FINAL PROJECT REPORT

ON

“FINDING OF SAFE ISLAND IN THE SEA OF

RISK(Fundamental Analysis of stocks of Pharma sector) ”

Submitted to AMITY UNIVERSITY in Partial Fulfillment of the

Requirements for the Degree of

Masters of Business Administration

FACULTY GUIDE: SUBMITTED BY:

Mr. Sanker Sen Tuhin Das
10th May 2010

2008-2010
AMITY GLOBAL BUSINESS SCHOOL
Kolkata

1
 CERTIFICATE OF APPROVAL

This is to certify that the dissertation work entitled “Fundamental

Analysis of stocks of Pharma sector” is a bonafide work carried out by
Tuhin Das in partial fulfillment for the degree of Master of
Business Administration (Finance $ Marketing) from Amity
Global Business School, Amity University, Noida.

Faculty Guide

Prof. Sankersan Sarkar

Amity Global Business School,

Amity University, Noida

2
 DECLARATION
I hereby declare that the report on “Fundamental Analysis of
stocks of Pharma sector” is submitted to Amity Global Business
School for the partial fulfillment of the continuous evaluation
of the dissertation work, MBA (Finance &Marketing) class
of 2010.

I further declare that this report has not been submitted to

other university or organization for any purposes
whatsoever.

Tuhin Das

Enroll No: AGV30901908099

Amity Global Business School,

Amity University, Noida

3
 ACKNOWLEDGEMENT

No matter how much enterprising and entrepreneurial one’s thinking is, yet nobody can do
everything all by himself without some help and guidance. It is inhumane if the concerned
person’s assistance goes without appreciation and thanks.

I sincerely thank to Mr. Johar Bagchi, Head of Department ( Amity Global Business School,
Kolkata) and to my Project Guide Mr. Sankersan Sarkar for their guidance and moral support.
I deem it my privilege to have carried out my Dissertation work under their able guidance.

Finally, I would like to thank all those who have helped me in successful completion of the
project.

(TUHIN DAS)
Enrolment No. AGV30901908099
MBA (Finance & Marketing)

4
 EXECUTIVE SUMMARY

The project is all about finding stocks in pharmaceutical sectors which are worth investing. In
this project I have done comprehensive study on pharmaceutical sector of India to find out its
growth prospects in the near future. For this a report from Deutsche Bank has been used by me.
After study I came to know that with increasing talent pool in India and masses getting more
aware of need of new patents, with people of India getting more and more disposable income in
their kitty, their sector is poised to contribute a lot in years to come. Apart from this unlike any
other industry it is recession proof and are thus least affected by up and downs of disposable
income of individuals.

In later part of the report I have done valuations of few stocks of pharmaceutical sector namely-
Biocon, Dishman Pharmaceuticals and Chemicals Ltd, Orchid Chemicals and Pharmaceuticals
Ltd. After valuations I came to conclusions that some of these stocks are hugely underpriced
while some are moderately underpriced there giving opportunity to the investors to get some
return out from this stocks.
I have also derived target price and time horizon of investments in these stocks.
Thus in nutshell this project would give comprehensive report to the investors which will aid
investors in designing their portfolio.

5
TABLE OF CONTENTS PAGE NO.

CERTIFICATE OF APPROVAL
DECLARATION 3
ACKNOWLEDGEMENT 4
EXECUTIVE SUMMARY 5

CHAPTER 1
Abstract 7
Scope of the project 7

CHAPTER 2
Introduction 8
Objective of the study 8
Methodology used 9

CHAPTER 3
Excerpts from the research report on Indian pharma 13
Sector

CHAPTER 4
Fundamental analysis of stock # 1(Biocon) 28

CHAPTER 5
Fundamental analysis of stock # 2(Dishman) 51

CHAPTER 6
Fundamental analysis of stock #3 (Orchid) 62

CHAPTER 7
Conclusions 71
Limitations of the study 72
References 73

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7
 CHAPTER 1: Abstract and the Scope of the Project

I worked on the project “FINDING OF SAFE ISLANDS IN THE SEA OF RISKS”(finding

healthy pharma stocks through fundamental analysis) as a part of my dissertation module
in 4th semester.

This project will give better insights to about choosing pharma stocks which are
fundamentally strong and are capable of giving defined return to certain extent.

Followings are objective of my project:

➢ Finding the growth prospects of Indian pharmaceutical sector using insights from
research report published by various market & corporate research organizations.
➢ Fundamental analysis of pharma stocks which are underweight and are thus
avenues for investment which are certain.

STOCKS COVERED:

1. BIOCON
2. DISHMAN PHARMACEUTICALS AND CHEMICALS LTD.
3. ORCHID CHEMICALS AND PHARMACEUTICALS LTD.

SCOPE OF THE PROJECT:

Following are the main features of the project:

1. Precise excerpts from the research reports on the pharma sector of India will help
individuals (investors) to understand the scope of huge untapped market (pharma)
in India.
2. Fundamental analysis on the individual stocks will help the investors
➢ To design their portfolio
➢ To get time horizon of investment on each stocks

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CHAPTER 2:

A. Introduction:
Stock market which is considered to be the place for getting high return at the cost of the high
risk. However it is not considered to be the reliable source of income for majority of investors in
India.
Indian stock market is considered as weak form of market where market run on, sentiments and
moves of the big investors and FIIs.
The study focuses on finding the stability of return in pharma sectors and finding of attractive
stocks with potential of giving satisfactory return for long time. About pharma sector there is one
thing unique , i.e it is recession proof or in other words it is less impacted by recession, as
irrespective of whatever may be the income it is by human nature that they will spend on drugs if
they are required or prescribed to do so sometime even at the cost of some other needs.
In this report various pharma stocks are valued using various valuation models to find out its
capability of giving returns in the long run.

B. Objectives of the study:

➢ To find out the growing prospects of pharmaceuticals sector in India.
➢ Finding out pharma stocks which are fundamentally strong for investment purpose by
using various valuation models.

A. Literature Review:
Every asset, financial as well as real, has a value. The key to successfully investing in and
managing these assets lies in understanding not only what the value is but also the sources of the
value. Any asset can be valued, but some assets are easier to value than others and the details of
valuation will vary from case to case. Thus, the valuation of a share of a real estate property will
require different information and follow a different format than the valuation of a publicly traded
stock. What is surprising, however, is not the differences in valuation techniques across assets,
but the degree of similarity in basic principles. There is undeniably uncertainty associated with
valuation. Often that uncertainty comes from the asset being valued, though the valuation model
may add to that uncertainty.
A philosophical basis for valuation
It was Oscar Wilde who described a cynic as one who “knows the price of everything, but the
value of nothing”. He could very well have been describing some equity research analysts and
many investors, a surprising number of whom subscribe to the 'bigger fool' theory of investing,
which argues that the value of an asset is irrelevant as long as there is a 'bigger fool' willing to
buy the asset from them. While this may provide a basis for some profits, it is a dangerous game
to play, since there is no guarantee that such an investor will still be around when the time to sell
comes.
A postulate of sound investing is that an investor does not pay more for an asset than its worth.
This statement may seem logical and obvious, but it is forgotten and rediscovered at some time
in every generation and in every market. There are those who are disingenuous enough to argue
9
that value is in the eyes of the beholder, and that any price can be justified if there are other
investors willing to pay that price. That is patently absurd. Perceptions may be all that matter
when the asset is a painting or a sculpture, but investors do not (and should not) buy most assets
for aesthetic or emotional reasons.
Financial assets are acquired for the cashflows expected on them. Consequently, perceptions of
value have to be backed up by reality, which implies that the price paid for any asset should
reflect the cashflows that it is expected to generate. The models of valuation described in this
book attempt to relate value to the level and expected growth in these cashflows.
There are many areas in valuation where there is room for disagreement, including how to
estimate true value and how long it will take for prices to adjust to true value. But there is one
point on which there can be no disagreement. Asset prices cannot be justified by merely using
the argument that there will be other investors around willing to pay a higher price in the future.
The extract from Mr. Buffett's letter to stockholders in Berkshire Hathaway for
1993 reveals-
The philosophy of a franchise buyer is best expressed by an investor who has been
very successful at it – Warren Buffet
"We try to stick to businesses we believe we understand," Mr. Buffett writes3. "That means they
must be relatively simple and stable in character. If a business is complex and subject to constant
change, we're not smart enough to predict future cash flows.
Apart from all this invest policy by Charles D.Ellis(Homewood,IL:Dow Jones-Irwin,1985)
Peter Fortune also developed a study on, “A Assesment of Financial Market Volatility:
Bills,Stocks and Bonds’ give some insights in finding the volatility of the stocks in regard to
market movements.

B. Methodology Used:

Approaches to
Liquidation
Market
Income
Asset
Capitalizati
Discount
Comparable
Adjusted
Approach
on
ed
Company
Book
Value
Method
Cash
Value
Method
Method
Valuation
Flow

10
Flow diagram above show various approaches to valuation. In my study I have used
usedcombinatrion of market approach and relative valuation approach using earning multiples
like PE multiple, EV/EBIDTA multiple.

Basis for Relative Valuation

In relative valuation, the value of an asset is derived from the pricing of 'comparable' assets,
standardized using a common variable such as earnings, cashflows, book value or revenues. One
illustration of this approach is the use of an industry-average price-earnings ratio to value a firm.
This assumes that the other firms in the industry are comparable to the firm being valued and that
the market, on average, prices these firms correctly. Another multiple in wide use is the price to
book value ratio, with firms selling at a discount on book value, relative to comparable firms,
being considered undervalued.
The multiple of price to sales is also used to value firms, with the average price-sales ratios of
firms with similar characteristics being used for comparison. While these three multiples are
among the most widely used, there are others that also play a role in estimated. 10 analysis - price
to cashflows, price to dividends and market value to replacement value (Tobin's Q), to name a
few.

Underpinnings of Relative Valuation

Unlike discounted cash flow valuation, which we described as a search for intrinsic value, we are
much more reliant on the market when we use relative valuation. In other words, we assume that
the market is correct in the way it prices stocks, on average, but that it makes errors on the
pricing of individual stocks. We also assume that a comparison of multiples will allow us to
identify these errors, and that these errors will be corrected over time.
The assumption that markets correct their mistakes over time is common to both discounted cash
flow and relative valuation, but those who use multiples and comparables to pick stocks argue,
with some basis, that errors made by mistakes in pricing individual stocks in a sector are more
11
noticeable and more likely to be corrected quickly. For instance, they would argue that a
software firm that trades at a price earnings ratio of 10, when the rest of the sector trades at 25
times earnings, is clearly under valued and that the correction towards the sector average should
occur sooner rather than latter. Proponents of discounted cash flow valuation would counter that
this is small consolation if the entire sector is over priced by 50%.

Categorizing Relative Valuation Models

Analysts and investors are endlessly inventive when it comes to using relative valuation. Some
compare multiples across companies, while others compare the multiple of a company to the
multiples it used to trade in the past. While most relative valuations are based upon comparables,
there are some relative valuations that are based upon fundamentals.

I. Fundamentals versus Comparables

In discounted cash flow valuation, the value of a firm is determined by its expected cash flows.
Other things remaining equal, higher cash flows, lower risk and higher growth should yield
higher value. Some analysts who use multiples go back to these discounted cash flow models to
extract multiples. Other analysts compare multiples 11 across firms or time, and make explicit or
implicit assumptions about how firms are similar or vary on fundamentals.

1. Using Fundamentals
The first approach relates multiples to fundamentals about the firm being valued – growth rates
in earnings and cashflows, payout ratios and risk. This approach to estimating multiples is
equivalent to using discounted cashflow models, requiring the same information and yielding the
same results. Its primary advantage is to show the relationship between multiples and firm
characteristics, and allows us to explore how multiples change as these characteristics change.
For instance, what will be the effect of changing profit margins on the price/sales ratio? What
will happen to price-earnings ratios as growth rates decrease? What is the relationship between
price-book value ratios and return on equity?

