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BW Businessworld

Two To Tango?

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At the sprawling Ranbaxy Laboratories headquarters in Gurgaon, nothing much seems to have changed in the last four years — since it was taken over by Japanese drug major Daiichi Sankyo in June 2008 (63.92 per cent stake for $4.6 billion, then valuing Ranbaxy at  Rs 36,000 crore or $8.5 billion).

Ranbaxy’s promoter family scion, the late Parvinder Singh’s photograph still adorns the central hall; there is not a single Japanese citizen in the top executive team and most of the employees deal with the same customers they were handling earlier. To an outsider, it will be hard to believe that Ranbaxy is part of a Japanese multinational company.

“I would characterise Ranbaxy as a pharmaceutical company of Indian origin with Japanese investment,” says MD and CEO Arun Sawhney. “There is lot of Indianness in Ranbaxy and it is important to retain that character. Probably that is the value proposition for Daiichi.”

But those assertions are some sort of camouflage. It is Daiichi philosophy on corporate governance and Daiichi processes that are driving the new Ranbaxy today. And not without reason: the company is still reeling from the effects of the worst crisis in its history.

Shock To The System
Daiichi’s acquisition of Ranbaxy has, in a way, been unique. While Daiichi has always been a drug discovery company, the other is a generic firm. The acquisition was meant to result in a hybrid business model that gave Ranbaxy access to Daiichi products and Daiichi access to Ranbaxy’s bigger geographical presence.



But things haven’t quite panned out — so far. The 51-year-old Ranbaxy, once the benchmark in production and quality systems among Indian drug makers, was banned in September 2008 by the US Food and Drug Administration (USFDA) from selling 30 drugs in the US for bad practices at three of its plants (at Dewas in Madhya Pradesh and Paonta Sahib in Himachal Pradesh). The ban came on top of an even more serious investigation into whether it had falsified data during the drug approval process.

Within a month, Daiichi, which had paid 20 times Ranbaxy’s operating profits for FY07, at a premium of over 53 per cent on Ranbaxy’s average stock price, saw its stock crash 40 per cent.

 
"Ranbaxy knows how to develop, register and market generics across the world" D.S. BRAR Former MD & CEO, Ranbaxy
Also, Daiichi struggled to keep the Ranbaxy flock together as ever since the change in management, there were frequent changes at the top level. Several senior executives left, reportedly finding it difficult to adapt to the new environment. This includes former MD Atul Sobti, president and CFO Omesh Sethi (a 20-year veteran) and global HR head Bhagwat Yagnik.

In August 2010, Daiichi Sankyo elevated Arun Sawhney, president of the global pharmaceuticals business, as MD following Sobti’s exit. Dale Adkisson, a Daiichi executive based in the US, was brought in as executive vice-president and head of global quality.

Daiichi also faced another challenge in the form of Zenotech, a Ranbaxy subsidiary. Its founder, Jayaram Chigrupati, was unhappy with the price Daiichi was offering to buy him out, which was lower than Ranbaxy’s open offer. The legal battle that ensued is as yet unresolved. However, Daiichi managed to increase its stake through an open offer to the public, and now owns nearly two-thirds of the company. Daiichi and Ranbaxy brought in B.K. Raizada, an old Ranbaxy hand, as Zenotech’s MD. Says Raizada about the then state of affairs at Zenotech: “The plant was not even functional; we decided to have a complete overhaul.”

The USFDA issue dragged on for four years until, in August this year, Ranbaxy agreed to a consent decree imposing stringent regulatory compliance levels on itself. As part of the agreement, Ranbaxy withdrew the application for approval for 27 of the 30 drugs banned by the US regulator.
 
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The settlement comes as a major relief for Ranbaxy; but it has to make up for lost time. Analysts estimate that it will be another two or three years before the buyout comes to fruition. Will that mean more time lost for Daiichi, or will Ranbaxy rebound quickly?

Following The Money
In 2002, Ranbaxy had set an ambitious internal target of $5 billion in revenues by 2012 (Ranbaxy crossed $1 billion in 2004). Today, its revenues are just over $2 billion, even if it is the first Indian drug company to reach that milestone.

Sawhney concedes that it has been a tough four years since Ranbaxy became a subsidiary of the Japanese company. Foreign exchange, business profitability and reserves were just some of the fundamentals of the company affected by the crisis, besides the time and management energy that went into fixing the regulatory issues. But, Sawhney insists, it is now a stronger company. The revised deadline for achieving the $5-billion target is now 2017.
 
