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Is Sun-Ranbaxy Deal Heading For A Probe?

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Ever since the announcement of the Sun Pharma-Ranbaxy deal, in April 2014, the speculation has been rife whether the case would progress to a detailed investigation phase in its scrutiny before the Competition Commission of India (CCI) or not. It has been covered and debated in the media extensively. By the own announcement of the parties, this merger seeks to create the "Fifth Largest Global Specialty Generic Pharma Company in the world", and also become the No.1 pharmaceutical company in India. The combined entity would have operations in 65 countries, command 47 manufacturing facilities across five continents, and be a significant platform of specialty and generic products marketed globally. The deal itself is an all-stock transaction with a deal value at approximately $4 billion ($3.2 billion in equity and $0.8 billion in net debts). In exchange, Ranbaxy shareholders will receive 0.8 shares of Sun Pharma for every share they own. While the deal has been cleared by the National Stock Exchange, the Bombay Stock Exchange, as well as the Andhra Pradesh High Court, it still needs the approval from the Securities and Exchanges Board of India (SEBI) and CCI before consummation.

To understand the implications of this deal and examine likelihood and the form of its clearing the regulatory hurdle, it is necessary to understand the nature of Indian pharma industry. The Indian pharmaceutical is one of the developing world's largest and most developed industry, ranking 4th in the world in terms of production volume. Over the last 30 years, India's pharmaceutical industry has evolved from its earlier almost nonexistent place to a world leader in the production of high quality generic drugs. India has garnered a worldwide reputation for producing high quality, low cost generic drugs. The industry currently meets India's demand for bulk drugs and nearly all its demand for formulations, with the remainder being supplied by foreign multinational corporations.

From June 1, 2011, the enforcement provisions of the Competition Act, 2002(the Act) relating to review of combinations (popularly also known as 'merger control' in different competition law jurisdictions) have come into force in India. The Act empowers the CCI, to review all proposed combinations crossing the thresholds provided under Section 5 of the Act read with relevant notifications issued by the Government. Review of mergers or combinations are undertaken by the CCI with the intent that if the competitive structure of the market is preserved or enhanced, there will be less need for an ex post intervention against any likely abusive conduct. According to the procedure laid out in the Act, read with the Competition Commission of India (Procedure in regard to the transaction of business relating to combinations) Regulations, 2011 (The Regulations), there can be three stages of enquiry into combinations: the first stage is when on due notification of the combination, the CCI is of the 'prima facie' opinion that the combination does not, or is not likely to cause an appreciable adverse effect on competition(AAEC) within the relevant market in India, it can approve the combination. However, if the CCI is of the 'prima facie' opinion that the proposed combination causes or is likely to cause AAEC, it can issue a show cause notice to the parties as to why an investigation in respect of such a combination should not be conducted. Thereafter, after receipt of the response of the parties to the combination to such a show cause, the Commission may call for a report from the Director General (DG).

In the present scheme of the Act and its stiff time lines, a report from the DG looks to be an impractical possibility. After the receipt of the response of the parties to the combination and the report of the DG, if any, the CCI is to form (another) 'prima facie' opinion that the proposed combination has or is likely to have an AAEC. After this, if CCI is of (another) 'prima facie' opinion that the proposed combination has or is likely to have an AAEC, it shall require the parties to the said combination to publish details of the combination bringing the combination to the knowledge or information of the public and persons affected or likely to be affected by such combination . At this stage, the CCI may invite any person or member of the public, affected or likely to be affected by the said combination, to file his written objections, if any before the CCI. After this, the CCI may also call for additional or other information as it may deem fit from the parties to the combination.

Thereafter, the CCI can pass any order it finds appropriate within the provisions of section 31 of the Act. It is important to note that from the time when the merger control provisions were brought into force till now, CCI has cleared more than 160 proposed combinations, including more than 30 so far in this year, without going to the stage of issuing the show cause notice to the parties to the combination. Thus, the Sun Pharma-Ranbaxy transaction is the first combination proposal that has received a show cause notice under Section 29 of the Act.

