MACR

Case Analysis: Dr. Reddys Laboratories

Submitted by : Amol Mahajan BM-A B12008

Introduction
1. 2. 3. 4. 5. The given case deals with bid placed by Dr. Reddys to acquire Betapharm. The bid is placed in early February 2006. The final decision on the competitive bidding was expected within a week, from 3i, a venture capital firm based in U.K. Dr. Reddys had placed bid earlier in March 2004 as well when it lost and 3i had taken hold of the bid. One of the worries which was haunting VS Vasudevan , CFO , Dr. Reddys was the question mark upon the value expected on this transaction in the future.

Deal Conditions:
Dr. Reddys Bid : $ 570 million Out of this 400 million were to be taken from Citibank and rest through Accruals Deal will be all cash and will stripe off all resources plus a debt of 300 million Dollars 50% lending to be placed on each of the balance sheets i.e. acquirer and target. Dr. Reddys had shareholder approvals in place to raise capital from the markets, but it didnt have any immediate plans to do so.

Global Pharmaceutical Industry

1. 2. 3. The global Pharma industry was valued at US$550 billion in 2005. Growth rate of 7% was moderate for a sector like pharma. The sector has high concentration and high herphindal index as top 10 players contributed $ 101 billion of sales. 4. 18.36% of the sales contribution shows the dominance of big players 5. US market itself was holding 50% share of the world market, so this lured all players across the globe to hunt for US market. 6. The industry had seen a drastic change over the years .Early the model used to be a blockbuster business model. Blockbuster model means that you discover a drug and hold patent of it for years and garner huge amount of money for it by selling at premium and licensing the manufacturing for a royalty on sales. 7. By the time, patent will get over , the companies used to get patent for the other and so a chain of single drug was very prominent where one drug gave a huge margin for a decade. e.g. is that of Lipitor , a drug used to treat high cholesterol levels, had generated a sales of 8% for Pfizer in 2003 , which is more than the overall industry revenue in India that time. 8. But Blockbuster model slowly got a fading due to flaws. It involved huge time and cost in R&D.The success rate was 0.02% from preclinical to 1st three phases of trial and only 0.2% used to reach the commercial stage. 9. However, the blockbuster model used to have its own advantages. It used to bring the prestige, power and hence profits. 10. But the blockbuster model used to create a niche market type of scenario and under current scenario when the focus was shifting to high growth markets and targeting high value drugs, the model was disappearing. 11. The closest competitor to US pharma market was Europe at 170 billion dollars but had a better growth rate.

Indian Pharmaceutical Industry

1. Indian Pharma sector was valued at $ 10 billion in 2005

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Growth rate was around 9% which was much better than US and European market. Local manufacturing dominates the market by meeting over 75% of the overall demand. Highly fragmented marketed with 20,000 businesses involved in it. Patent regime to comply with WTO was introduced very recently in 2005, this was expected to bring a shift from generic to patented drugs. Difference between generic and patented original drug matters in terms of cost as generic drug costs around 80% as there is huge cost savings on R&D .Also there are no legal , marketing , development and clinical trial costs involved for a generic drug. Otherwise, Generic drugs contain almost same API(active pharmaceutical ingredient) as the clone drug. Cost saving for generic drugs was also contributed by using less expensive alternatives for non-active ingredients like colorings, starches, saccharoses and packaging. The dominant trend in Indian pharma for more than two decades has been to produce copycat versions of the drugs which were under patent process somewhere else and selling them in domestic as well as the markets with less stringent patent laws. Another major factor which led to the widespread usage of the generic drug in the developed market was the effort on the part of government to bring down their health care costs. This is the exact reason why Teva Pharma had a huge number of prescriptions worldwide. It was 36% ahead of its next competitor, PFIZER, which was otherwise retail leader across globe. Other prevalent trend in the market was moving up the value chain This basically means that companies used to earn a lot of revenue through generic route and then they will use these profits to finance their drug discovery and development channel. But the reason why Generic drugs held a prominent role in Indian Market over the years owes a lot to Hatch Waxman Act in USA in 1984. This really vitalized the growth in Indian Pharmaceuticals. There was a great liberalization in some of the provision of the Federal Food, Drug and Cosmetic Act and reduced the waiting time for a generics maker to secure a license to market a clone in the USA. One of the great feature of this act was that it reduced the waiting time for a generics maker tosecure a license to market a clone in USA. Capitalizing on the above act , and riding on their low cost of production and economies of scale, the Indian pharmaceutical industry grew rapidly during the 1990s The current growth rate of 9% was much lower than 15% in 1990s. Export growth rate was as high as 30% .This shows a lot of dependence on the external markets. The scenario in Indian Pharmaceutical is expected to change due to new patent regime in 2005. The three prime reasons for this are : a. MNCs which had left India in 1970s because of pronounced Socialist stance of the federal government that time, were seeking entry to capture value from local attributes such as low cost of drug development b. Large domestic drug companies which had built up scale and developed skill sets during the intervening period, were moving up the value chain. c. Some firms, such as Dr. Reddys were acquiring and creating new capacities across globe both in emerging as well as developed world. Now we will talk a bit about the bidder, Dr. Reddys laboratories