"The Zenotech plant was not even functional; we decided to have a complete overhaul" B.K. RAIZADA Managing director, Zenotech
Take a closer look to see how much the crisis has affected Ranbaxy. In 2008, revenues were Rs 7,445 crore, a growth of 8 per cent over the previous year. But it also made a net loss of Rs 934 crore, mainly due to mark-to-market foreign exchange derivative losses of Rs 784.3 crore. The main reason: bad hedging decisions. In 2009, it had revenues of Rs 7,611 crore and a net profit of Rs 310 crore. In 2010, Ranbaxy did even better with Rs 8,975 crore in revenues and profits of Rs 1,515 crore. In 2011, Ranbaxy’s revenues crossed Rs 10,180 crore, but it posted a net loss of Rs 2,883 crore — the biggest in its history.

The company had to provide for a $500 million (nearly Rs 2,460 crore) penalty to resolve all potential civil and criminal liability related to the investigations by the USFDA, and the agreed consent decree that outlines Ranbaxy’s obligations in fixing the quality issues.

Analysts believe that Ranbaxy has 13 first-to-file opportunities (FTF), which includes Takeda’s  diabetes drug Actos ($4.5 billion in sales) and AstraZeneca’s heartburn drug Nexium ($5 billion in sales). “Lipitor’s gains were shared with Teva (the Israli generics company),” says Ranjit Kapadia, vice-president Centrum Broking. “The same profit-sharing might apply for future FTF opportunities too.”

The US will remain the chief revenue earner for Ranbaxy, says Sawhney. In 2010, Ranbaxy had 135 product approvals in the US, with another 70 drug-marketing applications pending with the USFDA. “We will continue the aggressive US Para IV strategy (breaking patents, and fighting legal battles to get first exclusive generic drug launch opportunities for six months upon patent expiry),” he says.

Despite the US ban, revenues were sustained by the FTF windfall accruing from the sale of Valacyclovir in 2009, Donepezil in 2010 and now from Lipitor, besides an authorised generic version of Caduet. As it turned out, sales of Lipitor’s generic version helped Ranbaxy pay its penalties, says former MD and CEO D.S. Brar.

The generic variant of anti-cholestrol drug Lipitor — the world’s largest selling drug with $9.6 billion in sales in 2011 — helped the company double its revenues in the North American market during the first quarter of 2012. Ranbaxy had a six-month market exclusivity on the product, being the first successful patent invalidator. Ranbaxy went on to acquire 50 per cent market share, even better than the original and its authorised generic, and was cheaper by 60-70 per cent. “Though Lipitor is now a generic, our product will continue to have a good share of the market,” says Sawhney.
 
 THE HYBRID MODEL SO FAR
  • Daiichi leverages Ranbaxy¡¦s presence in Africa for marketing & distribution
  • Ranbaxy launches Daiichi¡¦s antihypersensitivity drug Olvance in India
  • The two expand business in Japan
  • Ranbaxy launches Daiichi's Prasugrel in India
  • Launch of Evista by Ranbaxy in Romania
  • The hybrid model has been expanded to Mexico
  • Ranbaxy markets Daiichi¡¦s products in Singapore
  • Ranbaxy launches Daiichi¡¦s Tavanic in Romania & South Africa
  • They have joint social contribution initiatives in India and Africa
  • Ranbaxy extends Daiichi¡¦s product reach to pharmacists in Italy
  • Ranbaxy launches DS¡¦s Cravit in Malaysia
  • Collaboration extended to Venezuela
  • In Mexico and Japan, Daiichi is the front-end for the business
  • In Africa, Malaysia, Singapore, Romania and India, Ranbaxy is the front-end

The company is also filing for new products (about 20-25) from its latest Mohali facility, besides its other plants. The USFDA is expected to assess the remedial measures implemented by Ranbaxy at Dewas and Paonta Sahib in the second quarter of this year.

There is still a huge market out there. Global generic spending is estimated to be $234 billion for 2010 and it is expected to be between $400-430 billion by 2015; 70 per cent of this will be outside the developed markets, according to market research firm IMS Health.

Goodbye Research, Hello Generics
Until mid-2010, Daiichi had allowed Ranbaxy’s research unit to function independently, though it had slowed down or abandoned most of its existing new drug research programmes. In July 2010, it transferred Ranbaxy’s New Drug Discovery Research to Daiichi Sankyo India Pharma, a 100 per cent Daiichi subsidiary registered in India; 170 scientists moved to Daiichi’s global R&D team.

The Daiichi Sankyo Life Science Research Center, the new setup in India, was expected to play a key role in the group’s global drug discovery research programme as one of its four R&D hubs — along with Daiichi Sankyo RD Associe (Japan), Asubio Pharma (US) and U3 Pharma (Germany).

The only new drug molecule that was not transferred was a drug candidate for malaria, which was launched after successful clinical trials by Ranbaxy in India a few months ago. “We have around 1,000 scientists in Ranbaxy who will continue our earlier work on developing new differentiated products and novel technologies and we will increase our research and development spends,” says Sawhney.
 
