 2019. If any Indian pharma player plans to buy a specialty pharma asset in the US, this is the best time to buy. 
 

The earnings multiple in India can be arbitraged favourably for underwriting the acquisition costs. Of course, one would have to assess the quality of the assets with focus on complex (difficult to make molecules), including controlled, substances.

Under the Trump rule, would it be helpful if Indian companies have production facilities in the US?

Yes, it would be helpful from a risk arbitrage. There are all types of manufacturing facilities in the US that are planning to be hived off by big pharma. Good time to buy is based on one’s pocket. The impact on Indian companies from a potential border tax implementation in the US is high. 
 

Currently, Indian pharma companies are not seized by border tax implications and, therefore, risk could be high for the sector under the Trump Administration. 
 

The impact can be mitigated through more site transfer of existing products to the US and, in the medium term, increasing capacity in the US. An important consideration for Indian companies is to have a greater percentage of US sales manufactured in the US itself.

How can specialty pharma help Indian companies overcome pricing pressure in the generic drugs market in the US?

Generics, by its very nature, has a commodity life cycle that is governed by laws of demand and supply. More suppliers lead to lower prices and lesser margins. Then, this leads to the exit of many players. This creates a lesser number of suppliers eventually, increasing the prices and margins. Specialty pharma tends to be agnostic of the generic cycle and helps strengthen the core sales base of a company. Prices tend to hold firm for a longer time frame and there is limited competition. It is quite similar to branded generics in India, with the focus on doctors and hospitals rather than just the buying agencies. 

There is a surge of interest on the part of Indian companies in investing in oncology, controlled substances, NDDS (Novel Drug Delivery System), extended release products. We can gauge that by investments made by them in product development and production capabilities and capacities.