Dr. Reddys Laboratories

1. 2. 3. 4. Founded by a scientist Entrepreneur , Dr. Anil Reddy in 1984 at Hyderabad ,India Became first Indian company to export API to Europe in 1985. Started targeting U.S. generics in 1994 by building a home base approved by USFDA. By 1999, it became the 5th largest pharmaceutical company in India

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The above fact was contributed mainly due to acquisition of American Remedies ltd. In November 1999.The target had a turnover of 912.9 million INR ,i.e. 19.82 million US $(assumption that 1 US $ =46 INR) 1st Indian company to have an exclusive generic license in USA .It got a generic exclusive license for fluoxetine, which was a low cost version of Eli Lillys blockbuster Prozac. With 180 day exclusive offer In 2001, it completed its IPO of $ 132.8 million ADS(American Depositary Shares) and secured a listing on the New York Stock Exchange. Later on the funds from IPO was used for Acquisitions on global level. Financials were going very good and had a huge pool of amount for the Acquisiton.With a cash and equivalents kitty of 9.8 bn INR, the amount should be invested in some project or takeover or otherwise it is useless to keep such a huge amount of idle cash. As discussed earlier that there are two major categories of players in pharmaceuticals, the company fall more in generics category. It had built an image of a niche, particularly by getting specialized in two segments, namely, Cardiac drugs and Non-steroidal Anti inflammory drugs-both were among the top 10 therapeutic segments in the world. Corporate office was located in Hyderabad but had subsidiaries in Brazil, Germany, Mexico, US, UK which were wholly owned. Subsidiaries were focused mainly on sales and marketing, although, they had dedicated teams to handle compliance issues related to individual products. As far as manufacturing locations were concerned, the company had three Greenfield manufacturing facilities in India and one each in Mexico and UK. Took a majority stake in a tripartite venture in China in 2000 with an investment of $ 15 million to manufacture bulk formulations.

Betapharm
1. 2. 3. 4. Set up in 1993 as sales and marketing subsidiary of Hexal, a leading German generics firm. Had a turnover of 107.5 million euros in 2003. Had also a not for profit beta institution in R&D in community medicine Acquired by 3i in a MBO in 2004 in a 300 million Euros buyout. During the time of buyout, it was in the process of product line up gradation. Interestingly , the new bidder ,Dr, Redyd had also participated in this bid and had lost to it. 5. Why 3i acquired Betapharm? There was a strategic motive as 3i wanted to move to Big Five league of generic makers in Germany. Germany was more special as it was undergoing health reforms to bring down health care cost and also 10% of the cost was to be paid by the patient. Hence in the anticipation of this , generic markets was expected to get a Boom .To get advantage of this boom , 3i made this acquisition. 6. How 3i helped beta pharm? 3i helped betapharm to forge partnerships with drug makers in Asia and create a remunerative product pipeline which was exactly what Betapharm was looking prior to acquisition. 7. 3i also provided another subsidiary benefits. One such benefit was it developed a new organization structure for Betapharm which now boosts of its own business development supply chain and finance divisions. 8. In 2005, the revenue of Betapharm rose to 220 million US dollars.In Germany, it became 4th largest generics maker with roughly 3.5 market share.. 9. Amongst 50 most prescribed drugs in Germany, 74% was betapharm .This could be very crucial factor for Reddys. 10. Betapharm with a 250 sales team personnel had one of the best frontline forces in the business. 11. Most Importantly, 72% of the companys products were long term therapy medicines, that were low switch probable and had a promise of repeated long term purchase.

