Second-gen promoters more open to selling out: Rothschild MD Subhakanta Bal

Health care and pharma M&As in India have been on the rise in recent years driven by interests from private equity players and Indian firms opening up to inorganic growth among other factors. Subhakanta Bal, managing director, Rothschild & Co, one of the world's largest independent financial advisory groups, in a video interview with Sohini Das, talks about emerging trends in the sector. Edited excerpts:

How is the healthcare M&A space looking in the last few years?

The Indian health care sector has witnessed strong M&A activity over the last 8-10 years. Over the last four years (2020-2023), the Indian healthcare sector has witnessed a cumulative M&A deal value of over $33 billion versus nearly $20 billion over 2016-2019. There has also been a meaningful increase in average deal value over time during the same period.

With a global team of around 100 bankers dedicated to the health care sector, Rothschild & Co has advised on around 50 deals a year on an average in the health care sector. Of this, R&Co has advised on over 15 deals in the health care sector in India in the last seven years, including as advisors to TPG on stake sale in Care Hospitals to Blackstone and to Piramal Enterprises on Carlyle’s 20 per cent stake investment in Piramal.

Post Covid, there was a spike in interest in healthcare deals. Will this continue?
 

By and large, I think the appetite for doing M&A continues to be pretty strong and from that perspective, we certainly think that health care and specifically the pharma sector will continue to be pretty strong. There continues to be a lot of appetite from the larger domestic players to expand their footprint within India and there are portfolio gaps that people want to fill up. Also, organically launching a brand is not the easiest thing— buying something that is already scaled up is probably faster and easier. Larger Indian pharma companies have pretty low leverage levels. So, there we have a lot of flexibility from a balance sheet perspective to deploy more capital. So, for larger players, M&A is quite mainstream now compared to 10 years back when the appetite for Indian companies to acquire another asset in India was probably lower. The general conventional wisdom 10 years back probably was that I can organically do something that is better than spending money and buying growth, buying assets.

Another driver of M&A across the entire health care ecosystem — pharma, hospitals, medtech etc — obviously is private equity. In pharma areas like high potency APIs, sterile manufacturing capabilities, antibody drug conjugates, peptides etc are areas that are growing fast and there is an inherent entry barrier.

Do you see a China-Plus-One strategy at play?
 

There is a certain visibility of China-Plus-One strategy clearly. I mean, clearly there are people who are saying look to the extent we can diversify outside of China sourcing, we would like to. There are certain areas where China is just so big and massive, that it is very difficult to overnight supply chains. There are certain products where China probably accounts for 70-80 per cent of the world's total production. And if you think about it from an API perspective, as an example, outside of China, the two key areas really are Italy and India. I mean a little bit of Spain, a little bit in Germany. Some of the Indian API companies are net kind of beneficiary of that trend. So in general, I would say with this whole manufacturing-related realignment around the supply chain around the world, from China-Plus-One perspective, clearly India is getting some benefits of that. I would say a large part of that is being driven by private equity, and to be candid, inbound interest into India. People are necessarily keen to buy Indian assets purely from a capacity perspective and from a cost-efficient infrastructure in India.

What kind of multiples are Indian businesses fetching – from pharma to healthcare space?

If you look at domestic formulations by and large, multiples continue to be quite healthy because of these branded generics. Branded generics are very sticky businesses. Once you build up a particular brand, it starts a virtuous cycle. Domestic formulation businesses of larger Indian companies are pretty good margin businesses. The nature of the business is cash generative, high returns profile etc. Also, given the levels of penetration in this country, one has a multi-decade growth opportunity. Even mid-sized domestic formulation businesses are looking at north of 20 times EBITDA multiple. If you look at most of the listed players, they are probably trading at even higher, 25-28 times EBITDA multiple. I am talking about companies which have a greater presence in India, right relative to their revenue. However, if I look at people who have a greater share of revenue coming from the US and Europe, clearly valuations are more muted because of the risk and because of the nature of the market. Those markets fundamentally are not branded generics markets. There is much greater competition, much greater pricing pressure. For companies which have a much greater skew towards US and Europe, we may see a low double-digit multiple, and in some cases even high single-digit multiples anywhere from 9 to 11-12 times if it’s a US-European business. In Business-to-business pharmaceutical space (more of commodity pharma), the multiples are as low as 8-9 times. However, on patented products-driven contract development and manufacturing organisation (CDMO) business, the multiples can get as high as 20-25 times. Of patent businesses in CDMO where there is competition from Chinese companies, the multiples will be impaired or kind of low.

The other thing is obviously scale. The larger you are the better multiple you get, and this happens whether it is a listed market or whether it is private market deals. Scale by itself has some virtue to it. All else being equal, people are happy to pay a higher multiple for a business, which is Rs 500 crore EBITDA versus a business which is Rs 100 crore EBITDA.

Why are hospital M&As on the rise?
 

Hospitals will continue to see strong interest in India. Most of the interests are either from private equity or from the larger hospital companies wanting to consolidate further in India. Because if you think about it, the top 10 corporate hospital chains in this country, which would include the likes of Apollo, Max, etc, put together, will probably be less than 3 to 4% of hospital beds in India. Which just tells you the scope of expanding and how much fragmentation exists in the country. For larger chains, M&As are a good way to expand their network. Secondly, organically putting up a hospital, attracting doctors, patients, is a reasonably long gestation time cycle.

How hospital assets in Western markets trade versus how in India they get viewed and traded are different. In a lot of the Western market, hospitals are thought of as somewhat quasi-infrastructure assets so they get what I would call ‘infrastructure’ kind of multiples. In India, however, they get viewed as a quasi-consumer asset. There is a lot of brand resonance. So there is a little bit of the quasi-consumer brand pull and hence these guys get also valued in a very different way. In western markets, these assets trade at low double digits in some cases, maybe even high single digit, but maybe more likely low double digit. In India, larger assets anyways traded notes of 20 times, even the mid-size assets probably are, you know going for between sort of 15 to 20 times. In single specialties, this could be even higher.

Are second-third generation promoters looking to exit pharma and health care businesses?

We are certainly seeing more kinds of instances at least of the second generation when the baton passes on in a lot of cases. Second generation being more open to value creating ideas and in some cases that could have actually been just selling out completely. On a lighter note, I mean 15 years back, when I started my career, I don't think I had many instances where we would have senior bankers’ kind of going into the first meeting with the promoter and openly asking him look, would you be open to partnering? Would you be open to selling out? And what are your thoughts for the long term? There was a lot of beating around the bush.

People would carefully navigate how they structured their words because you didn't want to offend the promoter, how dare you ask me about selling? These days at least, when I go to a lot of these meetings in the first meeting, I ask these and in a lot of cases, the answer is no. But I don't think there is any negative connotation associated with it.

Do you see more MNC pharma businesses up for sale in India in coming years?
 

For a strong Indian local company, which has operated forever in India, obviously their ability to navigate India as an ecosystem is better than some of the MNCs. The second reason also that is in some cases driving some of these decisions by MNCs to pare down, rationalise. If you look at Big Pharma globally, a sizable number of them have gotten out of generic business and are only focused on patent business. So there is a realignment at the headquarters level itself. The reality is, in India for the foreseeable future, there will continue to be a large branded generics market. There is going to be a very small proportion of the population at the upper layer that can afford a truly innovative drug just given the pricing. This is going increasingly to drive some of these decisions. Maybe you will have some of these MNCs where they sell off some of their legacy brands. They will continue operating in India, but in that small segment focused on innovative drugs.