The Ranbaxy-Daiichi Deal: Good Medicine, or a Harbinger of Future Ills?

Published: June 12, 2008 in India Knowledge@Wharton

Just a few days before announcing that he had sold his family's 34.8% stake in Ranbaxy Laboratories to Japanese pharmaceutical firm Daiichi Sankyo, Ranbaxy's CEO and managing director, Malvinder Mohan Singh, said his company was on the hunt for its own acquisitions.

He told the New Delhi-headquartered business daily, the Business Standard, that he had "de-risked" and charted a strategy for the company to make acquisitions of its own. "When you are the leader, you have to set the pace for the industry," he declared.

So, Indian investors and pharmaceutical industry leaders were astounded by the June 11 announcement. To be sure, the markets were aware that something was afoot between Ranbaxy, India's largest pharmaceutical company, and Daiichi Sankyo, Japan's second largest, but investors were expecting no more than a sale of a strategic stake of about 10% or so to shore up an alliance between the two companies. The sale of the Singh family's entire stake came as quite a shock. Asked one journalist after the announcement: "Haven't you sold the family silver?"

Singh contends that this is just what the doctor ordered. "[This] puts us on a new and much stronger platform to harness our capabilities in drug development, manufacturing and global reach," he said. "Together with our pool of scientific, technical and managerial resources and talent, we will enter a new orbit to chart a higher trajectory of sustainable growth ... in the developed and emerging markets, organically and inorganically. This is a significant milestone in our mission of becoming a research-based international pharmaceutical company."

Daiichi Sankyo president and CEO Takashi Shoda said the two companies are a good fit: "The proposed transaction is in line with our goal to be a global pharmaceutical innovator and provides the opportunity to complement our strong presence in innovation with a new, strong presence in the fast-growing business of non-proprietary pharmaceuticals." He added: "While both companies will closely cooperate to explore how to fully optimize our growth opportunities, we will respect Ranbaxy's autonomy as a standalone company as well." Not only will Singh stay with the company, Shoda said, he will also be chairman of its board of directors.

Getting into the Generic Market

Wharton marketing professor Jagmohan Raju, who has consulted with pharmaceutical companies including Wyeth and Johnson & Johnson, says that while Daiichi Sankyo will find it easier to enter the Indian market with Ranbaxy, its bigger goal would be in securing a strong presence in the global market for generics. "Ranbaxy has a good foothold in the worldwide generics market, which is lucrative and growing," he says.

Singh has been a pugnacious leader, pursuing takeovers in India and abroad. Among his foreign acquisitions are the unbranded generic drug business of Allen SpA (a division of GlaxoSmithKline) in Italy; Terapia in Romania; Ethimed, a generics company in Belgium; the Mundogen generic business of GSK in Spain; and Be-Tabs Pharma in South Africa.

Singh has taken over or acquired strategic stakes in a host of domestic companies such as Zenotech Laboratories, Cardinal Drugs, Krebs Biochemicals and Jupiter Biosciences. He was recently involved in a raid on the Chennai-based Orchid Chemicals. Although he denied it was a hostile takeover, the promoter of the beleaguered company didn't agree.

Singh has also been taking on the world's big names in pharmaceuticals in court cases all over the globe. This includes Pfizer for Lipitor, GSK for Valacyclovir and AstraZeneca for Nexium. (Many of these patent battles have recently been settled out of court.)

After such an acquisitive strategy, why would Singh suddenly agree to be acquired? The answer is not immediately clear. Raamdeo Agrawal, co-promoter and non-executive director of Motilal Oswal Securities, speculated that there may be problems with the Indian drug industry that analysts are not fully aware of. "We need to look at the sector again," he said. Others expressed surprise and disappointment. "It's a landmark deal for the pharma industry. But I can't help feeling a twinge of regret about an Indian MNC becoming a Japanese subsidiary," Mahindra & Mahindra chairman Anand Mahindra told The Economic Times.

The Deal

Singh is selling his 34.8% stake for around Rs. 10,000 crore ($2.4 billion) at Rs. 737 ($17) per share. Daiichi Sankyo will pick up another 9.4% through a preferential allotment. According to Securities & Exchange Board of India (Sebi) norms, it will have a make an open offer to the shareholders of Ranbaxy for another 20%. There could also be a preferential issue of warrants to take the Daiichi Sankyo stake up by another 4.9%. That will come into play if the ordinary shareholders don't respond to the open offer and Daiichi Sankyo needs another way to raise its stake to 51%.

