Can Orchid bloom again?

Early in December 2005, when then President Abdul Kalam visited a new injectable dose facility of Orchid Chemicals & Pharmaceuticals on the outskirts of Chennai, it made for a high point in the life of the ambitious drugmaker, built up by a first-generation entrepreneur. The company was moving up the value chain from bulk cephalosporins, an antibiotic similar in action to penicillin, to packing the drug in vials ready for injections. The $80-million (or Rs 367 crore then) facility came badged with manufacturing approvals from the US and UK drugs regulators, which meant smooth access to those lucrative markets. The future looked bright.

Not any longer. Today, that injectables facility has a new owner in the local unit of Hospira Inc., an Illinois, USbased company. In December 2009, Orchid had to sell the factory, which was clocking some $90 million revenues, as a last ditch effort to retire debt that threatened to choke it. The deal got shareholder and other approvals on March 31.

Orchid, it would seem, has sold its future. A non-compete clause with Hospira keeps it away from the injectables business for at least a decade. "The company has lost its image by selling its prized possession and one which cannot be replicated," says analyst Surya Narayan Patra of Systematix Shares & Stocks.

The Chennai drugmaker is now left with a basket of cephalosporin products, bulk actives and orals, perceived as plain vanilla by the market. Coupled with the obvious decrease in revenues (the injectables business accounted for more than one-third of Orchid's sales), the loss of a high-margin niche business has made Orchid's future uncertain. Shares of the company are at Rs 160-levels, down from a peak of Rs 373.50 in April 2006— four months after the Kalam visit.

So, is it the end of the road for Orchid, at least from the perspective of high growth? Its Managing Director K. Raghavendra Rao, who started his career in Mumbai in 1980 with Kwality Ice Cream after graduating from the Indian Institute of Management, Ahmedabad, doesn't believe so. "Our first move will be to protect our top line," he says, adding that he hopes to achieve this as quickly as the end of fiscal 2011—or the first operational year after selling the injectables facility. Of the $90 million revenues it gave up through the sale to Hospira, the company expects to recover $65 million annually through the sale of bulk actives to the acquirer as part of a 10-year sourcing deal.

"In fact, as Hospira grows its own injectables sales, Orchid's sales to it would also grow," says Rao. Analysts say they are not so sure. "...we have conservatively assumed contribution of $37million in FY2011 and $48million in FY2012 from the contract," Sarabjit Kour Nanga and Sushant Dalmia of Angel Research, the research arm of securities firm Angel Broking, wrote in December after news of the Hospira sale broke. A telling sign that the markets don't see a future for Orchid in the near term: almost all brokerages have stopped tracking the stock.

The remaining $25 million revenues will be made up, the company believes, by growing exports of high-value antibiotics and complex cephalosporins' oral formulations. These products may not have the high margins of injectables, but Orchid hopes to make up for the revenue losses with sheer volumes of its exports to both developed and developing countries. It also expects to make copycat formulations ahead or just in time of patent expiry of medications going off patents, a strategy common among Indian drugmakers.

HURT BY DEBT How it Happened Rapid expansion and diversification required huge capital. Opted for a debt-funded expansion as low promoter shareholding prevented equity dilution. Large-scale debt pushed up the interest costs. Over-dependence on a single blockbuster drug, Tazo+Pip, which failed to deliver. In the absence of expected revenues, losses began to pile up. What Orchid Did Sold its new injectables facility along with R&D to Hospira for $400 million. Signed a non-compete clause with Hospira with regard to injectables business for 10 years. Used the $400 million to reduce its debt. Brought debt-equity to a manageable level of 1:1. What it is Left With An agreement with Hospira to supply all bulk drugs for 10 years. Cash to plan future investments in acquiring front-ending firms abroad. Freedom to plan out first-to-file strategy for the oral basket, hitherto unexplored for all drug categories.

"As early as 2002-03, we developed complex injectables and some oral formulations that were technologically hard to replicate and went for Para 4 filings," says Rao. Para 4 filings refer to first-to-file applications to manufacture and sell the product soon after it goes off patent. Often, companies that win such approvals get a exclusivity period of six months to sell a copy of the drug that has just gone off patent and enjoy high margins.

