Is Sun set on Taro?

What was considered a done deal has now come undone. A year ago, in late May 2007, Mumbai headquartered Sun Pharma, together with its subsidiaries, announced that it had signed ‘definitive agreements’ to acquire Taro Pharmaceutical Industries, a multinational manufacturer of generic pharmaceuticals with products being sold in the US, Israel and Canada. The deal, an all-cash one, was struck at $7.75 (Rs 310) per share, giving it a total value of $454 million (Rs 1,816 crore).

The rationale behind the acquisition made a lot of sense then, as it does even now. First, Taro is well-entrenched in the US. North America accounted for more than 90 per cent of Taro’s sales at the time of acquisition. Secondly, Taro has world-class manufacturing sites with regulatory approvals in Canada and Israel. At the time of signing their agreement, Taro had more than 100 ANDAs (abbreviated new drug applications, which are basically approvals for generics) in the US. As an industry watcher puts it, the Taro acquisition would have been Sun’s “passport to the US generics market”.

However, even at the time of the acquisition, not all was well. For one, as of March 2007, Taro hasn’t been a hugely profitable company. Its 2006 losses are estimated at $141 million (Rs 564 crore); a year later, there was a turnaround, although net sales of $313 million (Rs 1,252 crore) and a net profit of $21.1 million (Rs 84.4 crore) weren’t exactly cause for celebration.

For another, Franklin Advisers and Templeton Assets Management, the owners of approximately 9 per cent of Taro’s ordinary shares, had filed a motion in a Tel Aviv court to prevent alleged discrimination against minority shareholders. Sun Pharma and Taro then had stated that the filings by Franklin Advisers and Templeton were “without merit” and Taro would contest the action “vigorously”. That was May 2007.

Shanghvi’s options Raise the bid price to above $10.25 a share and renegotiate with Taro’s Board Sell the 34 per cent stake that Sun holds in Taro at a higher price to a third party once valuations look up Go to the Israeli courts Make a special tender offer to purchase the remaining outstanding equity from the public and force founders to sell their share

Come 2008, the agreement is in tatters and both parties are washing dirty linen in public. It started with Taro calling off the agreement last fortnight. Barrie Levitt, Chairman of Taro’s board, in a rather bluntlyworded letter informed Dilip Shanghvi, Chairman & Managing Director, Sun Pharma that the agreement was off.

“When we signed our merger agreement last year,” wrote Levitt, “for the purchase of Taro at $7.75 per share, we were both surprised at the intensity of objections raised publicly by Templeton and Brandes (another shareholder in Taro). Continuing the $7.75 merger agreement in effect more than 12 months after it was signed no longer makes sense....”

Levitt also suggested that the board had unanimously determined that a renewed offer by Sun, of $10.25 (Rs 410) per share, was ‘inadequate.’ (Sun, for its part, says the offer hasn’t yet been formally made as it has still to be ratified by the board.) According to Levitt, given Taro’s “dramatic return to profitability”— the company registered a first quarter net profit of $7.5 million (Rs 30 crore)—the value of Taro’s new product pipeline and advice from Merill Lynch (Taro’s advisor), the new offer simply did not hold its ground. He also went on to add that Sun had refused Taro’s request to permit their respective financial advisors from meeting and ironing out their differences.

Barely 24 hours later, the letter war intensified; it was time for Shanghvi to fire his salvo. In a missive addressed to Levitt, the Sun CMD shot down many of Levitt’s allegations and even went on to make a few of his own. For starters, Shanghvi dismissed Taro’s right to terminate the merger. He also poohpoohed Taro’s claims of a financial turnaround. “We remain sceptical of Taro’s claims of a turnaround.

Taro has only $47 million (Rs 188 crore) in cash as of March 31, 2008. In our opinion, if not for Sun’s cash injections of approximately $60 million (Rs 240 crore) last year, Taro would virtually have negative cash—hardly the ‘dramatic’ improvement of which Taro has boasted,” Shanghvi told a bunch of probing equity analysts in Mumbai last fortnight. Sun has also objected to Taro’s attempts to sell its Irish operations, almost accusing Taro of asset stripping. “Why is the value of Taro Ireland in the proposed sale agreement less than the real estate value of the facilities?” he asks.