At the end of the exercise, scheduled to be completed by March 2009, Ranbaxy will become a subsidiary of Daiichi Sankyo. Despite all the denials from Ranbaxy leadership, an Indian icon will vanish. (Similar circumstances drove Sunil Mittal of Bharti Airtel to walk out of a deal with MTN of South Africa; he wouldn't compromise the Airtel brand which had become "the pride of India.")

What will Singh be doing with his $2.4 billion? He says that major investments are needed in Religare and Fortis, the group's forays into financial services and hospitals. But both are really part of the herd in their sectors while Ranbaxy was number one.

Ranbaxy, with $1.6 billion in global sales in 2007, had a profit after tax of $190 million, a gain of 67% over the previous year. It has a footprint in 49 countries and manufacturing facilities in 11. It has 12,000 employees, including 1,200 scientists and has been pouring money into R&D, though obviously not on the same scale as the Western majors. Ranbaxy is among the top 10 global generic companies. Its stated vision has been to be among the top five global generic players and to achieve global sales of $5 billion by 2012. How much of that survives the Daiichi Sankyo regime remains to be seen.

Indeed, there is a question over whether Singh himself will survive. He said that Ranbaxy is in his genes and there is no question he will remain CEO and, now, chairman. But will he be able to make the transition from a promoter to a professional CEO? He may have delivered Ranbaxy to Daiichi Sankyo, but now he has to deliver the goods.

Daiichi Sankyo is the product of a 2005 merger between Sankyo and Daiichi. In the financial year ended March 2008, it had net sales of $8.2 billion and a profit after tax of $915 million. It has a presence in 21 countries and employs 18,000 people. It is the second largest pharmaceutical company in Japan. The company can trace its roots back to 1899, though the formal entity today is relatively new. Daiichi Sankyo makes prescription drugs, diagnostics, radiopharmaceuticals and over-the-counter drugs.

The combined company will be worth about $30 billion. The acquisition will help Daiichi Sankyo to jump from number 22 in the global pharmaceutical sector to number 15. "The deal will complement our strong presence in innovation with a new, strong presence in the fast-growing business of non-proprietary pharmaceuticals," according to Shoda.

The combination has other benefits for the Japanese company. It gets a stake in a major player in generics, an area that is becoming increasingly important in Japan. According to the 2008 Japanese Pharmaceuticals & Healthcare Report (2nd quarter), the country's pharmaceutical market is currently valued at $74.4 billion and is the most mature in the Asia-Pacific region. By 2012, the market will grow to $82 billion. The country's generics sector is one of the most promising. "In an effort to control ballooning healthcare costs, the ministry of health plans to raise the volume share of generics within the total prescription market to at least 30% by 2012," says the report. "The current value of the sector is $5.5 billion, which equates to 7.3% of total medicines sales. Changes to prescribing procedures and the influx of foreign firms with low-cost goods will provide a stimulus to the generic drug sector." The comparative figures of volume share of generics for the U.S. and the UK are 13% and 26%, so there is some way to go.

Getting into Japan

Ranbaxy will gain easier access to the much-coveted Japanese market by operating from within the Daiichi Sankyo fold, says Raju. "Ranbaxy could bypass a lot of European and U.S. companies that are finding it difficult to enter the Japanese market, where safety and testing requirements are a lot higher." He notes that Pfizer has done a smart thing in forming an alliance with Eisai of Japan to jointly market the former's drug Aricept, which treats Alzheimer's disease. "No other Alzheimer's drug sells well in Japan," says Raju.

Daiichi Sankyo's proposal is to make the much cheaper generic drugs the default option over branded drugs. The ministry stamp of approval will eliminate the problems patients have been facing with health insurance claims; some insurers have not been accepting generic drugs as valid medicines. Indian pharmaceutical companies have been aware of this opportunity. Some have started their preparations. Last October, the Mumbai-based Lupin Ltd acquired an 80% stake in a Japanese generic pharmaceuticals company, the $70 million Kyowa Pharmaceutical Industry Co Ltd. Orchid Chemicals & Pharmaceuticals has set up a wholly-owned subsidiary in Japan called Orchid Pharma Japan.