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But for all practical purposes, Ranbaxy is now a pure generics company. “Ranbaxy’s DNA is generics. It knows how to develop, register and market generics across the world,” says Brar. “It gives Daiichi a strategic advantage for its growth in the generics segment, especially in the fast-growing Japanese generics market.” Which was one of the original objectives of buying out the Singh brothers: Ranbaxy would lead Daiichi’s generic entry into its home base.

Challenges Galore
With the regulatory cleanup, the financial beating absorbed, and an almost-complete business restructuring, will glory days be back again? Ranbaxy’s business mix remains almost the same as before. If emerging markets were contributing 44 per cent and developed markets about 43 per cent of Ranbaxy’s revenues in 2005, the current ratio is almost similar —   emerging markets 47 per cent and 46 per cent from developed markets.

Its troubles in the US may not be over yet. Angel Broking notes that the consent decree between Ranbaxy and the FDA has not specified any timeline by when the issues would be considered over and done with. “As of date, we have fulfilled all the obligations and, going forward, we should be able to continue doing so,” says Sawhney. “Please do not expect an exponential growth; it will be only incremental business; but we are doing well in the US.”

In India, though, business is not doing that great. Its domestic formulations business has been growing at merely 7-8 per cent for a few years — below industry growth rates. Sales of antibiotics, which account for less than 17 per cent, did not grow much last year. Also, Ranbaxy’s operating profit margins fell from 12.6 per cent in 2006 to 6.1 per cent in 2009, due to regulatory problems and forex losses.

But things seem to be getting better. Operating margins were 16.6 per cent and 14.2 per cent in 2010 and 2011, respectively.

Predictably, finances are vulnerable. The company also has a derivatives exposure of $1.5 billion as of the first quarter of 2012, says an analyst report. “They still have a backlog of derivatives,” says Centrum’s Kapadia. “Currency fluctuation will continue to have its impact on the company’s quarterly results, thanks to provisions for mark-to-market losses.”



The Hybrid Business Model

Given the rocky road, Ranbaxy is banking on a hybrid model: a combination of Daiichi’s patented drugs and established out-of-patent products (the company is present in 21 countries), and Ranbaxy’s inherent generics strength.

Outside home territory, Daiichi operates in the US, 15 European countries, China, South Korea, Thailand, Mexico, Brazil and Venezuela. About 52 per cent of its revenues are from Japan, 19 per cent from Ranbaxy, and another 19 per cent from North America. Ranbaxy is strong in Africa, Russia and other emerging markets, besides the Asia-Pacific region. In 2012, Ranbaxy and Daiichi are targeting 150  billion yen ($1.9 billion) from markets outside Japan, the US and Europe; in Europe alone, the target is $1.6 billion in net sales through Daiichi Sankyo Europe GmbH and Ranbaxy’s European operations.

In markets where Daiichi Sankyo is strong ( Japan, Germany, France), it will sell Ranbaxy’s products. In markets where Ranbaxy leads (South Africa, Romania, Russia, Singapore), it will sell Daiichi products. In markets where both are strong, they will go to the market separately.

Ranbaxy and Daiichi will synergise across the globe — via collaborative marketing opportunities, manufacturing, raw material sourcing, R&D, global supply chain, IT and CSR activities.

The hybrid model is intended to help Daiichi  get access to high growth, high volume markets and to low-cost R&D and manufacturing capabilities. To Ranbaxy, the alliance will give access to advanced competencies and capabilities, and  to proprietary products. A ‘Global Hybrid Business Office’, spread between Tokyo and New Delhi, will ensure synergy.

Novel though the idea is, it is not without challenges. The generics business is vastly different from innovation-driven original drug manufacturing. Few innovator companies have successfully sold generics (except Novartis and its generic arm Sandoz, both working as totally independent companies).

In the wafer-thin-margin generics business, increasing the base business with acquisitions in key geographies is an important game plan for growth. For example, the largest generics company, the $18.3 billion  Teva Pharmaceuticals, completed four major acquisitions in the last four years — Barr Pharmaceuticals for $7.5 billion, German generic maker Ratiopharm for $5 billion, US-based Cephalon for $6.8 billion and Japanese Taiyo Pharmaceutical Industry for 40 billion yen ($0.5 billion).

Ranbaxy paid over $500 million in 2006 to acquire Terapia (Romania), Be-Tabs (South Africa), Allen (Italy), Mundogen (Spain), Zenotech and Biovel in India. Acquisitions and new market entry are a continuous process for big generic companies. But, says Sawhney, “We will not go for acquisitions to boost topline; it has to be profitable from day one and should be business or technology accretive.”

Will the generic-innovator alliance work? One cannot really predict. This we do know, though: it is not going to be easy.

(This story was published in Businessworld Issue Dated 15-10-2012)