2. Using Comparables
The more common approach to using multiples is to compare how a firm is valued with how
similar firms are priced by the market, or in some cases, with how the firm was valued in prior
periods. As we will see in the later chapters, finding similar and comparable firms is often a
challenge and we have to often accept firms that are different from the firm being valued on one
dimension or the other. When this is the case, we have to either explicitly or implicitly control
for differences across firms on growth, risk and cash flow measures. In practice, controlling for
these variables can range from the naïve (using industry averages) to the sophisticated
(multivariate regression models where the relevant variables are identified and we control for
differences.).

Definitions of PE ratio
The price earnings ratio is the ratio of the market price per share to the earnings
per share.
PE = Market Price Per Share/Earnings per share

12
The PE ratio is consistently defined, with the numerator being the value of equity per share and
the denominator measuring earnings per share, both of which is a measure of equity earnings.
The biggest problem with PE ratios is the variations on earnings per share used in computing the
multiple. In Chapter 17, we saw that PE ratios could be computed using current earnings per
share, trailing earnings per share, forward earnings per share, fully diluted earnings per share and
primary earnings per share.
Especially with high growth firms, the PE ratio can be very different depending
upon which measure of earnings per share is used. This can be explained by two factors.
➢ The high growth in earnings per share at these firms: Forward earnings per share can
be substantially higher (or lower) than trailing earnings per share, which, in turn, can
be significantly different from current earnings per share.
➢ Management Options: Since high growth firms tend to have far more employee
options outstanding, relative to the number of shares, the differences between diluted
and primary earnings per share tend to be large.
When the PE ratios of firms are compared, it is difficult to ensure that the earnings per
share are uniformly estimated across the firms for the following reasons.
Firms often grow by acquiring other firms and they do not account for with
acquisitions the same way. Some do only stock-based acquisitions and use only
pooling, others use a mixture of pooling and purchase accounting, still others use
purchase accounting and write of all or a portion of the goodwill as in-process R&D.
These different approaches lead to different measures of earnings per share and
different PE ratios.
Using diluted earnings per share in estimating PE ratios might bring the shares that are
covered by management options into the multiple, but they treat options that are
deep in-the-money or only slightly in-the-money as equivalent.
➢ Firm often have discretion in whether they expense or capitalize items, at least for
reporting purposes. The expensing of a capital expense gives firms a way of shifting
earnings from period to period and penalizes those firms that are reinvesting more.
For instance, technology firms that account for acquisitions with pooling and do not
invest in R&D can have much lower PE ratios than technology firms that use purchase
accounting in acquisitions and invest substantial amounts in R&D.

13
CHAPTER 3 :Excerpts from the research report
Booming Sales India is gaining in importance as a manufacturer of pharmaceuticals. Between
1996 and 2006, nominal sales of pharmaceuticals were up 9% per annum and thus expanded
much faster than the global pharmaceutical market as a whole (+7% p.a.). Demand in India is
growing markedly due to rising population figures, the increasing number of old people and the
development of incomes. As a production location, the country is benefiting from its wage cost
advantages over western competitors also when it comes to producing medicines.

India Has Discovered The World market: Since the end of the 1980s India has been exporting
more pharmaceuticals than it imports. Over the last ten years the export surplus has widened
from EUR 370 m to EUR 2 bn. At 32% in 2006, the export ratio was about twice as high as in
1996 and will likely rise further in the coming years (Germany: 55% at present).

New patent law necessitated reorientation Legal changes in India in 2005 made it
considerably more difficult to produce “new” generics. Foreign pharmaceuticals, which enjoy 20
years of patent protection, can no longer be copied by means of alternative production
procedures and sold in the domestic market.
Hence, a reorientation was required in India’s pharmaceutical industry. It now focuses on drugs
developed in-house and contract research or contract production for western drug makers.

Considerable impact of hampering factor The sector’s development is slowed by major

infrastructure problems. These are, above all, qualitative and quantitative shortcomings in the
energy and transport sectors.

14
Strong growth continues Up until 2015, we expect pharmaceutical sales to rise by 8% p.a. to
just under EUR 20 bn, compared with an increase of 6% in the world as a whole and 5% in
Germany. But even then, India’s share in the world pharmaceutical market would only come to
slightly over 2% (Germany: 7%). In Asia, India looks set to lose market share, as other Asian
countries are registering even stronger growth.

India's pharmaceutical industry in the spotlight

In 2001, India’s pharmaceutical industry became the focus of public debate when Cipla, the
country's second-largest pharmaceuticals company, offered an AIDS drug to African countries
for the price of
USD 300, while the same preparation cost USD 12,000 in the US. This was possible because the
Indian company produced an all-inone generic pill which contains all three substances required
in the treatment of AIDS. This kind of production is much more difficult in other countries as the
patents are held by three different companies. In the final analysis, the price slump was a result
of India's lax patent legislation. In 2005, patent legislation was tightened, so India’s
pharmaceutical sector had to adjust.

1. Development of India’s pharmaceutical industry

Up until the 1970s India’s pharmaceuticals market was mainly supplied by large international
corporations. Only cheap bulk drugs were produced domestically by state-owned companies
founded in
the 1950s and 60s with the help of the World Health Organisation (WHO). These state-run firms
provided the foundation for the sector’s growth since the 1970s. Back then, India’s government
aimed to reduce the country’s strong dependence on pharmaceutical imports by flexible patent
legislation and to create a selfreliant sector. In addition, it introduced high tariffs and limits on

15
imported medicines and demanded that foreign pharmaceutical companies reduce their shares in
their Indian subsidiaries to twofifths. This made India a less attractive location for international
companies, many of which left the country as a consequence. Especially India Drugs and
Pharmaceutical Ltd. (IDPL) is credited with speeding up the development of a national
pharmaceutical industry. Several IDPL staff have successfully founded their own firms, which
now belong to the top group among India’s pharmaceutical companies. In the 1980s, however,
the decline of state-run companies began − among other things because of increasing
central government bureaucracy and insufficient corporate governance. Today, there are no
(entirely) state-owned pharmaceutical companies left.
By contrast, the weakening of the patent system and numerous protectionist measures sped up
the development of a major national pharmaceutical industry on a private-sector basis, which
made it possible to provide the population with a large number of drugs.

Large market share for generic drugs

As there was no efficient patent protection between 1970 and 2005, many Indian drug producers
copied expensive original preparations by foreign firms and produced these generics by means of
alternative
production procedures. This proved more cost-efficient than the expensive development of
original preparations as no funds were required for research, which contained the financial risks.
This spending block may come to as much as EUR 600 m for only one drug. This kind of money
could previously only be raised by large corporations in the industrial countries. The
competitiveness of generics producers is based on cost-efficient production. In this field, Indian
companies are currently in top position. At one-fifth, India’s share in the global market for
generic drugs is considerably higher than its share in the overall pharmaceuticals market (approx.
2%). At the same time, India’s pharmaceutical companies gained know-how in the manufacture
of generic drugs. Hence the name “pharmacy of the poor” which is frequently applied to India.
This is of significance not least for the domestic market as disposable income is as little as EUR
1,900 per year for roughly 140 million of the total of 192 million Indian households1, which
means the majority of Indians cannot afford expensive western preparations.

Current situation
India’s pharmaceutical industry has been in transition for several years now. This is the result
mainly of the changes to drug patent legislation in 2005. Prior to the Patent Amendment Bill, not
the substance itself but merely the manufacturing process was protected for a period of seven
years. India’s patent legislation had frequently been the reason for legal disputes with large
western drug firms, especially from the US. In line with international standards, the sector is now
subject to product and process patents valid for a period of 20 years. Indian companies seeking to
copy drugs before the patent expires are forced to pay high licence fees. This became necessary
following the signing by India's government of the TRIPS Agreement (Agreement on Trade-
Related Aspects of Intellectual Property Rights). So Indian drug firms could no longer simply
copy medicines with foreign patents by using alternative manufacturing processes and offer them
on the domestic market.

16
As a consequence of these major changes to India’s drug patent legislation, the country’s
pharmaceutical industry is undergoing a process of re-orientation. Its new focus is increasingly
on self developed drugs and contract research and/or production for western drug companies.

Disproportionately high sales growth

Between 1996 and 2006, nominal sales of pharmaceuticals on the Indian subcontinent were up
9% per annum and thus expanded much faster than the global pharmaceutical market as a whole
(+7% p.a.). Indian companies strongly expanded their capacities, making the country by and
large self-sufficient. Nonetheless, with total sector sales of roughly EUR 10 bn, India commands
a less than 2% share in the world’s pharmaceutical market (1966: 1.5%). This puts the country in
twelfth place internationally, even behind Korea, Spain and Ireland and before Brazil, Belgium
and Mexico. Among the Asian countries, India’s pharmaceuticals industry ranks fourth at 8%,
but has lost market share to China, as sales growth there was nearly twice as high and sales
volumes nearly four times higher than
in India.

17
India’s pharmaceutical industry currently comprises about 20,000 licensed companies employing
approx. 500,000 staff. Besides many very small firms these also include internationally well-
known companies such as Ranbaxy, Cipla or Dr. Reddy’s. With sales of roughly EUR 1 bn,
Ranbaxy is currently the world’s seventh largest generics manufacturer.
Currently the most important segment on the domestic market is anti-infectives; they account for
one-quarter of total turnover. Next in line, and accounting for one-tenth each, are cardio-vascular
preparations, cold remedies and pain-killers. By contrast, medicines against civilisation diseases
(such as diabetes, asthma and obesity) or so-called lifestyle drugs (anti-depressants, drugs to help
smokers
to quit and anti-wrinkle formulations) are of little significance at present. All in all, the Indian
pharma industry produces about 70,000 different drugs, which is higher than the number
produced in
Germany (60,000).

How does this compare with China and western industrial countries?
Despite its high turnover growth rates, India cannot match the sales achieved by its two major
competitors in ex-Japan Asia, China and Korea. With sales to the tune of EUR 36 bn or four
times as much as India’s, China is clearly the leader in the pharmaceuticals market. Korea, too,
outstrips India, with pharma sales amounting to EUR 14 bn. High growth rates are also being
registered in the pharmaceuticals markets of Singapore, Malaysia, Thailand and Indonesia. To be
sure, sales in these countries are relatively low at EUR 1-7 bn. Compared with the large
industrial countries, India’s pharmaceutical industry is still relatively unimportant – despite its
high growth rates. In the US, pharma sales are fourteen times higher, in Japan five times and in
Germany four times. The gap with India is even more obvious when comparing per-capita sales.
In the western industrial countries, per-capita sales of pharmaceuticals amount to a good EUR
400 per year, this is forty times higher than in India.

Pharmaceuticals one of the export-driven sectors

In 2006, India’s pharma industry exported products worth EUR 3 bn, up from only EUR 650 m
in 1996, which was due to the fact that demand for low-cost generic drugs is strongly on the rise,
above all in the US, Europe and Japan. At 22%, export growth in 2006 was even twice as high as
the global average and in Germany (roughly 11% each). Meanwhile, India’s export ratio has
reached 32% – about double the figure registered ten years ago. For some time now, India has
exported more pharmaceutical products than it imports. Over the last ten years, the export
surplus has risen from about EUR 370 m to currently just under EUR 2 bn. Slightly over 80% of
the drugs are sold to the US and Europe, where India’s companies are benefiting from the
population’s purchasing power as well as regulatory changes (greater cost-consciousness).
By contrast, traditional sales markets such as Russia, Southeast Asia, Africa and Latin America
have lost in importance. However, only 60 production locations of India’s pharma sector have
been certified by the World Health Organisation, which implies they comply with the strict
quality standards imposed by the US Food and Drug Administration (FDA). Compliance with
FDA standards is the precondition for selling products on the important US market.

