Fixing the Ranbaxy Problem
That eventful day on March 25, 2015, when Ranbaxy Pharmaceuticals was formally handed over to its acquirer Sun Pharma in a $4.1-billion deal, Sun had set a stiff challenge to its staff. Each of Ranbaxy's 19 manufacturing plants, eight in India and the rest in seven other countries, had to extinguish the Ranbaxy brand and replace it with Sun Pharma branding that day itself. Even visiting cards, vouchers and letterheads had to reflect the new branding, while work on changing the packaging material was to start in earnest after regulatory approvals.
It is such perseverance and attention to detail that sets Sun Pharma founder and Managing Director Dilip Shanghvi apart from other businessmen. The branding exercise went off as precisely as planned. Shanghvi is now hoping that his prescription for Ranbaxy will cure it with equal precision.
A raft of measures by Shanghvi in the 18 months since the handover are aimed at rationalising the portfolio around the world to focus on profit-making products; closing down or selling nearly half-a-dozen plants for greater economies of scale and synergy; pruning overlapping staff; and re-examining trade (wholesale and retail chemists) and incentive policies. Not to mention dealing with the biggest headache that he had inherited with Ranbaxy - its poor record in the US (its biggest market) with the Food and Drug Administration (FDA) - with very conciliatory moves.
Yet, not everything has worked as per plan. Shanghvi is embroiled in a suit by the company's marketing executives for alleged violation of labour laws. And Sun Pharma's erstwhile dream EBITDA (earnings before interest, tax, depreciation and amortisation) margin of 40-45 per cent has fallen sharply. To some extent, it was expected. "Ranbaxy is bleeding. My priority is to stop that," Shanghvi had said in an exclusive interaction soon after the deal. But how far is Shanghvi from achieving the ultimate goal of fixing Ranbaxy, his career's 17th turnaround, integration synergies (read, pruning costs) of $300 million and getting as close as possible to the 40 per cent-plus EBITDA margin? The last would add 10 per cent to its EBITDA.
Details are hard to come by, as Shanghvi, Sun and senior executives remain tight-lipped about the integration exercise. BT has pieced together the story of biggest integration in Indian pharma industry through a combination of e-mail responses from the company, discussions with current and former employees, and early indicators from Sun Pharma's financial and other public disclosures.
To Sun's credit, after the merger, financials have improved and market share has surged. While the two entities had a combined net profit of Rs 2,283 crore in 2013/14, the year before the acquisition, the net profit more than doubled in the next two years, to Rs 4,539 crore in 2014/15 and Rs 4,716 crore in 2015/16. The combined top line rose slightly from Rs 26,620 crore in 2013/14 to Rs 27,744 crore in 2015/16. Sun does not say how far it is from the $300-million synergy benefits, but claims it is well on course.
"The targeted synergies are achievable. The integration process is slow, messy and long. Rather than the plants getting remediated, the focus should be on fully utilising them to optimise revenues and profits. We expect Sun Pharma to grow revenue by 12 per cent and EBITDA by 30 per cent this year. In the domestic market, 15-16 per cent growth is achievable," says Sarabjit Kaur Nagra, Vice President of Research (IT and pharma) at Angel Broking.
Data from AIOCD AWACS, a pharmaceutical market research company, show that in India, the legacy brands of Ranbaxy have been growing faster than the industry average after the takeover. Sun's two best-selling brands in India - Volini and Rosuvas - are from the Ranbaxy stable. There are at least four former Ranbaxy brands in the Top-10 list in the domestic market (see Look Who Rules).
PERFORMANCE PRIORITY
On Monday, April 7, 2014, the first trading day after the announcement of the acquisition, the stock of Sun Pharma rose 2.68 per cent and ended the day at Rs 587.25 on the Bombay Stock Exchange, while that of Ranbaxy lost 3.12 per cent and closed at Rs 445.20. But Sun Pharma's stock fell 9 per cent on the BSE on April 21, 2015, when Daiichi Sankyo announced its exit from Sun Pharma.