Why was Dr. Reddys looking for this Acquisition What was the value driver for this?
The given 5 reasons can be attributed for the intent of Dr. Reddys to place bid for Betapharm 1.) Part of Strategy The founder had clearly articulated vision to be amongst top 10 pharmaceuticals across the world and the tool he was focusing for this was moving up the chain to drug discovery. However, the interim goals like becoming a billion dollar company and half a billion dollar sales in generics by 2008 were also there but those were more of the means to achieve the top 10 position than a long term vision. 2.) De-risking through Partnerships i) Dr. Reddy labs had been going through a numerous chain of partnerships .In 2005, it signed a $56 million deal with ICICI Venture, an Indian PE investor, to fund generic drugs launch in UK in return for royalty on net sales to ICICI for 5 years. This helped Reddys to get the financial constraints out of the way as cost could go up as high as $5 million to get new drug into picture for approval. ii) In august 2005, it went into another partnership with a joint venture with ICICI and Citigroup Venture capital International which brought in 75% of total 30 million dollars for riskier drug business. Thus by merely contributing 25% of the funds, Dr. Reddys was able to foray into the business. This became more important when the company was losing out in all three exchanges in which it was listed. iii) Another one was Anrgenta discovery for pulmonary disease related collaboration to develop a new approach. iv) Last but not the least, there are three phases in drug development.Dr. Reddy used to do phase 1 of it.For phase 2 of it , it was using PE firms for funding .and for phase three , it was outsourcing to external party and in return getting a royalty on sales. Hence, it was shredding the risk. 3.) Globalization Dr. Reddys Laboratories believed that Indian Market was not a good proposition for high growth momentum. It had a feeling that if it gets trapped in the cheaper generic drug market, it would lose out on the opportunity to become a research based firm and given the fact that even 25th ranked research based pharmaceutical had a bigger share than number 1 generics firm. The other reason for getting global was that Dr. Reddy was finding it difficult to get the top scientists in India and for innovation, outside places like USA was offering a lot for intellectual resources easily. And it was tough to get those people to work in India .So the company was trying to get into these innovation hubs to source talent easily. Some of the past globalization efforts included: i) Joint venture in Russia In 1992, with Biomed , countrys biggest pharma producer. ii) Two Greenfield units were set up in Middle East in the following year. Very soon, it was able to export bulk drugs to Middle East and rust for further processing to finished products. iii) In 2004, Global Business services organization was phased to have 99% accuracy and was able to achieve 4 sigma till now. This was done to attain efficiency across domains in marketing, finance, ERP, internal controls etc. iv) The company was having belief in flexible organizational structure than a rigid one. Hence focus was to change structure every 2-3 years. Hydra headed structure was dominant. v) Project Suraksha, best in class internal controls for financial reporting was done to become compliant to Section 404 of Sarbanes Oxley Act, 2002. vi) Project Disha: It aimed at creating cost effective end-to- end global supply chain solution across all business and reducing logistics costs to effectively manage enhanced supply chain. 4.) Acquisitions

Dr. Reddys had always use Inorganic route to achieve growth .In order to become a reckoning force in pharmaceuticals, it had always put a focus on Acquisitions. The big plus for Acquisitions possibility for Dr. Reddys was that there was a cash lying on its balance sheet to the tune of $ 209 million on mar 31, 2005 and to add further advantage for acquisitions. It had hardly any long term debt. 5.) Looking for opportunities outside USA Large companies in USA had started appointing authorized generics, to put a block on the generic companies. They were also resorting to sophisticated life cycle management which was evading generic companies to eat into their sales. To hedge this risk, the companies like Dr. Reddys was looking for European market where 4 major patents were getting over in 2011, of around 11.8 billion euros .This served as a gait for the companies to look for ventures in Europe. Though due to lack of any exclusive licenses, there were no windfall revenues in European market but offered a fixed stream or revenues. Within Europe, German market itself was around 7 billion dollar worth. 6.) Image Building process Very recently, the company received two setbacks to its images as a drug researcher and developer Firm. Ragaglkitazar, an insulin sensitizer molecule licensed by it to Denmarks non nordisk had adverse effects in clinical trials. Subsequently, novo returned another molecule, balaglitazone, in 2004 even without putting to clinical trials. In March 2004, it lost bid for specialty chemical amlodiphine maleate, a variation of Pfizers amlodiphine in a legal suit which wiped off sales by 5% and profits 77% in 2004. These two incidents, led to degradation of its image as a drug research and was seen as a minnow and was seen to better suited for API and generics market. To blot out the stains due to these two recent stigmas, it was looking aggressively to acquire a firm to build its muscle and regain image in drug research.