18
2. Medium-term outlook
High GDP growth rates, rising population numbers and, as a result, a growing middle class are
the drivers of India's pharmaceutical market.

Boost from population growth

India’s pharma sector is receiving a major boost from population growth. According to UN
estimates, the population total looks set to rise from 1.1 bn at present to 1.4 bn in 2020. Up until
2020 India will see as many children being born as there are people living in Germany, France,
the UK and Italy together. By 2025, India will probably have overtaken China as the world's
most populous country. Its population growth results not least from higher life expectancy. This
is attributable, among other things, to improved
preventive healthcare. Of course, though, average life expectancy in India is still markedly lower
than in western countries. While the figure is 64 years for men and 66 years for women in India,
life expectancy in Germany is 76 years for men and 82 years for women.

The ageing of the population in India offers considerable market opportunities. According to a
UN estimate, the share of people over the age of 65 in the total population will rise from 5%
currently to 8%
in 2025. This would mean roughly 55 million more people aged 65 and over than today. As a
result, typical age-related illnesses such as cancer and cardio-vascular diseases will be more
wide-spread.

19
The pharmaceutical sector will also receive a boost from the gradual spreading of civilisation
diseases such as obesity and diabetes.
According to PricewaterhouseCoopers (PwC), the number of Indians with diabetes will reach
approx. 74 m in 2025 (currently 34 m); this is roughly the population of Turkey today. In the
developing countries as a whole, there could be just under 230 m diabetes patients. This
development should benefit India’s generics manufacturers.

Support from rising household incomes

For the next 15 years we expect average annual growth in India of 6-7%.2 Strong income growth
will broaden the middle class, an important group for foreign drugs manufacturers, as it has
considerably
higher incomes at its disposal than average Indians.

Already today, nearly 60 m people in India’s middle class, with disposable incomes of EUR
3,500 to EUR 17,000 p.a., can afford western-produced medicines. Until 2025 their number
looks set to rise to approx. 580 m (+12% p.a.), according to McKinsey estimates. Over a space of
ten years, a four-member middle-class family has seen spending on pharmaceuticals grow five
times over, to approx. EUR 170 p.a. People’s improved income situation has also led to a
growing desire to insure against illness. At this juncture, only 4% of all Indians have health
insurance, but this share should rise strongly over the medium term. This will have a positive
impact on the demand for drugs as people with health insurance are usually more likely to obtain
prescriptions than those without cover.

Globalisation has not caused traditional medicine to be abandoned but with higher education,
rising income and a change in lifestyle, western medical treatment is gaining in importance. At
present the
population especially in rural areas still sees western medicine as a stop-gap cure which is
unlikely, though, to provide a lasting solution to health problems. Today, about 70% of the
population on the
Indian subcontinent depend entirely or at least in part on traditional Indian medicine which is
cheaper and more easily available than western drugs.

20
Changes in drug patent law lead to development of “original” drugs
Since 2005 India’s pharma sector has no longer been protected by the country’s lax patent
legislation. Hence innovation must come before imitation now. Large manufacturers already
began to adjust their business models some time ago and put greater emphasis on drugs research.
On a long-term horizon, they do not want to limit themselves to the production of low-cost
generics. Even though a number of companies are well positioned in the generics market, many
of them are seeking to turn into research-based firms.

However, they are facing fierce international competition in this segment. So it will take many
years for India to become a serious competitor for western pharmaceuticals companies in the
field of patent-protected drugs. According to the company’s own information, approx. 40% of
turnover at drugs manufacturer Ranbaxy stems from drugs developed in-house, which would still
be about one-tenth lower than at similarly large western companies. In order to increase the
speed of development and share the financial risk, there are likely to be more strategic alliances
between Indian and foreign companies.

India’s leading pharmaceutical companies are currently spending nearly one-tenth of their
revenues on research and development. At the large western companies, however, R&D
expenditure comes to 20%. Already in 1994, Dr. Reddy’s launched a basic research programme
and was followed by Ranbaxy and Wockhardt in 1997. Last year, as many as twelve companies
engaged in research for new pharmaceutical substances. The focus here is on drugs against
malaria and AIDS, as demand potential in these segments is particularly high. Malaria is the
21
most common tropical disease, with about 300 m to 500 m new infections per year, according to
the WHO. The number of people infected with HIV adds up to about 40 million worldwide.

However, compared with the large international players, the volume of research at Indian
pharmaceutical companies – especially basic research – is still very small. Average R&D
spending of Indian pharmaceutical companies comes to just under 4% of total turnover,
compared with 9% in Germany. However, one must bear in mind the different sizes of the
pharmaceutical industries in the two countries.
In this context, Indian companies are likely to benefit from the liberalisation process on the
domestic capital market, which began at the start of the 1990s and is not yet completed. The
loosening of financial market regulations has until recently led to an increasing presence of
foreign investors, with interest focussing mostly on the equity market. Since the beginning of the
1990s, Indian companies may also be listed on foreign stock exchanges.

High level of education benefits pharma sector

The fact that despite the low level of unit labour costs India boasts a highly skilled workforce has
enabled the country's pharmaceutical industry at a relatively early stage to offer quality products
at competitive prices. Each year, roughly 115,000 chemists graduate from Indian universities
with a master’s degree and roughly 12,000 with a PhD.4 The corresponding figures for Germany
– just under 3,000 and 1,500, respectively – are considerably lower. After many chemists from

22
India migrated to foreign countries over the last few years, they now consider their chances of
employment in India to have improved. As a result, a smaller number is expected to go abroad in
the coming years; some may even return.

Competitive advantages over traditional manufacturers

Irrespective of the disadvantages in some areas, India's pharmaceutical companies make use of
their competitive advantages over traditional drugs manufacturers in western industrial countries.
Wage costs in the Indian drugs industry come to only about 30% of the European level or 20%
of the US level. Overall drugs manufacturing in India is up to 50% cheaper than in western
industrial countries.
For international pharmaceutical firms, India is attractive as a location for research primarily
because of its low development costs. Clinical tests may be conducted more easily and often
even yield more precise results. Thanks to higher population numbers, there are considerably
more suitable persons to be found who can take part in tests than in the west. Approval for drugs
to go on the market will only be granted if they have passed several tests on humans. In order to
achieve this, companies usually need several thousand persons per drug. This means that roughly
100,000 volunteers must be subjected to initial examinations. In many cases, clinical tests by
drug manufacturers in the west failed because their test persons had already taken a number of
other medicines so the effect of the new drug could not be proven. Moreover, roughly 40 to 70%

23
of all drug trial persons will fail to complete the test phase. By contrast, 90% of all probands in
India complete the tests, not least because they seek to improve their income situation by
participating. This could cause a problem if ethical aspects gain in importance; in light of the
relatively high financial incentive, participants pay too little attention to potential side effects.
However, it is not altogether easy for western firms to relocate their clinical tests to emerging
markets. In many cases, local hospitals must make large-scale investments and train their staff.
Despite these difficulties several large international companies have chosen India as their
location for clinical tests. Eli Lilly, the US pharmaceutical company, currently has several
projects in India, and Pfizer (US) is carrying out clinical tests for malaria drugs there. The
market for contract research in India could reach a volume of nearly EUR 2 bn by 2010, up from
EUR 600 m in 2006. All in all, the global market volume for contract research is likely to rise
from EUR 8 bn recently to EUR 20 bn by 2020.
So the formerly distant relationship between Indian and international companies is beginning to
turn increasingly towards cooperation. A case in point is the Contract Research Agreement
between an Indian and a British company, which lays down a limited number of previously
agreed steps to develop a new drug in laboratories in India.

Manufacture for foreign pharmaceutical groups more important

Indian companies also see profitable business opportunities in contract production for
international pharma groups. There are sufficient production capacities available following the
massive expansion of plants for generics manufacture. Already today, Ranbaxy for instance
produces drugs for Germany’s Hexal and Ratiopharm. According to an analysis by IBEF (India
Brand Equity Foundation), total contract production worldwide has a volume of approx. EUR 25
bn, which looks set to rise further to EUR 40 bn by 2010. Growth is driven mainly by the
relocation of production for preparations whose patent protection will expire soon. Building a
pharmaceutical plant in India is about 40% cheaper than in Europe or the US, and manufacturing
costs for pharmaceuticals are markedly lower. This cost advantage provides a strong incentive to
move production also for western firms.
Given the improvements in patent law and capital protection, the Indian market has become
attractive again for western drugs manufacturers. Add to this the relatively low wage costs,
employees’ good qualifications and expectations of strong growth in the market. According to
the German-Indian Chamber of Commerce, twenty German drugs companies have already
started operations in India.

Indian pharmaceutical companies increasing investment abroad

In the coming years, Indian drug makers will likely continue to look to foreign countries to
expand their operations. An example for the global orientation of Indian pharmaceutical
companies is Ranbaxy.
Currently, Ranbaxy exports its products to 125 countries, has subsidiaries in nearly 50 countries
and production plants in more than 10 countries. The US has become its most important sales
market. Sales to the US recently amounted to just under 30% of Ranbaxy’s total sales, while
sales to Europe came to nearly 20%. Overall, approx. 80% of the manufacturer’s total sales are
generated abroad. According to PwC, about half of all larger Indian drug makers are looking to
expand abroad through take-overs, whereas less than 20% of their Chinese competitors pursue

24
that strategy. Targeted markets are still the US and Europe. In many cases, there are institutional
obstacles to overcome first. More often than not, Indian medicines fail because doctors and
pharmacists in other countries are reluctant to prescribe or hand out drugs produced in India.
There is a tendency to favour locally/nationally produced drugs. For this reason, drug companies
from India are finding it hard to gain a foothold in western markets.
Over the past few years, for instance, Ranbaxy has bought companies in Romania, Belgium,
Italy and France, and intends to become the world’s fifth largest manufacturer of generics by
2012. Wockhardt is operating in Germany and the UK, as is Cadila in France. At the beginning
of 2006, Dr. Reddy’s bought Betapharm, a German generics manufacturer, for almost EUR 500
m.
The German market is particularly attractive for Indian companies as generics prices there are
relatively high by international standards. Compared with the UK, a generic drug costs nearly
50% more in Germany. So it cannot come as a surprise that Indian producers are loath to leave
the lucrative German market to the large German generics companies such as Ratiopharm, Hexal
and Stand-alone.

Factors weighing on the pharmaceuticals industry

Besides the positive outlook for India’s drugs industry, there are also a number of adverse
factors. These include, above all, serious shortcomings in infrastructure.
Compared with western industrial nations, energy prices are low but companies must expect
repeated power cuts and offset fluctuations in the electricity network with the help of emergency
power generators. In many areas, the hot and humid climate makes high demands on climate
technology at production plants and on the refrigeration of finished products. Insufficient energy
supply also leads to a situation where production hours must be handled very flexibly. This
shortage can only be eliminated in the medium term and will require maximum effort. However,
India’s government intends to expand power generation capacities to roughly 240 GW by the
end of the 11th five-year plan in 2012. This would mean a more than 100 GW, or nearly 90%,
increase on today's total. Moreover, the country’s lacking transport infrastructure is increasingly
turning into a major obstacle. The pharmaceuticals industry is especially dependent on road
transport. However, the major transport links are chronically congested and many are in a poor
state of repair. Of the total road network covering just over 3.3 million kilometres, only about
6% are relatively well built National and State Highways. In many cases, there are no paved
surfaces or there is only one lane for all traffic. But the government has launched an extensive
investment programme entitled the National Highway Development Programme, to be
implemented by the middle of the next decade.

