API business demerger: A value enhancer for Strides

Move will allow company to focus on its core business leading to higher margins

Strides Shasun's announcement regarding the demerger of its API (active pharma ingredients) business in February was cheered by the street. The stock had then scaled to its 52-week high of Rs 1,259 on 3rd February before closing at Rs 1,190 or a gain of almost 10 per cent (in a couple of sessions). With Strides now providing the demerger details, it's not surprising that the stock was flat on Wednesday. But, what's more important is that the move is seen as value accretive by analysts, who also believe there are potential gains for the stock going ahead.

Here how? The commodity or low-value API business of Strides and Human API business of Sequent Scientific will be demerged into a wholly owned subsidiary of Strides, SSL Pharma Science, which will be listed separately. Shareholders of Strides will own 60 per cent of SSL and will be issued one share of SSL for every six shares held in Strides (each of face value Rs 10).

The API business acquired through Shasun merger was anyway not a key focus area for Strides, and has seen profitability pressures in FY17, which analysts attribute to increased compliance costs. Thus, hiving it off will help Strides concentrate on its core formulations business, while SSL can concentrate and work on growing the API business. Experts, however, say that there could be synergies from combination with Sequent API business through economies of scale and cross-selling in new geographies, which is positive for SSL's new shareholders.

Analysts at Jefferies believe that that the spinoff of the API business is a positive as it allows Strides management to focus on the key B2C businesses across geographies. The company's B2C business in US is focused on limited competition and difficult to manufacture products, while it is third largest player in branded generics in Australia and has strong footprint in Africa. Most brokerages, including Jefferies, believe it will generate significant value over medium term.

With hive off of API business will also boost Strides overall profitability. Analysts at JM Financial say that assuming no contribution of the API business in FY19, there will be consequent 200 basis point improvement in Strides overall EBITDA margin to 23.9 per cent (compared to 10 per cent of SSL).

Also, debt worth Rs 425 crore pertaining to Strides' API business will be transferred to SSL and analysts at Credit Suisse see two per cent value accretion due to transfer of debt itself. The foreign brokerage remains positive on Strides post demerger and expects the stock to re-rate once the return on capital employed (RoCE) expands and the company starts generating free cash-flows from FY18. JM Financial has increased its target price to Rs 1,433 for the stock trading at Rs 1,147, following the demerger details.