Example: Tazo+Pip, an antibiotic injection used to fight severe infections and patented in regulated markets by Wyeth. Orchid developed a generic equivalent of the drug and after protracted legal battles won the rights in September 2009 to sell the drug in partnership with Hospira. Its six-month exclusivity added an estimated $50-60 million to its fiscal 2010 revenues.

Other instances: generic Cefepime and Cefoxitin. Orchid plans to make similar bets now in oral antibiotics—it has already obtained generic approvals for some—and as B. Gopalan, Chief Scientific Officer, says, basic research is being done on diabetes, inflammation, oncology, obesity and clotting disorders. A new oral medications facility at Visakhapatnam is set to start operations in 2012 with international regulatory approvals expected by then.

"The basket of orals is still untapped as we were focussing on injectables," says Rao. First Global Securities' Associate Director of Research Hitesh Kuvelkar estimates that Orchid could have at least 60 products with approvals for the US market ready by 2012. But, still, as Angel Broking analyst Sushant Dalmia says: "There are at least four to five players in some blockbuster products where Para 4 filings have been made—so it is difficult to see where Orchid would have a significant advantage."

The company has already made first-to-file applications for seven drugs, which treat allergies, Alzheimer's disease, central nervous system disorders, osteoporosis, and bacterial infections, and today count for some $5.5 billion in revenues for their patent-holders. By 2014, if—it is a big assumption that the company will receive all seven approvals—Orchid gets its foot into the market first, it could conservatively have revenues of $550 million a year. Typical conservative assumptions for the market for first-into-the-market drugs are between 10 per cent and 25 per cent of patented drug revenues.

ORCHID'S PIPELINE

Seven first-to-file applications that Orchid has already made; seven more to follow.
Product	Treatment area	Brand name	Patent Holder	Current market size
Desloratidine IR	Anti-allergic	Clarinex	Schering Corp	$275 million
Desloratidine ODT	Anti-allergic	Clarinex (variant)	Schering Corp	$20 million
Memantine	Alzheimer’s disease	Namenda	Forest Labs	$1 billion
Eszopiclone	Cntrl. Nervous System	Lunesta	Sepracor	$800 million
Ibandronate	Osteoporosis	Boniva	Roche Labs	$1 billion
Gemifloxacin	Anti-bacterial	Factive	Oscient Pharma	$30 million
Duloxetine	Cntrl. Nervous System	Cymbalta	Eli Lilly & Co	$2.5 billion
Source: Company

Orchid expects to get a window of exclusivity for at least two drugs (it doesn't name which two), but this time it is not banking on the same for expected high revenues. But, to be sure, it can expect the innovator or patent-holding companies to pull out all defences. In the case of Tazo+Pip, for instance, the company fought Wyeth in courts for two years before it got the regulatory approval to sell the generic variant. Had it come in time, Orchid could have made some $400 million from it.

Rao blames that delay as one of the reasons for Orchid's cash flow troubles that snowballed into a debt crisis. "There was a lumping of investments and a lumping of sales, and we got caught in that bad middle where revenue was not forthcoming to service the debt," he says with candour. Today, after paying off part of its debt, Orchid still has $134 million outstandings in convertible debentures that Rao is confident he will service through internal accruals by the time they come up for redemption in 2012. The company has not declared its fiscal 2010 results yet, but First Global analyst Kavita Thomas predicts that it will end the year with net profits of Rs 65 crore on sales of Rs 1,571 crore, buoyed by the sale to Hospira.

It helps that Orchid's debt-equity ratio now allows flexibility on raising fresh capital. "The money would be used to acquire front-ending companies for direct sales in regulated markets and retain sales commissions paid to partners," says Ch Ram, Head of Investor Relations at Orchid.

Rao, on his part, is clear. As an entrepreneur he has faced challenges in the past and, he says, he will surmount this one, too. "I have learnt from my mistakes and moved on." The gutsy entrepreneur could get it right, yet.