25
Outlook for India’s pharmaceutical industry up to 2015
All in all we expect India to see drugs sales rise by an annual 8% to nearly EUR 20 bn between
2006 and 2015. To be sure, this growth rate is higher than that seen for Germany (+5% p.a.) and
the entirevworld (+6%). Nonetheless, India’s share in world pharmaceutical sales will rise only
marginally to a good 2%.
Growth of India’s pharmaceutical industry and thus its share in global drugs manufacturing
could even be slightly higher if the infrastructure problems could be remedied quickly. While the
pharmaceutical industries of China and Singapore will likely continue to show much higher
growth, India looks set to even lose market share in Asia. Mainly affected by this development
are smaller Indian companies with sales of up to EUR 10 m which focus on traditional Indian
medicines. It is likely that many of these companies will merge or disappear from the market
altogether. By contrast, large pharmaceutical companies with sales volumes of over EUR 50 m
will be able to increase their sales as they will be better equipped to adjust their product ranges to
the demands of international markets. These firms will expand their capacities in India – mostly
in the sector’s clusters surrounding Delhi and Mumbai – but will also take over firms in the
industrial countries. Medium-sized businesses will benefit from increasing contract production
for western firms. All in all, the share of pharmaceuticals in the total chemicals industry in India
will come to roughly 17% in 2015 (2006: 18%), compared with 28% in Germany (from 24% in
2006). For the world as a whole, the ratio will likely be only slightly lower than the German
level
(25%).
Although India’s pharmaceutical sector is growing strongly, the population’s demand for drugs
cannot be met by the country’s own production in all segments. At EUR 1.5 bn, India’s total

26
drugs imports are comparable in size to Norway’s entire pharmaceuticals market. Imports look
set to continue to rise strongly.
On a medium-term horizon, one-fifth of the world’s pharma sales will be accounted for by the
emerging markets. China will then be among the group of the five largest manufacturers, while
India will join the group of the ten largest suppliers.

High export growth of Indian drugs makers

In the course of increasing contract production and low-cost manufacture of proprietary
medicines, exports are expected to receive a major boost in future. However, Germany's very
high export ratio of currently 55% will hardly be achieved by 2015, as this would imply more
than a trebling of total exports. In this context, it should be considered that take-overs of foreign
companies will lead to a strong increase in foreign production by Indian manufacturers, which
will have a dampening effect on exports. A positive impact on exports is expected from foreign
investment in India, though.
Competition between Indian firms and western drug makers will probably be much fiercer as the
companies from Asia are increasingly seeking to tap the global markets. The generics market
will grow in
both the developed countries and in the emerging markets. Most vital medicines are already
exempt from patent protection today.
The manufacture of generic drugs in that segment is growing strongly. In addition, patents for
high-turnover drugs with a volume of EUR 100 bn will expire in the next few years. Of these
drugs, roughly one-third will likely be produced by Indian companies.

27
India's pharmaceutical industry in reorientation process
The pharmaceutical industry is expanding worldwide. For some years now, it has been benefiting
from the particular dynamics of the Asian economies as both purchasers and producers. It is not
only
the markets in China and India that register high growth rates. Annual growth rates are also
impressive in Singapore, Malaysia, Thailand and Indonesia.
Thanks to low costs, qualified staff and extensive production and research units India is
becoming more and more of a major pharmaceutical location. Drivers of growth are the growing
population, which at 1.5 bn should exceed that of China already in 2025, as well as the larger
number of older people with markedly higher demand for medicines. Add to this the increase in
middle-class households which have considerably higher incomes at their disposal than the
population on average.
As a result of the new patent legislation, the country’s pharmaceutical industry is reorienting
itself and focussing on self-developed medicines and/or contract research and production for
western drugs companies. Also the expansion of Indian firms abroad looks set to continue –
preferred target markets are the US and European countries.
Despite the positive outlook India will lose market share in the Asian market in future. The
winner, first and foremost, will be China, which will remain the No 1 thanks to its expected
higher sales growth and
volume, as Indian companies' strategic reorientation away from generics to original preparation
is still in its infancy. The sooner India manages to close the infrastructure gap, the higher growth
will be in the country’s pharmaceutical industry.

Finding investment avenues for this sectors: Criteria

While choosing stocks in this segment investors should look at following in the companies for
investment:
➢ No. of approvals like FDA, ASSOCHAM etc.
➢ No. of patents hold by the companies.
➢ No. of generic v/s OTCs.
➢ No. of DMF holdings.
➢ Prudence of Board of Directors of the company.

For a long time large sized pharma stocks were popularly picked by the investors because of the
very reason that they were capable of conducting complex reactions and research and thus were
having monopoly in the market for quite sometime.
But with the opening of the economy, more and more companies started entering into this
segment which constitutes both domestic as well as foreign players.

28
CHAPTER 4: FUNDAMENTAL ANALYSIS OF STOCK #1

29
Status: Underweight
Call : Buy
Target Price: 350
Time Horizon: 12 to 18 Months

COMPANY BACKGROUND
Biocon was incorporated in 1978 to manufacture select enzymes for the breweries industry.
In 1999, the company began its transformation to an innovation-led biopharmaceuticals
company.

The evolution …

30
In 1978, Biocon was promoted as a 70:30 joint venture (JV) between Indian promoters (70%
stake) and an Ireland-based Biocon Biochemicals (30% stake) to manufacture and export few
enzymes for breweries. In 1995, Unilever acquired Biocon Biochemical’s stake in the JV and
merged with Quest,
Unilever’s Food & Breweries subsidiary. Biocon was to supply enzymes to Quest of
international standards. This led Biocon to invest heavily in creating world-class fermentation
assets, which it exploited later to make a foray in the fermentation-based pharmaceutical
products. In 1999, Unilever sold Quest to ICI. As Quest had 23% stake in Biocon, this was also
up for transfer. At this point in time, Indian promoters used their first right of refusal and bought
Quest’s 23% stake, which led to a 100% holding of
the Indian promoters in the company.

…the transformation
Post acquisition, the company moved from enzymes to fermentation-based pharmaceutical (Bio-
pharma) products, which has now become the mainstay of Biocon. Biopharmaceutical business
took off with identification and production of APIs (active pharmaceutical ingredients), which
required advanced fermentation and had significant market potential in the regulated markets.
The company started with statins and evolved as a significant player in statins API globally
including regulated markets. Simultaneously, the company also started contract and clinical
research services. Looking at the significant pricing pressure on statins during 2004-05, the
company diversified to other products including insulin, immunosuppressant and bio-similars
and launched Insugen, its brand of recombinant human insulin for diabetes in the Indian market.
In a major breakthrough, under partnership with CIMAB, Cuba, the company launched a novel
cancer drug, Biomab EGFR in September 2006. In 2006, the company bought the assets of
Nobex IP, which boosted its patent assets greatly.

Current status
Biocon is now focused on its biopharma verticals that include APIs, biologicals and proprietary
molecules both commercialized and under development. Currently, the company is a fully
vertically-integrated biotech company with innovative research to commercialization. The
interesting part is that Biocon has worked for each level of drug life cycle. While Biocon houses
the biopharmaceutical manufacturing, its 100% subsidiary, Syngene, provides contract research
for the molecules in pre-clinical stage and Clinigene, another 100% subsidiary, provides clinical
research for the molecules aspiring to get commercialized. Its 51:49 JV with CIMAB, Cuba
provides manufacturing services for the Biomab EGFR to Biocon.

Exhibit: Biocon’s Business Model

31
Source: Companay

Exhibit: Biocon’s Corporate Structure

Source: Company

32
Exhibit: Biocon’s fully integrated business model

Source: Company

Manufacturing capabilities
In 2006, the company established Biocon Park, India’s largest integrated biotech hub spread over
a 90 acre of land, in a SEZ (special economic zone). The company has built additional capacity
by commissioning the multiproduct microbial fermentation and synthetic conversion facilities at
Biocon Park. These facilities were inspected and approved by the US FDA.

33
34
35
INVESTMENT RATIONALE
Biocon is emerging as a biopharmaceutical major in India with a strong focus on innovation in
niche areas of oncology, diabetes, cardiovascular. The commercialization of discovery-led
Biomab EGFR for head and neck cancer and strong focus on discovery-led biotechnology assets
such as noninjectable
oral) insulin differentiate it from its Indian peers. The business model based on discovery focus
entails higher risk and long gestation, however the revenue generation and margins are
phenomenal. Moreover, Biocon is moving up the value chain to include formulations in its
product basket. Increasing proportion of formulations in the product mix and increased revenue
flow on account of licensing in coming years makes us optimistic.

Big triggers: Barely 12-24 months away

Biocon could generate windfall gains in next 12-24 months through the outlicensing of its
innovative oral insulin. Further, in a bid to unlock value, it plans to list its contract
research arm, Syngene, in the next 12- 15 months.
These events are expected to trigger a re-rating on the counter.

I) Windfall gains from out-licensing of oral insulin

Biocon is working on a non-injectable oral insulin, which has a potential to become a
blockbuster drug. According to estimates, the potential market size of oral insulin is US$1-3
billion. The company plans to out-license oral insulin to other companies for further
investigation and commercialization in certain geographies in return for a fee and royalty on
commercialization after the proof-of-concept phase of clinical trials (phase II clinical trial). The
molecule is entering phase II trials now, which may take 15 to 24 months. Biocon may generate
windfall revenues through this out-licensing. We have assumed the deal size to be between
US$100 to 300 million with upfront payment in the range of 10 % to 25% and have worked out
the EPS sensitivity (Exhibit 6). The out-licensing deal may happen any time either during FY09E
or FY10E. We have constructed two matrices, one for FY09E EPS sensitivity, and the second for
FY10E EPS

36
If the out-licensing deal happens in FY10E, the upfront payment would impact the FY10E EPS
as follows.

II) Value unlocking through listing of CRO business

In order to unlock value, Biocon plans to list its contract research business in coming 12 to 15
months. We believe that the contract research business of Biocon would command better
valuations after the imminent IPO (initial public offer) of TCG Lifesciences. TCG Lifesciences
has filed draft red herring
prospectus with SEBI in October 2007 and it is expected the IPO to come in next few months.
The listing could act as a benchmark valuation for the CRO business of Biocon. I expect a 29%
CAGR in top line of Biocon’s CRO business over FY07-10E to Rs 308 crore, while net profit
would witness a 33% CAGR to Rs 106.10 crore. We expect a handsome ramp up in Syngene
operations on the back of Bristol Myers Squibb (BMS) deal and turnaround in the operations of
Clinigene.

37
 Valued the business at 20X FY10 EPS

GROWTH ENGINE ON A ROLL – BIOPHARMACEUTICALS

Strong discovery pipeline – a goldmine for future

Strong product pipeline-the future growth driver

Biocon has a very rich pipeline of bio generics, which includes both insulin and biosimilar
monoclonal antibodies. We are quite optimistic about the recent Research and Development
progress of Biocon and strongly believe that these products having good market size will
definitely offer them a short, medium, and long term opportunity.
Drug Preclinical Phase-I Phase-II Phase-III On market

PEG-GCSF Oncology

Bmab 100 Oncology

Bmab 200 Oncology

BVX-20 Oncology

IN-105 Diabetes (oral insulin)

T1h Oncology (Inflammation)

BIOMAb EGFR Oncology

Insulin Glargine Diabetes

BIOMAb EGFR (H&N) cancer

Insulin Diabetes

38
 GCSF Oncology

Streptokinase Cardiology

EPO Nephrology/Oncology

Faster growth in formulations revenue

We expect revenue growth in biopharmaceuticals, the largest revenue grosser, to pick up now.
We expect a 16.88% CAGR in biopharmaceutical revenues to Rs 1173.63 crore over FY07-10E
on the back of (I) growth in formulation revenue in the subsequent years of launch, (II) entry into
regulated markets with immunosuppressants after patent expiry, (III) double digit growth in
licensing and royalty income (IV) start of marketing of Abraxane from Q1FY09E and (V)
commissioning of large capacity in the H2FY07. While we expect flat sales growth in statins due
to pricing pressure, other products in the biopharmaceutical space are likely to grow strongly at
26.37% CAGR over FY07-10E.
Formulations revenue are expected to grow at a faster pace vis-à-vis the API revenue as the
formulations would be entering the growth curve after launch. New products such as novel
cancer drug Biomab EGFR (launched in September 2006), immunosuppressants (launched in
March 2007) and GCSF would be entering the second year of launch and are likely to see good
growth. The management has indicated that the formulations contribution to the total
biopharmaceuticals revenue is expected to increase to 35% in next 3-4 years from the current 6%
on the back of the company’s entry into regulated markets and new launches get matured.