That was despite Shanghvi's known record of acquiring and turning around 16 companies, most of them either sick or troubled, including the epic hostile acquisition of Taro Pharmaceutical of Israel, over an entrepreneurial journey spanning 33 years. He is not a man of chemistry - unlike other industry leaders such as Habil Khorakiwala of Wockhardt or Dr Y.K. Hamied of Cipla or Dr Anji Reddy of Dr. Reddy's Laboratories - but a commerce graduate who started out as a pharma wholesaler in Kolkata. Despite humble beginnings as a pharmaceutical entrepreneur from Vadodara with a couple of generic molecules, he remained focused. Unlike other generic companies, he ensured that Sun developed only high-margin products in select therapeutic areas. His company's profits were 30-35 per cent of sales despite acquisitions; they had peaked at 40 per cent-plus in the 2007 to 2009 period. This helped him win the hearts of investors and become the second-richest Indian businessman after Reliance Industries' Mukesh Ambani. But will that magic work on Ranbaxy?
One of the earliest diagnoses made by Sun Pharma in the run-up to the Ranbaxy acquisition was that since the entire management was focusing on resolving the US FDA's negative observations, there was a lack of focus towards expanding the business. The company lost Rs 1,000 crore on revenue of Rs 13,268 crore in 2013/14.
"Eventually, Sun will be a positive story. While Sun's R&D is better, Ranbaxy's geographical spread was far better"
So, the first challenge was to improve the performance of the acquired assets not impacted by the US FDA action and reduce bleeding. "New and renewed leadership, clear direction, prioritised areas of improvement and emphasis on productivity helped in turning around the overall performance," a Sun spokesperson said in an email response.
One objective was to retain profitable products/brands and discontinue loss-making or overlapping brands. Soon after the closure of the deal, Sun started looking at each and every product, and its customers, from a profitability point of view. In September 2015, it entered into a Rs 165-crore deal with Strides Arcolab to sell 'Solus' and 'Solus Care', the central nervous system (CNS) divisions inherited from Ranbaxy. As per the July 2015 report by IMS, a market intelligence firm, these two divisions accounted for Rs 92 crore sales. The sale was part of efforts to consolidate the CNS business in India. Sun Pharma did a product by product, customer by customer evaluation across all geographies - the combined entity has presence in 55 countries - for identifying products that needed to be retained, pushed, or discarded.
Sun discontinued a large number of unprofitable products in Western Europe. Its budget for Europe for 2015/16 was, in fact, lower than its sales in Europe in the previous year. The intention is clear. Sun's aim is to improve profitability, even at the cost of downsizing and lower sales in the immediate future. The results are yet to be visible, though lower revenues from the rest of the world have begun to show. During the April-June quarter of 2016/17, Sun Pharma's revenues from the rest of the world stood at $84 million, 7.3 per cent less than in the same quarter the previous year.
FIXING THE US BUSINESS
The merged entity's biggest market, the US, accounts for 52 per cent of revenue. And although Sun Pharma is also not entirely free from US FDA interventions (its business has not been largely affected because of exclusive marketing opportunities), Ranbaxy has had a nightmarish experience with the FDA. As a result, its US revenue more than halved from nearly $1 billion in 2012 to $400 million at the time of the takeover.
"Cultural integration is another issue. The expertise of the management lies in bringing in a common culture"
Kewal Handa, former Managing Director of Pfizer India, says the merged company's US worries could be a drag on its synergy plans. "I don't think Sun will be able to realise the merger synergies of $300 million, as it expects, within the timeframe suggested. Rationalisation can be done faster in HR, finance, stockists, field force and costs, but Sun Pharma is still struggling with production issues, plants and therapy units. The real value it expects from the ANDAs (abbreviated new drug applications filed in the US) of Ranbaxy will not be realised unless it is able to quickly remediate the plants (that are under the US regulator's scrutiny)," he explains.
