Wednesday, April 9, 2014

Sun Pharma Part #1: The ever acquiring darling of the markets

The Sun pharma and Ranbaxy deal will be covered in 3 parts - Sun Pharma, Ranbaxy and then the merger analysis.

Sun Pharma can be described better as a pharmaceutical company hedge fund than an pharmaceutical company - over 76% of the revenue comes from acquired companies. It has to be said that the acquisition capability of this company is stellar give the string of successful acquisitions. Overall the company has plants in the US, India and a few all over the place(Europe, Israel, South America). 

The global pharmaceutical market in 2011 was 956 Bil USD and as per the company should 1.2 Tri USD by 2016. Patent expires in 2012 were worth 35 Bil USD in revenue. 

ANDA approval - approval for a generic drug in the US - Abbreviated New Drug Approval

NDA approval - approval for a new patented drug in the US - New Drug Approval

I have a fear of pharma companies as I was always not so great at chemistry. So I am going to follow a strict regime here.

1. How good is the moat?

Grade B+ moat
  • Brand: The brand for generics is of not too great a value. It can be replicated with capital and advertising. The company currently faces a US FDA ban in one of its plants - it has dealt and resolved a ban before on its US subsidiary's Caraco's plant and Taro's plant in Canada. 
  • Product replication - This is a generics company where the product replication is not complicated.
  • Sales and distribution - Here is where the company has a good system going. Scale is massive and its constantly looking globally to market its products. 54% of the sales come from the US which is risky - but US is the world's biggest market.
  • Vendors - no real moat seen here.
  • Employees - Nothing much seen here. Something which is not explained is the 304 Crores of largely unsecured loans given to employees.

2. Risks

  • Growth sources - no dearth of these. Lots of drugs going off patent. Opportunities in markets outside US and India.
  • Obsolescence risk - This is a constant fear with this company and they need to be able to evolve their drugs pipeline and approvals process to keep this going.
  • Debt/financial risk - Debt/EBITDA is at .04 times so not much to worry here? Should be but what concerns me is the subsidiary reports where the assets and liabilities seem to be much larger than can be explained without debt.
  • Transparency risk - Doesn't seem to be much of an issue. Although the investor communication is something that is clearly focused on which can be a a good and bad thing.
  • Customer credit - Payment cycle seems to be 2.9 months - which is very high and doubtful debts written off are 3 times of last year - although as a % of profits is less than 0.5%.

3. Financials

  • Given the acquisitive nature of the business the financials are complicated. Subsidiary roll up into the consolidated sheets is still not clear to me.
  • FX exposure - net FX earner of about 1200 Crores per year which is a good thing
  • Stock options - there is no Employee or executive directors stock options scheme. Subsidiary company Taro Pharmaceuticals has a ESOPs scheme
  • Cash flow from operations and net income is not very different
  • Inventory % of sales is about 23% - which is high as the value of the inventory is over 80% of the annual profits after tax.
  • Debtors % of revenue is about 23.9% which is also signaling a 2.9 months payment cycle
  • ROE and ROIC is around 23% which is good. My only concern is that I cannot get the subsidiary financials to add up to the consolidated financials. I fear that the invested capital may be higher than what meets the eye
  • Dividend % of earnings - has fluctuated between 17% to 22% which is healthy
  • There is about 1,130 crores of goodwill on the books which does not seem to be impaired

4. Soft factors

  • Indian promoters own 63.65% of the company
  • Executive director on the board Shailesh T. Desai has sold 700K shares on the 26th of Mar 2014. There are also insider sales in 2012 and 2013.
  • All stock deal proposed with Ranbaxy signals to me that the company thinks their shares are overpriced - otherwise they may have gone for a larger % of cash or even used debt funding to buy Ranbaxy.

5. Pricing

  • Without the merger in question the stock is trading at 49 times trailing 12 months earnings. At that valuation the company would have to grow earnings at 30% a year for 12 years and then 10% till eternity every year - which is unlikely and is probably overpriced at this point. The all stock deal also points to that as well.

Please follow this space for the next section on Ranbaxy and the Sun Pharma Ranbaxy deal.

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