Launch of insulin and GCSF in regulated markets: Key growth driver

It is believed that recombinant DNA insulin would become the largest value driver for Biocon
for the next few years. The strategy of the company is to grow via generics (injectable insulin) in
the short to medium-term and launch its patent protected oral insulin in the long run. We expect
the injectable insulin revenue growth to pick up now on launch of the insulin in the Chinese
market by its licensing partner, Bayer, in FY09E. We expect supplies to the Chinese market
would increase the penetration of Biocon to the overall unregulated countries’ market size of
around US$2 billion. We expect supplies to regulated markets to start from FY10E (the drug is
likely to be launched in the US and Canada in FY10 by its licensing partner). FY10E would be a
key insulin revenue-driving year for the company. Moreover, Biocon also signed an agreement
with Invitrogen for supplying its high quality insulin for cell culture on a global basis, which is a
very attractive business.
Biocon launched GCSF in the domestic market in FY08 and out-licensed it to Abrexis for the US
and EU markets. Abrexis is likely to start marketing GCSF in these markets from 2011.

Immunosuppressant: Long-term strategy to enter regulated markets

In our view, the medium to long-term revenue outlook for Biocon from this segment is much
brighter than in the short-term. The company is likely to enter the regulated markets only in the
medium to long term after patents for different immunosuppressants expire, starting from the end

39
of the current calendar year. The company has already filed DMFs for immunosuppressants and
has approvals in place. Immunosuppressant is a fast growing class of nephrology drugs, where
the competition is lower due to complexity in manufacturing. In the domestic market, Biocon is
the largest manufacturer of immunosuppressants. The company is targeting a 25% market share
in the domestic market from immunosuppressants in next five years. The current size of the
domestic markets for Immunosuppressants is estimated at around Rs 125 crore (total market for
nephrology products in India is estimated at Rs 300 crore) which is likely to witness a 26%
CAGR. To capture the growth in the segment, the company launched a division focusing on
nephrology drugs in March 2007 in domestic market.
Immunosuppressants are used in nephrology ailments. We expect the company to achieve the
target market share as Biocon provides competitive quality immunosuppressant products at 35 –
40% cheaper price than the existing drugs in the market.
The global market for nephrology products is estimated at US $3.3 billion. The company is
currently marketing its product in India, the GCC (Gulf Cooperation Council) region and
neighboring countries. The company has plans to enter the regulated markets but that will
happen once the products are off patent. Most of the immunosuppressants are currently on-patent
and are slated to go off patent during 2008-10.

Immunosuppressant and insulin to become largest revenue contributors

Currently, immunosuppressants and insulin contribute around 25% of the biopharmaceutical
revenue. We expect this segment to grow at a CAGR of around 25% over FY07-10E to Rs 400
crore, accounting for around 34% of biopharmaceuticals revenue.

Revenues in immunosuppressant and insulin (Rs Crore)

Monoclonal antibody Biomab EGFR likely to grow at 69%

The monoclonal antibody Biomab EGFR, which is Biocon’s proprietary product, is likely to
grow at a CAGR of 69% over FY07-10E on a lower base. The company launched the product in
September 2006, and in the first year of launch the product generated Rs 20 crore in revenue.
Monoclonal antibody falls under oncology segment. Globally this product has a 30% CAGR. We
are expecting higher sales as the product is in initial years of launch in India and would be
launched in other geographies in neighbouring countries.

40
Exhibit: Biomab EGFR to grow at a 69% CAGR (revenue in Rs crore)

Launching Abraxane in Q1FY09

In July 2007, Biocon signed an in-licensing agreement with Abraxis BioScience, US, for the
commercialization of Abraxane in India, Pakistan, Bangladesh, Sri Lanka, UAE, Saudi Arabia,
Kuwait, and countries in the Gulf. In this in-licensing agreement, Biocon will pay royalties to
Abraxis based on the Abraxane sales. Abraxane is a breast cancer drug and Biocon targets a
market potential of Rs 25 crore from the geographies where the company has marketing license.

Double-digit growth in licensing income

Biocon out-licensed GCSF to Abraxis Bioscience for the US and EU markets. As part of this
deal, Biocon received upfront payments and will receive milestones based on the progress of
product registration in regulated markets. In FY07, the company received Rs 27 crore from out-
licensing of insulin rights for six markets including US. This further validates effectiveness of
Biocon’s strategy to generate significant licensing income through monetization of IP assets. The
management has indicated a similar y-o-y growth in the out-licensing income based on milestone
payments. We expect he out-licensing revenue of Biocon to grow at a CAGR of 23% over FY07-
10E to Rs 51 crore.

Commissioning of new facility

Biocon commissioned its new facility in the Biocon Park, which would lead the revenue to grow
faster. After commissioning of the facility the capacity of Biocon would improve multifold.

CRO business: Fulcrum of growth

We expect the CRO business to contribute around 20% to consolidated revenue in FY10E, but
the bottom-line contribution is likely to be around onethird. The high-margin CRO business is
gradually gathering lot of significance in Biocon’s overall business as top line growth has a
multiplier effect on the bottom line. In CRO operations, the company provides end-to-end
services in drug discovery exercise, from pre-clinical stage to clinical trials. Syngene provides
contract research for the molecules in pre clinical stage and Clinigene provides clinical research
services. The combined top line of Syngene and Clinigene is likely to see a 29% CAGR over
FY07-10E to Rs 308 crore, while the combined bottom line is set to witness a CAGR of 33% to
Rs 106.10 crore through FY10E.

41
Syngene: To contribute around 1/3rd of bottom-line
We believe BMS (Bristol Myers Squibb) deal would be the main growth driver in the medium
term. However, the long term growth would depend upon the regular ramp up in number of
scientists. Under the BMS deal, the company would be employing 400 scientists. Currently the
company has strength of800 scientists, which the company would be ramping up to 1200 in next
two years (addition of 400 scientists under BMS deal). From Q1CY09, the company would
employ 250 scientists, while another 150 would be added in Q1CY10. We expect Syngene’s
operating revenue to grow at a CAGR of 29% over FY06-10E to Rs 267.60 crore, while bottom
line is likely to increase at a CAGR of over 42% to Rs 96.85 crore over this period.

Exhibit: Robust revenue growth estimates (Rs crore)

FY06 FY07 FY08 FY09 FY10E

42
EXHIBIT: Asuumptions for revenue model

Biopharmaceuticals

FY07 FY08 FY09 FY10E

ENZYMES DIVESTED
FY07 FY08 FY09 FY10E

43
CONTRACT AND CLINICAL RESEARCH

FY07 FY08 FY09 FY10E

BBPL(51:49 JV FOR MANUFACTURING BIOMAB EGFR)

FY07 FY08 FY09 FY10E

Clinigene: Likely turnaround in FY09E

We expect Biocon’s clinical research business to turnaround in FY09. This business has higher
proportion of fixed cost, which allows it to turn around the operations with increase in volume of
business. We expect a good ramp up in Clinigene operations and the top-line to move up at a
steady growth rate. Top line of Clinigene is likely to grow at a CAGR of 65% over FY07-10E to
Rs 40.50 crore in FY10E. We expect the bottom line to follow the top line movement at turn
black in FY09E. We expect the bottom-line of Rs 3.33 crore in FY09E. In FY10E, we expect the
bottom-line to be Rs 8.95 crore.

44
EXHIBIT: TURNING AROUND IN FY09 (Rs crore)

MAR’06 MAR’07 MAR’08 MAR’09 MAR’10E

BBPL: Dark horse

Biocon Biopharmaceuticals Private Limited (BBPL) is 51:49 JV between Biocon and CIMAB of
Cuba, in which Biocon holds 51% stake. BBPL has a right to manufacture Biomab EGFR for
other geographies also. The company is currently supplying to only Biocon for India and
neighbouring countries. The company is likely to start supplies to European Union from FY10E
(CY09), and US and Japan from FY11E. Revenue from EU is likely to be Rs 20 crore while that
from the US and Japan is likely to be Rs 70 crore. Being a proprietary product the variable
production cost of Biomab EGFR is very low while most of the costs are fixed in nature. With
increase in sales we expect the margins to improve substantially. We expect the JV to make

45
losses till FY09 and turnaround in FY10E with a profit of Rs 9.15 crore on sales of Rs 41.56
crore in FY10E.

FINANCIALS
Biocon has just completed a huge capex where it increased its capacity multifold. We believe the
company would reap the benefit from these expansions in the years to come. We expect top-line
of the company to rise at a 15.47% CAGR over FY07-10E largely on the back of improvement
in formulation revenue and monetization of IP assets. However, the concerns such as higher
depreciation cost due to initial years of commercialization of large expansion, higher R&D cost
on oral insulin in phase II of clinical trials, increased selling expenditure on formulations and
rising tax expenditure after FY09E due one of its plant exiting EOU (export-oriented unit) status,
are there, we expect the operating and net margins to improve over FY07-10E. Margins are
likely to improve on account of rise in such revenues (out-licensing revenue, leasing revenue),
which does not require large recurring expenditure. We expect the bottom-line of Biocon to grow
at a robust CAGR of 17.79% over FY07-10E.

Revenue mix is enriched

Biocon sold its enzymes business in the H1FY08. Despite that we expect sales growth
momentum to continue as the company is likely to start earning revenue from new geographies,
other revenue stream such as lease income on account of leasing out of the facility related
enzymes business to Novozymes A/S, the company which bought the enzymes business of
Biocon. Post the sell-off, Biocon is likely to start revenues from new streams such as its
licensing partner in China is likely to launch Insugen in Chinese market in FY09E, Biocon is
likely to launch the in-licensed cancer drug Abraxane in Indian markets in FY09E. BBPL is
likely to start adding meaningful revenue to the consolidated P&L from FY10E. Moreover,
Syngene would start generating revenue from the BMS deal from FY09E. In addition, the
company is set to generate more revenues through monetization of IP assets to fund its increased
R&D expenses on its discovery pipe line advancing to higher stages of investigation.

46
Exhibit: Revenue mix of Biocon business in FY07

Exhibit: Revenue mix of Biocon business in FY10E

Rising revenue from CRO business, out-licensing business (monetization of IPassets) and BBPL
suggests that the high-margin business revenuecontribution is increasing.

47
Consolidated revenue to rise at 15.5%
We believe that the consolidated revenue of the company would rise despite the non-existence of
enzymes’ revenue. The overall revenue growth is likely to be on account of higher revenue
growth in CRO business (Syngene and Clinigene), revenue contribution from BBPL, revenue
from new streams and an increase in the formulations revenue in biopharmaceuticals space.
Margins likely to improve FY09E onwards
We expect the margin pressure to ease FY09E onwards as the R&D and selling expenditures as a
percent of revenue will decline on account on growth in revenue. Moreover, the power & fuel
expense (as % of top-line) is also likely to decline. Moreover, we expect a good ramp up in
better margin CRO business, BBPL and formulations.
Exhibit: Margins are likely to increase FY09 onwards

Mar’07 Mar’08 Mar’09 Mar’10E

Exhibit: Higher contribution from better margin business

48
 Mar’07 Mar’08 Mar’09 Mar’10E

Exhibit: R & D expenditure to remain high (Rs in crore)

Mar’07 Mar’08 Mar’09 Mar'10E

Exhibit: Selling expenses rising with increasing sales

49
 Mar’07 Mar’08 Mar’09 Mar’10E

Capital cost likely to keep pressure on net margin

The higher capital cost is likely keep pressure on net margin. The company commercialized a
new plant built on an investment of around Rs 500 crore, the depreciation cost is likely to remain
high. Moreover, the tax expenses are likely to zoom in the FY10E as one of the plants is getting
out of the EOU status and the tax rate is likely to increase FY10E onwards. Rising other income
is likely to subdue the pressure.