Even if one discounts Handa's worry as he is an outsider, the regulatory hurdles may continue to bog down Sun Pharma, as is evident from the slow growth in its top line. Not only are four major manufacturing facilities acquired from Ranbaxy (Mohali, Toansa, Paonta Sahib and Dewas) under the US FDA radar, Sun Pharma's own facility in Halol (Gujarat), which contributes 7-9 per cent to its total revenue and 15 per cent to its US revenue, too, is facing the US FDA heat. This means Sun cannot export medicines from these facilities to the US until it takes remediation measures. As Shanghvi himself states, the remediation process at the erstwhile Ranbaxy facilities is slow. "While significant efforts to make these facilities compliant are on, this will be a time-consuming process. We expect to complete the remediation steps in at least one of these facilities in 2017/18," he told analysts recently.
Historically, Sun has been trying to address US FDA concerns, rather than shying away from these problems. It spent a good three years to ensure its Caraco (US) facility got back the US FDA approval. Despite its negligible contribution to profitability and revenue, Sun is continuing work on measures to get FDA clearance for its plant in Karkhadi, Gujarat. Shanghvi, in the post-merger interaction with this correspondent, had said that Sun will "use technology to ensure that the ability to manipulate data (the key accusation against Ranbaxy) goes away". Asked about the company's views on the US FDA problem, Sun's spokesperson says that in the past 18 months, the company has succeeded in making a firm commitment to investors that it will submit one of its troubled legacy Ranbaxy facilities for recertification in 2016/17. "And that is the change, progress," he says.
"Sun Pharma's stock remains subdued primarily because there is no clarity on how and when it can steer clear of the US FDA-related issues hanging over its own and acquired manufacturing facilities. Even after 18 months, none of the five plants that are under the US FDA scrutiny has seen any progress. This means their problems will persist," says a Mumbai-based analyst who did not wished to be quoted.
EKING OUT SYNERGIES
The combined entity had dozens of manufacturing units, several of them high-cost ones. By closing down or divesting them, and getting the job done by increasing capacity utilisation at other facilities, Sun Pharma optimised capacities as well as costs. Recently, it sold the Bryan (Ohio) unit of Ranbaxy in the US to Nostrum Laboratories and closed down a unit in Detroit that belonged to its subsidiary Caraco. In addition, it sold two manufacturing units in Philadelphia and Aurora in the US. It plans to sell or close a Ranbaxy unit in Ireland that employs 100 people. More are likely to be on the block.
Next, Sun Pharma turned its attention to trade incentives. Instead of the Ranbaxy way of incentivising the trade heavily, Sun Pharma told sales representatives to focus on generating more prescriptions, reckoning that it was more sustainable. In order to increase prescriptions, the sales representatives were asked to increase interactions with doctors. The frequency of visits, the quality of the sales pitch and training have improved significantly after the takeover. Right from identifying the right doctor to sharing the relevant information, Sun is known to have attempted to get the basics right and, thereby, increase sales. The change in the overall quality of the business, if continued, is expected to bring in a significant rise in revenues from India in the coming years. If that happens, it will be a validation of Sun Pharma's belief that the same team, the same brand, and the same business had the potential to deliver much more.
"I don't think Sun will be able to realise the $300 million synergies, as it expects, within the timeframe suggested"
Getting more out of 30,000 employees through optimised performance was critical for cost rationalisation. Though unionised sales representatives inherited from Ranbaxy are on a protest, Shanghvi has managed to bring in a uniform work culture in most of the company's operations. "When such a merger happens, duplication of medical representatives and wholesalers is bound to occur. There should be a strategy and plan to sort out the issues and bring in rationalisation. Cultural integration is another issue. Expertise of the management lies in bringing in a common culture," says D.G. Shah, Secretary-General of the Indian Pharmaceutical Alliance (IPA) and CEO of Vision Consulting Group, a pharmaceutical strategic consultancy.
