A bitter pill

For Kailasam Raghavendra Rao, the promoter and Managing Director of Chennai based Orchid Chemicals & Pharmaceuticals, problems began as 2007-08 drew to an end. On March 17, a private equity investor in Orchid, Bear Stearns (which went bankrupt and was taken over by JPMorgan) suddenly offloaded all its Indian holdings—including one million shares of Orchid Chemicals. The Orchid scrip, which was trading at Rs 200 levels then, started falling rapidly.

As the stock dropped below Rs 180, margin calls were triggered for Rao, who had pledged his own 7 million shares with stockbrokers Religare and Indiabulls to fund another 3.5 million shares that he was planning to acquire in the open market. Rao had borrowed Rs 80 crore for this purpose. He could not meet the margin calls, and, consequently, 5.6 million shares were offloaded in the market at around Rs 140 to meet the margin requirement. Rao’s holding in Orchid fell to 17.06 per cent as on March 31, 2008, from 22.76 per cent in March 2007.

In the first week of April, even before Rao could recover from this shock, Solrex Pharmaceuticals, a Ranbaxy group company, started mopping up the depressed Orchid shares from the market and ended up accumulating as much as 12.8 per cent. This move was construed by many as a hostile takeover attempt by Ranbaxy, though its Chief Executive Officer, Malvinder Singh subsequently denied it. Rao himself did not go beyond the cryptic remark “whatever has happened has happened, but we will fight to the end.’’ Analysts remain divided on the possible outcomes of this battle. Will there be a hostile takeover, or a negotiated buyout of the promoter’s stake? Can this actually be an attempt by Ranbaxy to “arm twist” Orchid into contract manufacturing Ranbaxy’s products?

Says Himanshu Varia, Head, Institutional Sales, Asit C. Mehta, Investment Intermediates, a Mumbai-based securities firm: “While Ranbaxy has done this (acquiring strategic stakes in companies and enhancing contract manufacturing business with them) in the past, a near 13 per cent stake in Orchid is too large for (the promoter’s) comfort. However, if Ranbaxy does acquire Orchid, the exercise will be expensive.’’

Nath Balakrishnan, Senior Research Analyst at Spark Capital Advisors, agrees that an outright acquisition will be very expensive. According to him, there are too many overlaps in product lines between the two companies. “Just the lure of Orchid’s ANDA (Abbreviated New Drug Application) filings in the US market may not be attractive enough for Ranbaxy to go down the hostile acquisition route,” says Balakrishnan. Ranbaxy, after acquiring 15 per cent, will have to make an open offer for another 20 per cent. This could take its acquisition cost to more than Rs 450 crore, he estimates. Then, Orchid has Rs 800 crore of debts and Rs 800 crore of FCCBs (which were issued in February 2007 and will mature in February 2012). The company also has a large equity base of Rs 65.8 crore.

If Ranbaxy wants to buy Rao out, it is unlikely that he will agree (if at all he decides to cash out) until a very good offer comes his way—that would have to be well above Rs 360 per share. In such a case, the acquisition cost for Ranbaxy will increase even fur-ther, he says. Then, the US market, thoughlucrative, is a very tough one to operate in and a buyout of Orchid will not be a walk-through for Ranbaxy from the investment returns point of view. “The two companies don’t really complement each other,’’ Balakrishnan adds.

What are Rao’s options? He claims to have institutional support for now thanks to the company’s good performance, but he still has to pay Rs 72.4 crore in August this year to convert the 3.5 million bonds into equity, for which he had received approval in February 2007, at a rate of Rs 202 per share. Rao had paid Rs 10 crore upfront for this. This should take his holding back to around 22 per cent. He has shareholders’ sanction to convert 5 million bonds into equity. But converting the entire lot, experts say, will trigger an open offer (as he will cross the creeping acquisition limit of 5 per cent per year) and require him to fork out a further Rs 250 crore at least.

“We don’t know what Solrex’s mandate is. If it is just making an investment, it can make a pile of money by just offloading Orchid shares at a later date,” he says. At 16 times its 2008-09 multiple, Orchid’s share is valued at Rs 375.

Then, there could be a reluctant understanding between the two players to increase contract manufacturing for Ranbaxy from Orchid’s state-of-the-art plants. In fact, Orchid recently forayed into Japan and is set to make inroads into Europe. “We have supplied drugs to Ranbaxy in the past—but only those drugs for which we don’t have exclusive contracts with our existing buyers,” says C.B. Rao, Joint MD, Orchid.

The last word has not been said on this issue yet.

— Nitya Varadarajan