Mar’06 Mar’07 Mar’08 Mar’09 Mar10E

50
Exhibit: Expenses line likely to put pressre on NPM(%)

Healthy cash generation provides fillip for inorganic growth

Healthy cash generation from operations provides fillip to follow an inorganic growth avenue.
We expect traction in operations and higher depreciation is would generate substantial cash from
operations. Moreover, the recent selloff of enzymes business to Novozymes for US$115 million
adds substantially to the cash. We expect cash and cash equivalents to be ~Rs 770 crore. Huge
cash balance in the books gives the company the flexibility to adopt inorganic route of growth
aggressively.

2006 2007 2008 2009 2010E

Exhibit: Substantial cash generations from operations, sell off enzymes business.

Return ratios to recover FY09E onwards

It is expected to have return on net worth (RoNW) excluding inflow from sale of enzyme
business, to improve from 18.12% in FY07 to 18.40% in FY10E. However, in FY08E & FY09E,
RoNW may see a decline by 80bps and 72 bps year-on-year, respectively, due to lower bottom-
line growth on account of lower asset utilization and debt repayment. Asset utilization to
improve in FY10E but on lower leverage.
Dupont analysis for RoNW
FY07 FY08 FY09 FY10E

51
Dupont ratio analysis indicates that the overall tax rate would go up in Y09E and FY10E as one
of Biocon’s plants would lose its EOU (Export Oriented Unit) status leading to an increase in
overall tax rate. During FY08E to FY10E, we expect the interest cost as a percent of PBIT to
decline on account of better utilization of borrowed fund and increase in revenue from BBPL.
Improvement in RoNW is also due to improvement in margins from 21% in FY08E to 24% in
FY10E as Clinigene and BBPL are expected to contribute to nearly 1/3rd of the overall profit of
the company. Almost 50% expected y-o-y rise in profits on the back of turnaround in Clinigene
and good bottom-line contribution by BBPL in FY10E is likely to lead the RoNW to improve to
18.40% in FY10E.

Mar’06 Mar’07 Mar’08 Mar’09 Mar’10E

Exhibit: Return ratios on strong footing after midterm hiccups

52
Net profit is likely to see good growth in FY10E
The net profit growth of the company to increase by over 63% during next two years. However,
the net profit is likely to remain subdued in FY08E & FY09E as most of the investments in the
subsidiaries and joint ventures would start adding meaningfully to the bottom-line only from
FY10E.

The JV BBPL will yield good revenue and profit growth in FY10E, when it is likely to start
supplies to European Union. We expect all the segment of Biocon’s business to turn profitable
with good contribution to the bottom-line

Risks & Concerns

The discovery focus in itself is a very risky business proposition due to large gestation period,
large investment and lower chances of success. Delay in out-licensing, lower deal size or
different payment schedule under the deal have bearing on the valuation.
Moreover, if the molecule fails in the proof of concept level (phase II of clinical trials), there
would not be any out-licensing income and will have a great bearing on the valuations. In
addition if in the deal the up-front payment is lower and milestone payments are higher, this will
impact the immediate cash flow. Moreover, the risk may emanate from day-to-day business
operations. While formulating the revenue model, we have assumed various time lines for the
launch of different product in different geographies based on the schedule defined by the
company. Any change in the schedule or the failure on the part of the company to launch the
product in that geography may impact our earning estimates and valuations.
It is assumed that operations of Clinigene would turnaround in FY09E. The delay in turnaround
may have bearing on the financials and valuations. For Syngene,it is assumed that the similar
rate of revenue per scientist in the years to follow, if the rates decline or change or there is a
delay in execution of BMS deal, estimates would change accordingly. In estimating revenue
and profits for BBPL it is assumed revenues at high EBIDTA (due to lower raw material and
production cost) to flow in from European market from FY10E any change in cost structure or
delay in revenue flow from that market would impinge estimates.

CRO business (P/E valuations)

The high margin CRO business is gradually gathering lot of significance in Biocon’s overall
business as a driver of bottom-line mover. We expect the CRO business to add around 20% to
the consolidated revenue in FY10E but the bottom-line contribution is likely to be around one-
third in FY10E. In CRO operations, the company provides end-to-end services in drug discovery
exercise, from pre-clinical stage to clinical trials. Syngene provides contract research for the
molecules in pre-clinical stage and Clinigene provides clinical research services. The combined
top line of Syngene and Clinigene is likely to grow at a CAGR of 29% over FY07-10E to Rs 308
crore while the combined bottom line is set to grow at a CAGR of 33% over this period to Rs
106.10 crore in FY10E.
53
The CRO business is valued on comparable business method and compared the business with
WuXi PharmaTech, a NASDAQ listed Chinese CRO company. WuXi PharmaTech (Cayman)
Inc. (WuXi) is a China-based pharmaceutical and biotechnology research and development
outsourcing company. The Company provides a portfolio of chemistry, biology and
manufacturing services in the drug discovery and development process to pharmaceutical and
biotechnology companies. Its core operations are grouped into two segments: laboratory services
and manufacturing. The company’s laboratory services segment consists of discovery chemistry,
service biology, analytical, pharmaceutical development and process development services. The
manufacturing segment focuses on manufacturing of advanced intermediates and active
pharmaceutical ingredients (APIs).

Valuation and recommendation

Biocon is becoming a pure pharma play after the sell-off of the enzymes vbusiness to
Novozymes during H1FY08. In the pharma sector, the company differentiates itself from most of
its peers by virtue of its focus on discovery research and commercialization of one of its
discovery research product in the market. In the discovery pipeline, the company has few
exciting products such as non-injectable (oral) insulin, which targets the potential global market
size of US$1-3 billion. Non-injectable (oral) insulin is likely to enter the phase II of clinical trials
(proof-of-concept level) in March 2008 after which the company plans to out-license it. Out-
licensing may generate windfall revenue to the company. Besides discovery research, the
company also works on biosimilars in innovating new processes. In this category also the
company has created a good library of IP (intellectual property) assets, the monetization of
which has been generating good revenue with handsome revenue fetching out-look. Moreover,
the company is no longer a ‘statin-only’ play rather the product portfolio is diversifying,
decreasing the product specific risk. The revenue contribution from statin is decreasing and high
margin contract research revenue is increasing in the overall revenue of the company. We
believe the business-improvement efforts of the management should become visible in quarters
to come. Currently, margins are under pressure. But starting FY10E onwards, we think margins
would improve. We expect top line and bottom line to grow at a CAGR of 15% & 18% over
FY07-10E respectively while return on net worth to improve in the range of 18%.

The integration with low-margin Axicorp, big mark-to-market losses on the forex front and
lower contributions from high-margin licensing income has dragged net profit down for the
Biocon. The MTM losses will continue upto the next quarter due to hedging of export revenue at
Rs 41.5 per dollar.

Though the IN-105 and T1-H programme is progressing well but the market impact of the
recently introduced drugs is yet to be ascertained. And in a risk-averse environment, the stock

54
market and investors will not ascribe value to such a programme. At CMP of Rs 113 the stock is
currently trading at a PE multiple of 9.52 x FY09E and 7.44 x FY10E, hence we maintain
“underweight” position on the stock.

CHAPTER 5: FUNDAMENTAL ANALYSIS OF STOCK #2

Dishman Pharmaceuticals and Chemicals Ltd.

Status: Underweight
55
 Call: Buy
Target Price: Rs 243
Time Horizon: 12 to 18 months

Business Profile of Dishman

➢ Established in 1989 basically with production of quats, and after five year of their
commencement they achieved leadership in the field of PTC-quats.
➢ Now they have established themselves as recognized supplier of intermediates, actives, speciality
chemicals to various MNCs.
➢ Broadly its business model consists of two segments-
CRAMS (Contract Research And Manufacturing Services)

MM (Marketable Molecules)

CRAMS: INDIAN PERSPECTIVE-

➢ The CRAM segment market in India is worth about $500mn and has annual growth rate of 25%.
➢ There are around 150 dedicated contract manufacturing units in India that are contributing to 60% of the
total contract manufacturing business in India.
Investment Rationale
➢ Dishman’s business model has two major segment-CRAMS and Marketable molecules.
➢ Under CRAMS it produce APIs and few drug intermediates. the marketable molecules segment
comprises Quats,APIs and recently acquired VitaminD business of Solvay.

56
 ➢ The company is one of the largest manufactures of Quats in the world. Dishman’s strategy is to
focus on the CRAMS business due to huge potential in the pharma contract research (CRO).
➢ The company’s excellent execution capability coupled with the acquisition of Carbogen Amcis
has provided given it critical scale in this segment.

Tractio
n in CRAMS business
➢ With increasing customers base both in Central Europe and America and with couple of deals in hands
Dishman pharma is flying high in CRAMS segment, which will boost the revenue from this segment in
next two years.
➢ Apart from this rise in high end CRO revenue would also lead to margin expansion post the integration of
Carbogen Amcis.

CRAM which is the biggest contributor of total revenue of Dishman with 75% and 72% in 2008 and 2009 is
estimated to contribute 76% in FY2010.

Of this total value of CRAMS contribution of Carbogen Amcis is 53% and 49% in FY2009 and FY2010
respectively.

Execution Capacity enables Dishman to ramp up revenue fast:

➢ Strategy of inorganic growth of Dishman has helped them to add manufacturing facilities and laboratories
to address incremental projects.
➢ Having acquired a couple of small CRO businesses in Europe(like Synprotec,IO3S),it acquired Carbogen
Amcis,a major Swiss player in field of CRAMS, in August 2006 leading to sudden jump in high end CRO
and CMO capability. Strong technological competence and Swiss FDA patent in their pocket Carbogen
Amcis, acquisition is a strategically fit for Dishman adding extra fuel to their core business of CRAMS.
➢ Apart from this Dishman has also been adding manufacturing capability organically in India. A step to this
strategy is their expansion plan of Plant in Bavla.
➢ All these development has attracted confidence of many outsourcing pharmaceutical players towards
Dishman.

Supplies from Indian facilities to increase

➢ With the commissioning of new manufacturing facilities in Bavla, increased off take of existing
contracts, new supplies for fresh contracts with MNCs like Astra Zeneca, Pharmathen (Greece
Company), Polpharma and others the revenue from Dishman facilities in India is expected to
move at CAGR of 25% for next two year.

57
➢ Also company will be ramping up supply of Eprosartan Mesylate to Solvay after it completes
backward integration steps.
➢ In addition to supply of EM they have also established fourth manufacturing facility in Bavla
site dedicated for the production of Delnafaxin hydrochloride an API for anti depressant drug
for its supply to Solvay.

Solving Dishman’s way:

➢ Dishman has renewed their contract with Solvay for the supply of EM, which expired on
2008.Total requirement of API of Solvay, is mainly fulfilled by Lonza and Dishman.
➢ Apart from this they have also signed an agreement with them for the supply of another
API called Delnafaxin hydrochloride for anti depressant drug.
➢ Till December 2007, Dishman was supplying about 70tonnes of EM annually, but with
the commissioning of new layer facility from Jan 2008 Dishman is supplying about 200
tones of EM to Solvay from 2009 onwards.
➢ All these development has made contribution of Solvay to Dishman’s revenue to leap
from 110.65cr in FY2008 to 201,95cr in FY2009, a y-O-y growth of 82.5%.