"People want to be successful. When supported with the right strategy, direction and system, discipline begins to show," the company said in an email response, adding that the attrition rate in the legacy Ranbaxy division has fallen quite significantly.
THE RESULTS
Rajiv Gulati, former president, Ranbaxy, believes Sun will succeed eventually. He says the two entities complement each other perfectly. "Eventually, Sun will be a positive story. Before acquisition, 95 per cent of Sun Pharma's sales were from two countries - US and India. For Ranbaxy, US and India accounted for only about 40 per cent revenues, and 60 per cent sales were outside these two countries. While Sun Pharma's R&D portfolio is better, Ranbaxy's geographical spread was far better with sales teams in 46 countries," he explains. According to him, if one were to take Sun Pharma products and give these to Ranbaxy teams in those 46 countries, it would be a winning combination.
That's already happening. The Sun spokesperson says that the key for the company in its high-priority overseas markets - Romania, South Africa, Brazil, Russia, Malaysia etc. - is to scale up with augmented product portfolio.
Sun Pharma is not new to acquisitions. In fact, one of the reasons for its current profitability is the successful turnaround of its subsidiary Taro Pharma. The company, which closed with annual revenue of less than $400 million in 2010 (at the time of Sun's acquisition), reported $950 million revenues in 2015/16. Being a subsidiary, Taro's turnaround is easy to visualise. Whether the merged assets of Ranbaxy will fetch Sun a similar advantage is something that needs to be deduced from the overall revenue trends. Given the fact that the company's own deadline is still 18 months away, it might be too early for a prediction. But one thing is certain. The US, Ranbaxy's most troubled market, is not going to contribute to that growth until FDA clearances come through. It is also possible that Sun has not considered the US as the key market that will drive synergistic revenues in the first three years, as it used to be the most troubled piece of business within the acquired entity.
On the face of it, Ranbaxy's acquisition seems to have taken a heavy toll on Sun's EBITDA margins. For the standalone Sun Pharma, it was 45 per cent in 2013/14. The figure for the combined entity was 29 per cent in 2014/15, and almost similar - 28 per cent - in 2015/16. A closer look, however, shows that Ranbaxys EBITDA margin was less than 10 per cent in 2013/14, thereby making the combined EBITDA margin closer to the 30 per cent range. Also, if one discounts the three most important contributions to the high level of profitability for Sun - the high profits of Taro, one-time revenue opportunities for Sun in the US, and favourable rupee fluctuation - its realistic EBITDA will be in the 30-40 per cent range, making synergy possibility more realistic.
Announcing the results for the first quarter of 2016/17 on August 12, 2016, Shanghvi had said that the company "continues to accrue synergies from the Ranbaxy acquisition", adding that the accrued revenue is not visible due to simultaneous investments that are happening in the specialty business in the US. In other words, he was hinting that if the company is showing steady financial performance, even after making additional investments, it is only because it is earning more.
A comparison of the consolidated figures of the merged entity for 2015/16 and 2014/15 shows Sun Pharma's overall revenues and profits are rising, although US revenues came down from $2.24 billion in 2014/15 to $2.07 billion in 2015/16. Emerging market revenues shrunk from $611 million to $548 million. Rest of the world was also not positive. In 2013/14, Sun had 478 cumulative filings and 344 product approvals. With Ranbaxy, the next year's performance only improved to 597 filings and 438 total approvals. In 2015/16, filings came down to 567 and approvals to 417.
Though independent of the integration effect, whatever synergy that comes from the Sun-Ranbaxy merger is going to go into the investments that are happening in the global specialty business that Sun is setting up in the US. The company is building its own sales force in ophthalmology, and it already has a sales force in dermatology. It plans to in-license products and develop branded products for the US market. Thus, irrespective of the size of the Sun-Ranbaxy synergies, margins are likely to remain range-bound in the near future.
It is this business of the future that will probably be the key determinant of Sun Pharma's long-term fortunes.
With inputs from P.B. Jayakumar and E. Kumar Sharma