The gloves are off Both companies have their own story to tell. Point Sun’s renewed price offer of $10.25 per share is not adequate considering Taro’s pipeline and a dramatic turnaround of its financial health Sun’s offer was premised on deleting the provision of 1/3 disinterested minority shareholder approval in the merger agreement. That was against Israeli law Sun prevented the financial advisers of both companies from meeting up and resolving differences Counterpoint It did not make an offer to purchase Taro at $10.25 per share, but reached out to the Taro Board with a proposal to recommend to Sun’s board a potential merger at that price. That was done to facilitate meaningful discussion It did not prevent any meaningful discussion between the two parties. In fact, Shanghvi says he personally reorganised schedules to meet the Taro Board where most members were asked to be in a listen-only mode Taro’s ‘dramatic turnaround’ would not have been possible without the cash injection from Sun

Shanghvi also dismisses Taro’s allegations that Sun had stopped their financial advisers from interacting. “We only recently refused your request to permit our financial advisers to meet Taro’s financial advisers because it was clear to us that Taro had no intention of engaging in a meaningful discussion… I personally reorganised my schedule at short notice to meet the Taro Board…at the meeting, (Taro) Board members were prohibited from asking questions or engaging in any discussion,” is how Shanghvi puts it.

Shanghvi also informed analysts that Sun would now consider all its “options”. So, what are these options? For starters, Sun could consider upping its bid of $10.25 per share. The Indian company could also consider selling its share to a third party at the $10.25 per share price it had suggested.

Sun has acquired over 13.6 million shares of Taro over the past year, close to 34 per cent of Taro’s equity, at various price points, from $6 (Rs 240) to $10.25 per share. At today’s higher share price, Sun can walk away with more than a few million dollars in profit if it decides to sell. “It not a do-or-die acquisition for Sun. But, Sun can always walk away with a profit on the back of better valuations,” says Sarabjit Kour Nangra, Vice President (Research, Specialist-Pharmaceutical), Angel Broking.

A final option will be legal recourse. Analysts at Enam Securities expect Sun’s legal team to “file a reply to Taro’s motion for a declaratory ruling that has been filed in the Tel Aviv District Court”. As an Enam report points out: “Sun may choose to file a Special Tender Offer to purchase the remaining outstanding equity from the public; and simultaneously move to enforce the agreement whereby the Taro founders had covenanted to sell their stake—at the revised price.”

Legal experts believe that Sun’s case is likely to be strong. “If Sun goes to the courts, and can prove that Taro’s turnaround has happened because of the funds pumped in by Sun, then they stand a good chance in the courts,” says Murali Ananthasivan, Partner, AZB & Partners. Over to Sun and Shanghvi.

On takeover trail Sun Pharma is no stranger to acquisitions. May 2007: Signs agreement for acquiring Taro Pharma in a $454 million all-cash deal December 2005: Purchases dosage form manufacturing operations of Able Labs in the US for $23.15 million September 2005: Signs agreement to buy a manufacturing facility in Bryan, Ohio from Valeant Pharmaceuticals International August 10, 2005: Acquires a raw materials and dosage form manufacturing operations in Hungary from Valeant 2004: Niche brands purchased from Women’s First Healthcare. Merged Phlox Pharma, an API manufacturing pharma company 1997: Initial stake in Caraco; incremental stake increases (1997-2003); larger stake buyout (2004) Does taro mtter? It could be Sun’s passport to the US generics market. Taro is well-entrenched in the US market, with North America accounting for 90 per cent of sales at the time of acquisition Has world-class manufacturing sites with regulatory approvals in Canada and Israel Has a strong franchise in dermatological and tropical products, in addition to cardiovascaular, neuropsychiatric and anti-inflammatory therapeutic categories Would have been Sun’s big entry into the US generics market