The Ahmedabad-based Zydus Cadila group initially entered the Japanese generics market with Zydus Pharma in 2006. This U.S. company's mandate was to market formulation generics and look for alliances with Japanese companies. Last year, Zydus acquired a 100% stake in the Tokyo-based Nippon Universal Pharmaceutical Ltd. Zydus Cadila had earlier taken over Alpharma of France. In India, its acquisitions include Recon Healthcare, German Remedies, Banyan Chemicals and Liva Healthcare.

As much smaller companies than Ranbaxy have gone to Japan, shopping bag in hand, why didn't Singh try to purchase Daiichi Sankyo instead of selling? Domestic laws make Japanese companies difficult to take over. But there surely could have been an equivalent in Europe or the US. The Tatas and the Birlas have successfully targeted foreign companies several times their size. Why did Ranbaxy follow a different prescription?

The answer may be in the fact that that Ranbaxy was on a much weaker wicket. The official version talks of synergies. Says a joint company statement: "Daiichi Sankyo and Ranbaxy believe this transaction will create significant long-term value for all stakeholders through:

* A complementary business combination that provides sustainable growth by diversification that spans the full spectrum of the pharmaceutical business.
* An expanded global reach that enables leading market positions in both mature and emerging markets with proprietary and non-proprietary products.
* Strong growth potential by effectively managing opportunities across the full pharmaceutical life-cycle.
* Cost competitiveness by optimizing usage of R&D and manufacturing facilities of both companies, especially in India."

But beyond these positive results from the alliance lie problems that could have faced Ranbaxy had it chosen to continue alone. First, the company has thrived on selling off-patent drugs in the U.S. But this has become a much more expensive proposition because of litigation. Second, there is growing competition in generics at home and abroad. Finally, even as the Indian government has been insisting on stringent quality norms, it is extending its regime of price controls. The industry contends that it simply cannot make adequate returns on various products. "If the promoters of India's largest drug company felt it better to exit the business after many years of attempts to make it one of the largest in the world, then there must be serious issues with our drug policy," Swati Piramal, director of strategic alliances at Nicholas Piramal told the Business Standard.

Coming of Age

For Daiichi Sankyo, there are huge benefits in getting access to Indian research capabilities, said Vivek Wadhwa, executive-in-residence at Duke University.

"People are underestimating what is happening in India and China, where companies have rapidly come of age as they play on the world stage," says Wadhwa, adding that Daiichi Sankyo's selection of Ranbaxy underscores that trend. "The Japanese companies have a lot of money but not much by way of innovation. China, India and Indian companies are a very good way forward for them." He says Daiichi Sankyo is banking not just on the cost advantage Ranbaxy would bring, but also its research capabilities. "Japanese companies are shifting a lot of their R&D to India also," he says. "They don't have enough scientists and India has them in abundant supply right now."

There are fears that the Daiichi Sankyo takeover could be a sign of the times. The pharmaceutical industry has turned into a nervous place overnight. Earlier, one likely danger was perceived to be Ranbaxy itself. In March-April this year, it had launched a raid on the Chennai-based Orchid Chemicals and picked up a stake close to 15%.

An analysis shows that several mid-size companies are vulnerable to takeovers. Ankur Drugs, Avon Organics, Lyka Laboratories, Strides Arcolab, Surya Pharmaceuticals and Venus Remedies top the list of pharmaceutical companies in which the promoters have less than a 25% stake. "Indian generic players with established global businesses are definitely a target for multinational companies to beef up their businesses," Ranjit Shahani, vice-chairman and managing director of Novartis India, told the Business Standard.

Does the Daiichi Sankyo acquisition of Ranbaxy signal a countertrend to that exhibited by Indian corporations lapping up companies in foreign markets, like Tata Steel's purchase of European steelmaker Corus? "It's a two-way street," said Wadhwa. "Indian companies are becoming world class, they are growing fast, and they have competent management and technological abilities. The Ranbaxy-Daiichi Sankyo deal is one data point. You are going to see many more of these in the future."