Exhibit: Solvay’s revenue contribution to Dishman pattern

Marketable Molecules:

This segment contributes one fourth of total revenue of Dishman. Company is expecting to
increase its contribution and has taken no. of steps to commercialize this segment, some of their
strategies include:

Strategy to commercialize Quats:-

➢ Dishman enjoys competency in producing QUATS (Quaternary Ammonium Tertiary), PTC

(Phase transfer Catalysts) .Since these products are commodity in nature, thus have very
low profit margin.

58
 ➢ Also Chinese players pose great deal of competition to them by producing low price
QUATS, as cost of production is low in china.
➢ To answer all these challenges they established a new plant in Sanghai with investment of
$10 mn, for producing early phase APIs which would be transferred to Bavla plant in
Ahmadabad, for the production of High Potent API (HPAPI).
➢ Also they have renewed their contract with Ferro Corporation –a Chinese company
producing chemicals and plastics and other polymer based product for the supply of Quats.

Dishman Netherland: Boost marketable molecules business via inorganic route

➢ Acquisition of “Fine Chemical & Vit.D” business of Solvay in 2007 for €12 million,
inclusive of working capital, was their part of their strategy to increase their hold on
European market which constitutes over 80% of overseas sales of Dishman.
➢ This acquisition has also enabled them to increase their margin from Vitamin D business
which earlier was limited with the supply to Solvay only.
➢ Thus in all this move was a part of company’s strategy to increase the contribution of MM
segment in company’s revenue pattern and increasing product line of MM segment.
➢ The acquired business generates a revenue of €15 mn at an EBIDTA margin of around 17%
(EBIDTA of €2.6 million).

Post integration, EBIDTA margins to rise

➢ It is expected that EBIDTA margins of the acquired business would rise from existing
16-17% in FY10E and to 20% from FY10E onwards after the successful integration,
which may take around one year.
➢ The acquired business has broadly four products – Vitamin D2, Vitamin D3, cholesterol
and Vitamin D analogues. Currently, the acquired facilities manufacture cholesterol,
while Vitamin D2and D3 is outsourced from local players.
➢ Vitamin D analogue is manufactured at Solvay’s main plant at Weesp. Dishman plans to
transfer the plant and machinery used for manufacturing Vitamin D analogues from
Solvay’s main
➢ plant at Weesp to Veenendaal in Netherlands (plant acquired with the business
acquisition) and start production of Vitamin D analogue in that plant.
➢ Moreover, Dishman will start transferring production of Vitamin D2 and D3 to India
from FY09 onwards post to the contracts with local producers come to an end. The
company will continue production of Cholesterol and Vitamin D analogues in the
Netherlands.
➢ We believe the cholesterol and vitamin business has good scalability and margins would
expand after the successful integration.

59
 ➢ Under Solvay, the business was under-pressure as it was not a focus area and margins
were under pressure due to lower capacity utilization levels,
➢ It is expected that with increased focus on production and marketing, the business will
see good traction.

High-end products to be added through acquisition

➢ The acquisition placed Dishman into one of the three players worldwide manufacturing
high-end Vitamin D analogues.
➢ Vitamin D analogue is a high value and a high potency product (sold for almost $ 1
million per kg) used in manufacturing oncology drugs. Other products such as cholesterol
and Vitamin D2 and D3 are common products.
➢ Cholesterol is the raw material for Vitamin D2 and D3, and the raw material for
cholesterol is locally available in Netherlands, which is one of the reasons that the
company is not shifting the production to India.

Additional Developments

Expansion of Bavla facility (‘Project Taurus’)

➢ Dishman India has been developing four new API facilities at Bavla site in Ahmedabad, out
of which three are fully operated which exclusively cater the supply to Solvay (incurs
investment of Rs 1.5 bn ($37.5mn).
➢ Fourth plant will be dedicated to produce cytotoxic compounds for catering the demands of
rest of their clients which incurs investment about Rs 35cr.
➢ Bavla site is designed by its daughter company Carbogen Amcis, and will be the largest of
such facility in Asia.
Strategy for commercialization of QUAT production

➢ Dishman enjoys competency in producing QUATS (Quaternary Ammonium Tertiary), PTC

(Phase transfer Catalysts) .Since these products are commodity in nature, thus have very
low profit margin.
➢ Also Chinese players pose great deal of competition to them by producing low price
QUATS, as cost of production is low in china.
➢ To answer all these challenges they established a new plant in Sanghai with investment of
$10 mn, for producing early phase APIs which would be transferred to Bavla plant in
Ahmedabad, for the production of High Potent API (HPAPI).
Developing Quan Xie to bag long term API deal from Japanese majors.

60
 ➢ Recently they have formed JV with Japanese company named Azzuro Corporation for
distribution and marketing of specialty chemicals of Dishman, under the name of Dishman
Japan Ltd.
➢ This is also a part of their strategy to get long term deal for catering API needs of Japanese
companies as Japanese govt. has opened their market of API and are looking for partners for
long term API supply.
SolubilizingSolvay: Dishman Netherland

➢ Acquisition of “Fine Chemical & Vit.D” business of Solvay in 2007 was their part of their
strategy to increase their hold on European market which constitutes over 80% of overseas
sales of Dishman.
➢ Apart from this they also want to make their way into US Pharma and chemical market as
Solvay has developed a wide customer base in the US. Till 2008 US market contributes to
only 5% of overseas sales of Dishman.
➢ Targeting Polish Market

➢ Recently Dishman has concluded a deal with Poland based Polpharma, for the supply of
8-10 APIs.
➢ Company is quite bullish that this deal would bring 30% growth in revenue in coming three
years.
➢ Also this deal is another step by company to increase their client base in European market
which constitute about 80% of total Dishman’s sales in overseas market(in 2008),which was
earlier served by Solvay, Dishman Netherlands,& Carbogen Amcis Ltd.
➢ Polpharma is major player in Polish market having annual turnover of US$400 mn.

5.48, 5%
5.29, 5%
6.14, 6%
4.87, 5%
3.88, 4%

74.34, 75%

Polpharma Sanofi Aventis GSK Servier Sandoz Others

Fig: Value share distribution of various drug makers in Polish market

(Source: Polpharma quoted by Puls Bisnesu)

➢ Making base in promising US market

➢ Acquisition of Carbogen Amcis in 2006 was Dishman’s first step to enter US market as
Carbogen is having many US clients.

61
➢ After that they had made many deals with major US pharma players such as Pfizer, Merck
and others.
➢ Recently they are undergoing talk with US based company named Astra Zeneca for the
supply of 14- 20 APIs having order potential of $10-$20mn by 2010.

➢ Forex Move: converting FCCBs

➢ To mitigate the effect of MTM losses they have converted most of their FCCBs in equity.
➢ In Q3 FY09 they have registered MTM gain of about Rs 50 c

➢ Project SEZ: Benchmarking & Tax Shielding Mechanism

➢ Dishman has promoted the project of SEZ,one for Pharmaceuticals & Fine Chemicals
segment and another for Engineering Segment through its subsidiary namely Dishman
Infrastructure Ltd.
➢ The total project cost for two said two SEZ segment will be around Rs 650 cr & will be
funded partly by promoter of Dishman and partly by loan & private equity or public
participation.
➢ Over 90% of part of these SEZ will be processing units, where less than 20% of this SEZ
will be utilized by Dishman.
➢ After getting approval from govt. they are getting good response from both domestic as well
as overseas companies, willing to set up their units in SEZ.

Business model and assumptions(Rs,crore)

FY2007 FY2008 FY2009 FY2010E

CRAMS-Solvay 84.32 110.66 201.95 256.38

% of total revenue 15% 14% 19% 20%

CRAMS-Non-Solvay 106.2 137.96 168.59 222.30

% of total revenue 18% 17% 16% 18%

CRAMS-Carbogen Amcis 224.8 353 430.66 478.03

% of total revenue 39% 44% 40% 38%

Marketable molecules 163 168.43 210 232

% of total revenue 28% 21% 20% 18%
0 33.03 54.50 70.00

62
Vitamin D business of Solvay
% of total revenue 0% 4% 5% 6%
Total revenue 578.4 803.08 1065.70 1258.71

CRAMS-Solvay 84.32 110.66 201.95 256.38

CRAMS-Non-Solvay 106.2 137.96 168.59 222.30

CRAMS-Carbogen Amcis 224.8 353 430.66 478.03

Total CRAMS 415.32 601.62 801.20 956.71

EBIDTA margins

EBIDTA on Solvay CRAMS 60.90% 55.20% 71.40% 78.13%

EBIDTA on Carbogen Amcis CRAMS 62% 76% 61.70% 45.00%

EBIDTA on MM 18% 19% 35% 45%

EBIDTA on Vitamin D business 16% 19% 21%

Consolidated Profit & Loss Account

FY 2005 FY 2006 FY 2007 FY 2008 FY 2009 FY 2010E

Net Sales 187.36 277.44 578.57 803.08 1065 1254.08

Other Income 2.86 7.72 23.31 46.31 0 0

Total Income 190.22 285.16 601.88 850.75 1084.01 1254.08

Total Expenditure 137.82 213.19 463.54 650.28 801.2 917.98

% Total Sales 73.56% 76.84% 80.12% 80.97% 75.23% 73.20%

EBITDA 52.4 71.97 138.34 200.47 282.81 336.10

EBITDA (%) 27.97% 25.94% 23.91% 24.96% 26.55% 26.80%

63
Less: Depreciation 7.64 12.05 26.31 47.19 62.91 76.93

EBIT 44.76 59.92 112.03 153.28 219.9 259.17

EBIT (%) 23.89% 21.60% 19.36% 19.09% 20.65% 20.67%

Less: Interest 8.46 5.95 16.16 30.5 45.85 25.98

PBT 36.3 53.97 95.87 122.78 174.05 233.19

PBT (%) 19.37% 19.45% 16.57% 15.29% 16.34% 18.59%

Less: Tax 1.76 3.12 4.16 3.07 11.15 13.99

Net profit before extra-

ordinary items 34.54 50.85 91.71 119.71 162.9 219.20

Extra-ordinary Items 0 0 -0.09 35.17 -0.11 0

Adjusted Profit After Extra-

ordinary item 34.54 50.85 91.8 84.54 163.01 219.20

PAT (Adjusted) (%) 18.44% 18.33% 15.87% 10.53% 15.31% 17.48%

Valuation And Recommendation:-With increasing margin in MM segment and

maintaining growth in CRAMS segment company is expected to trade at PE of 9
with EPS of 27 in 2010.

CHAPTER 6: FUNDAMENTAL ANALYSIS OF STOCK #3

Orchid Chemicals and

pharmaceuticals Ltd
64
 Status: Moderately Underweight
Call: Buy
Target price: 180
Time Horizon: 8 to 10 months

About the company:

Orchid Chemicals and pharmaceuticals Ltd. is leading pharmaceutical company headquartered in
Chennai, India involved in manufacture and marketing of diverse bulk actives, formulations and
nutraceuticals.

65
With exports spanning more than 75 countries, orchid is the largest manufacturer –exporter of
cephalosporin bulk actives in India and ranked amongst the top 5 cephalosporins producers in
the world.

Orchid’s world –class manufacturing infrastructure including US FDA and UK MHRA

complaint API and dosage form facilities are located at Chennai and Aurangabad.

Orchid has dedicated state- of-the- art GLP complaint R &D centres for API research, drug
discovery and pharmaceutical research at Chennai.

Orchid has ISO9001:2000, ISO14401 & OHSAS18001 certifications. Orchid is listed on the
National Stock Exchange, Bombay Stock Exchange & Madras Stock Exchange in India.

Orchid has two subsidiaries to carry out drug discovery-Orchid Research Laboratories Ltd in
Chennai & Bexel Pharmaceuticals Inc. in the US, developing New Chemicals Entities (NCEs) in
six therapeutic areas.