What is in it for Betapharm? Why will it opt for it?

1.) Betapharm is looking to upgrade its product line and wanted to enter into Big Five league of the generic drug makers in the Germany .This was the driving factor for Betapharm to go for this route. 2.) Betapharms model was to outsource its entire production. So a deal with company like Reddys will give Reddys a chance to vertically integrate and this in return will bring stability to the Betapharm by having in house production. 3.) German market was looking to reduce cost on health care, hence Generics drug maker were expected to play a great role. 4.) Betapharm when acquired by 3i had a target to be in top 5 generic drug maker in the country and it was a strategic buyout by 3i .Since the goal was achieved and in 2005, with a turnover of around 220 US dollars , it was looking for further growth and opportunities.

SWOT analysis for Dr. Reddys Laboratories

Strengths
Huge Cash balance Legal expertise Expertise in Generics Low cost structure due to scale Similarity of German market with Indian

Opportunities
So far , it had four acquisitons but this will be biggest Provides an opportunity to set its base in Europe which is seen as a stable stream of revenues . Germany is the biggest Generics market in Europe and an entry over there will help to find foot in other European nation 74% of 50 most prescribed generics in Germany were from Betapharm Since Betapharm had its own supply chain , it can help Reddy's to tranform their ERP and become more of process driven

Weakness
Recent Stock rates downfall Recent failures as a drug research firm No expertise in Drug research , has been in generics Low in Intellectual Property

Threats
Compliance issues after acquisiton as it was relationship driven company while betapharm was process driven Pricing pressures as more discounts were sought in Germany in new cost cutting initiatives in health care. Failure in sales could be very fatal as it is already recovering from setbacks

Possible Sources of Synergy

1.) Manufacturing- Over the years, Dr. Reddys has got expertise in the manufacturing of the molecules to be taken over to the final processing phase.So it can be very successful to use the base of Betapharm which outsourced its entire production.Being a single entity, huge amount of operational efficiency is expected from the acquisition success. 2.) Human Capital Betapaharm had intellectual property IP .The major challenge with Dr. Reddys to set up its base in Drug research has been to get talented scientists who were more interested to work in innovation Hubs. This can help the combined entity in the long term. 3.) Brand Equity- Betapharm had acquired brand equity .Dr. Reddys can leverage the beta brand equity earned through CSR activities. 4.) Enhanced Customer Base- Betapharm had number of contracts with Insurance companies which covered 70% of the total German population 5.) Same set up in German and Indian Pharma- Both the markets were quite similar and this will make the task easier for Dr. Reddys. 6.) Legal Advantage- Dr. Reddys had a long expertise in filing suits and also dealing with them.On the other hand, betapaharm had advantage in regulatory infrastructure .Combined entity can have a very efficient set up in this. 7.) Long Term Sustainability Since most of the betapharms were long term therapy medicines,the chances of switching are low which can promise a steady stream of cash flows for Dr. Reddys. 8.) Economies of Scale- last but not the least, it promises economies of scale due to enhanced size and low fixed cost enhancement.

Conclusion
In the current scenario, the best alternative available with Dr. Reddys is to go for this deal. However, it can use independent verticals to do the valuation like legal, operational, marketing teams .This case mentions nowhere the role of an investment banker so the role of these valuation teams will be very crucial. Given the opportunities lying in the market and huge amount of synergy possible as discussed above, this deal can open the doors for Dr. Reddys and can be a gateway for it to go global. All it needs to care about is integration in finance and governance, supply chain, IT and regulatory processes. As far as post acquisition changes are concerned, it can actually benefit from Betapharm and use its process driven mechanism and adapt to that. The marketing play which is a trump card for betapharm can very well mingle with production and manufacturing expertise of Dr. Reddys .With this acquisition, Dr. Reddys will become a big player in a big league of generics market in Europe and will hedge its dependence on US market. However, it may face challenges as betapharm had entered into exclusive contracts with development houses and innovators in low-cost reasons of Asia for supply of finished dosages. But this task of consolidation , if done with precision can prove this acquisition to be very smart move.Anyways , 220 million dollars of reserve Cash equivalents are not going to serve it..Only risk averseness can deny this acquisition. In short , it is a double edge sword, Betapharm could well be a key element of Dr. Reddys recovery from its recent Setbacks. At the same time, for a company that was just beginning to get back on track from a fall in sales, a failure of the deal could be daunting.