Strategy:-
Company mainly started with the production of antibiotics and developed a robust leadership
position in the antibiotics space. But with the development of stiff competition in this field they
started moving their strategy to the production of niche products, which are premium priced, and
chemical entities which called for complex reactions and huge cost involvement.

Orchid, despite being a first generation enterprise that commenced operations only in 1994, has
distinctively and rapidly evolved to emerge as one of the few, fully integrated, globally present
Indian pharmaceutical companies, straddling the full pharmaceutical value chain. This evolution
is reflected in its multitier integration encompassing APIs and dosage forms for regulated and
emerging markets, drug discovery and drug delivery, capturing all the critical dimensions.

A clear strategic focus on niche generics and drug discovery, value chain integration, product
versatility, state-of-the-art infrastructure, collaborative partnerships and an empowered
organization constitute the key elements of Orchid’s growth model.

While the generics strategy is a key component of Orchid’s growth, the Company attaches a
great importance to its quest for novel drug delivery systems (NDDS). Typically, NDDS
products can reposition well established and well-proven medicines as more efficacious, better
tolerated products or as drugs extendable to other indications.

This can be brought about by innovative changes in formulations, change of dosage forms or
through novel combinations. Orchid is working on a few projects in this area, which will help
extend the frontiers of applications for certain medicines.

66
 Shareholding Pattern as on Mar,2009

Financial Abstract:
Sections Numbers
Beta 0.7

Institutional Holding 20.31%

Dividend Yield 0.59%

Current M-Cap 1179.55cr

CMP 179.09

Current Ratio Return on Investment

Investment Rationale:
Future Growth Drivers:
➢ Company is bullish about Carbapenems segment to be their main growth driver per year
beyond fiscal ‘09, along with few Paragraph IV first-to-file products like Ibandronic acid,
Memantine, Gemifloxacin and as per the management they are the only first- to file
company.

➢ Already launched high value product namely Cefdinir & Cefepime among others in US
will generate sizeable amount of revenue from 2009-10.

➢ Company is also expecting to launch around dozen of products in the Cephalosporin and
other categories in the US and the EU in 2009-10 with estimated market size of about
US$ 2.6billion (pre-patent expiry).

67
Piperacillin +Tazobactum: Growth factor of company
➢ On Sep, 16 company got approval from the US FDA for its ANDA for Piperacillin &
Tazobactum for injection. These approvals cover orchid generic equivalents in 2.25 g,
3.375 g and 4.5 g vial as well as 40.5 g (Pharmacy Bulk Package) dosage forms and
strengths.
➢ This generic is premium priced and thus help the company to get decent margin from this
product.
➢ Apart from this the US FDA has recognized that the company is a first applicant for the
product and accordingly has also granted 180 days exclusivity to market this product in
the US.
➢ This move would help the company to reap the full benefit of market opportunity of US$
250 million in the US. Company is also bullish that this product will surge for 15-20%
growth in revenue.
➢ They are also going to launch this product in EU, Canada and Australia.

Japan: New market Base

Findings & figures that make Japan an attractive market:
➢ Japan is the second largest pharmaceutical market and the second highest healthcare
spender.
➢ Japan is having large no. of ageing population in the world.
➢ The pharmaceutical sales in the Japanese market increased by 3% from US$66.6 bn in
2007 to US$68.6 bn in 2008.
➢ Liberalization by the Japanese government to increase the share of generics from the
current low of 4% to as high as 30% in years to come.
➢ In order to exploit these opportunities in emerging Japanese market they have established
Orchid pharma Japan .They have listed nine products for Japan, most of them are
injectables.So far they have filed three DMFs.

Alliances
Marketing Alliance:
➢ Company enjoys dominant position in the US Cephalosporins generics market.A part of
their success is due to their marketing partner Apotex.

List of generic drugs marketed by Apotex

Product Name Brand Reference Pack Size

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Cefazolin (injection) ANCEF 10X20 ML
Cefepime(injection) MAXIPIME 10X20ML
Cefoxitin(injection) CEFOXITIN 25X20ML
Ceftriaxone(injection) ROCEPHIN 10X20ML
Granisetron HCL KYTRIL 5X1ML

1ML,4ML
Piperacillin+Tazobactum ZOSYN 10X48ML

➢ For EU they formed major pan European alliances with Actavis and Hospira.
➢ Company is also involved in development of New Chemical Entities(NCEs) and drug
discovery in selected therapeutic areas of diabetes, pian management ,oncology & anti-
infective products.
To NCEs in the inflammatory and oncology areas are undergoing
regulatory toxicological studies and could be positioned for phase I studies on successful
completion.
In area of development and manufacture of Anticoagulant drug candidate they have
joined hands with for phase I trails, with Merck & Co.,Inc,US. Apart form this they have
invested in Diakron Pharmaceuticals Inc, which has an exclusive licensing agreement
with Merck for this compound.

Comparative Analysis:
PARAMETERS Dishman Pharmaceuticals Orchid Chemicals & Shasun Chemicals &
& Chemicals Ltd. Pharmaceuticals Ltd. Drugs Ltd.
It started with the 1. Started initially with the 1. They are mainly into
production of phase production of the manufacturing of
transfer catalysts (PTCs) Cephalosporin Active Pharmaceuticals
& Quaternary Ammonium (antibiotics), and then Ingredients (API),
& Phosphonium diversified themselves into intermediates & enteric
compounds. manufacturing of diverse coating excipients.
bulk actives, formulations
Currently, Dishman’s & nutraceuticals. 2. Also diversified
business is organized themselves into CRAMs,

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 under the two segments – 2. Recently they forayed in Biotechnology &
Non Penicillin Non Finished dosages. For
Business Model Marketable molecules and Cephalosporin segment this they have established
CRAMS. The marketable (NPNC). wholly owned subsidiary
molecules (MM) segment named Shasun Pharma
houses quaternary Solutions Ltd.(SPSL),
compounds (QUATS), UK, which provides
specialty chemicals, contract process research
Intermediates and & development.

APIs.

Sales 1062cr 1260cr 762cr

Market 1837.07cr 1179.55cr 14.44cr
Capitalization

The market capitalization of Dishman and Orchid chemicals are almost comparable, however
Orchid suffer from loss of 52.17cr.This is due to high interest & depreciation charges coupled
with high operating expenses.

A major part of operating expenses is on employee. Apart from this huge operating expenditure
is also due to their strategy of developing niche products which require huge cost involvement
and complex reactions. But once such products are developed they are premiumly priced in the
market which could draw decent margin for the company.

Regulatory Update
On July,3, received approval from USFDA for its generic version of Pfizer’s anti-hypertension
pills Amlodipine Besylate (Norvasc) in 2.5 mg, 5 mg and 10 mg strengths.
In May they received tentative approval from the US Food and Drug Administration (US FDA)
for its migraine pill Sumatriptan Succinate, in May.
In Aug,13, they received final approval from USFDA for its drug Sumatriptan Succinate tablets,
25mg, 50mg, & 100mg.
Apart from this they got final approval for its ANDA for Zaleplon Capsules, 5 mg and 10 mg
on Sept 18, 2009.

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Table of approvals

Segment ANDAs Marketing DMFs (in the US) CoS(Certificate of

Authorization (EU) Suitability)in EU
Cephalosporins 2 Cephalosporins 2
Formulations 9 3
Betalactams 0 Betalactams 0
5 1
Carbapenems 0 Carbapenems 0
3 2
NPNC 2 NPNC 0
1 3
APIs Cephalosporins 2 Cephalosporins 12
6
Betalactams 0 Betalactams 1
2
Carbapenems 3 Carbapenems Nil
3
NPNC 1 NPNC 07
1

Financials
Results of 2009 results are quite gloomy in the sense that company has to suffer from the loss of
33.81 cr in contrast to profit of 228.56 cr in 2008.

Growth in sales are flat, this is due to delay in approval by USFDA for Piperacillin Tazobactum
injection which was supposed to contribute 15-20% growth in sales. Pilling up of stocks
(intermediates, WIP, finished goods) of 72.46cr.

At the same time operating expenses has also increased from 961.02cr in 2008 to 1126.27cr in
2009, an increase of 17.19%.

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Analysis of credit:
Company has current ratio of 1.68, which is not very satisfactory when compared with its
competitors like Shasun Chemicals & Drugs Ltd. & Dishman Pharmaceuticals & Chemicals Ltd,
which have current ratios of 2.32 & 3.46 respectively.

Apart from this inventory turnover ratio is also undesirable when compared to its peers which
has average inventory turnover ratio of 5.63.

Analysis of leverage:
With debt equity ratio of 4.43 company is highly levered when it is compared with peers in this
field, i.e Shasun & Dishman who are having D/E of 1.09 & 0.52 respectively. High debt is a
major risk associated with the company.

However management of the company is confident of

repaying half their debt by Q2 FY2010, from the cash generated by the sales of their premium &
niche products in the market.

Overall Profitability
Company is having Operating profit & Gross profit margin of 16.3% & 5.4% respectively which
when compared with that of its competitors like Dishman who have OPM of 26.80%.

Also ROI of company is negative which is also a gloomy figure when compared to Dishman.

Valuation Ratios (Peer’s Comparison)

OCPL DPCL SCDL

Enterprise Value 1760 672.39 310.3
EV/EBIDTA 7.86 2.52 (5.1)
P/E (22.45) 9.10 (1.81)
P/BV 1.48 2.11 3.2

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Risks and Concerns:
Huge foreign currency loans & Foreign Currency Convertible Bonds are the main concerns of
the company as they are club to mark to market loss.

Company is having total FCCBs of US$ 193million out of which US$ 175million are to matured
in 2012 and 18million are to be matured in 2010.Out of this FCCBs amounting to US$ 22.79 has
been so far converted.

In Q1 FY2009 company has to suffer from mark to market loss of 58 cr due to depreciation of
rupee by 8% from 40.21 to 43.13.In addition to this company has also taken dollar denominated
long term loan of about 210 cr.

Recommendation
At the current price of 170.90, Orchid is trading at (22.45)X EPS of (7.61) which is lowest of
historic P/E range for five years. This is lower than that of Dishman, which is currently trading at
9.10X EPS of 20.22.

At the same time it has high enterprise value and high EV/EBIDTA ratio among its peers, there
by giving some cushion to the assumption that with the realization of revenue from their high
end products in the US, EU, Canada & Australia & also in emerging markets like Japan they can
part off their some of loans, and could bring their profit in positive figures by Q3FY2010.

Also with the introduction of Tazo+Pip, sales of the company are expected to increase by 15%,
and also conversion of FCCBs amounting Rs18m in 2010 reduces some burden of unsecured
loan.All these changes has made me to inferred that by 2010 its OPM will increase to 25% and
increase in EBDT margin upto 15%.

In the light of above discussions, I would recommend ‘buy’ call on this stock at current level
with a investment purpose of minimum two years.

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 CONCLUSION:

After making through study of report published by Deutsche Bank on future prospects of
pharmaceuticals sector in India following inferences have been made by me:

➢ Increasing disposable income of individuals in India.

➢ Large market share for generic drugs
➢ Cheap and literate labor
➢ Large human resource having knowledge of English language-there by giving room to
MNCs to get efficient human resource
➢ Large no. of pharma companies getting quality standards like FDA, ASSOCHAM etc.

All these factors made me to infer that there is huge untapped market in this sector to tap in
India.

Then after making valuations of few pharma stocks using earning multiples I came to
conclusions that the stocks tracked are underpriced and thus provide opportunity for safe
investment.

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References:
Websites Referred

http//www.moneycontrol.com

http//www.indiaearnings.com

http//www.biocon.com

http//www.dpcl.com

http//www.ocpl.com

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Books referred

Fundamentals of investments- By William Sharpe and Gordon

Financial Management –By IM Pandey

Journals referred

Investment policies by Charles D Harris (Homewood,IL:Dow Jones-Irwin,1985)

Peter Fortune also developed a study on, “A Assesment of Financial Market Volatility

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