The main focus ,while assessing combinations, is usually on the analysis of existing or near future potential competitors, estimating the merging parties' combined market strengths and focussing more on the overlapping product segments of the parties to the combination. The CCI aims to look at the comparison between these parameters prior to and after the merger having taken place. Therefore, by its very nature, it is an exercise in a good judgement extrapolation without being necessarily an exact mathematical calculation. One of the common methods of analyzing the competitive effects of a merger is by reference to the Herfindahl-Hirschman Index (HHI), which is one of the possible routes for estimating market concentration. In simple language, HHI is the sum total of the squares of the market shares of different market players in the relevant market. The difference in HHI (or  ∆ HHI ) before and after the merger indicates the impact of the merger on the market dynamics.  The increase in the HHI indicates the enhanced concentration or otherwise. While the Act or the Regulations do not provide specific reference to the HHI or ,for that matter, any other methods to measure market concentration, the latest Horizontal Merger Guidelines published by the US Federal Trade Commission (FTC) and the Department of Justice Antitrust Division categorise the market concentration , measured by the HHI , below 1500 as un-concentrated. Further, a merger having ? HHI below 100, according to these guidelines, is not a matter of much concern. No doubt, these guidelines have no binding force in any other jurisdictions, nonetheless the persuasive value of these economic tools from jurisdictions which have been practicing this craft for more than a century cannot be denied. Therefore, these aspects are quite likely to form the rough calculation noting sheets of the merger review teams looking at any merger including this one.

The Indian pharmaceutical industry is largely un-concentrated with the top ten enterprises currently occupying market shares between 3 per cent and 6.5 per cent. The break-up of market shares along with their sales values for the top ten pharmaceutical companies are as follows :
1.    Abbott 6.5 per cent market share with sales of $783 million
2.    Sun 5.4 per cent market share with sales of $651 million
3.    Cipla 5.0 per cent market share with sales of $604 million
4.    Cadila 4.4 per cent market share with sales of $538 million
5.    Ranbaxy 3.8 per cent market share with sales of $465 million
6.    GSK 3.7 per cent market share with sales of $447 million
7.    Mankind 3.6 per cent market share with sales of $431 million
8.    Alkem + Cachet + Indchemie 3.5 per cent market share with sales of $423 million
9.    Lupin 3.3 per cent market share with sales of $406 million
10.    Pfizer 3.0 per cent market share with sales of $354 million

Based on the above figures, it can be surmised that if the proposed combination is approved by the CCI, in its current form and structure, the newly combined entity of Sun Pharma and Ranbaxy would, without accounting for other dynamic factors during the deal duration, command a market share of 9.2 per cent with sales of approximately $1116 million. While a market share of 9.2 per cent by itself may not give much reason for concern in a market which is largely un-concentrated and where their closest competitor would continue to have a market share of 6.5 per cent, one needs to keep in mind that for the purposes of the merger, it is not only necessary to look at the entire pharmaceutical industry in India as a whole, but it is also imperative to realise that the pharmaceutical industry also consists of a number of different smaller segments, and the competitive effects of the merger on each of these segments has to be analysed as well. This is what may possibly be the concern of CCI warranting closer analysis. On the face of it, the enhancement in HHI after the merger, on the basis of the above market shares would be about 41. Even after the merger, the HHI is a little above 230 which 'prima facie' is not a matter of great concern in the entire market landscape. Now let us look at the other side effects of the deal.

Sun Pharma and Ranbaxy, currently, have 128 common formulations and, according to an analysis of the latest data from market research firm AIOCD Awacs, if the proposed combination is allowed, Sun Pharma will have a market share of over 40 per cent in the market of 25 separate drugs. Out of these 25 drugs, for nine drugs its market share will be more than 65 per cent and will range between 40-60 per cent in the market of the other 15 drugs.  Closer analysis reveals that Sun-Ranbaxy combined will have a 92 per cent market share in the combination of Rosuvastatin and Ezetimibe, used to treat high cholesterol; a share of more than 57 per cent in the market for common anti-inflammation drug Diclofenac, a market valued at Rs 430-crore; a 78 per cent market share in Somastostatin, used to treat gastrointestinal hemorrhage the market of which has an annual sales figure of Rs 50 crore; 76 per cent of the Rs 80-crore market in prostate cancer drug Leuprorelin; and 55 per cent of the Rs 48 crore market in Quetiapine, a drug used to manage dementia in the elderly.

Therefore, the disproportionate market share that the combined entity would command in various segments of the pharmaceutical industry of India is no doubt an issue any competition agency is likely to look at closely. Although it is not known in public domain but this could be one of the bases for the 'prima facie' opinion and the consequent show cause notice to the parties to the combination in this case.

Section 31 of the Act allows the CCI to follow one of three courses of action - Where the CCI is of the opinion that the proposed combination does not, or is not likely to have an AAEC, it can pass an order approving the said combination.  Alternatively, where the CCI is of the opinion that the proposed combination has, or is likely to have an AAEC, it can pass an order prohibiting the combination.  Additionally, if the CCI is of the opinion that the proposed combination has, or is likely to have an AAEC but such adverse effect can be eliminated by suitable modification to such combination, it may propose appropriate modifications to the combination to the parties to such a combination . This proposal of modifications is commonly referred to as remedies to mergers. These remedies are usually of two types: structural remedies and behavioural remedies.

Structural remedies focus on eliminating the possible adverse effects on competition in the relevant market by modifying the structure of the combination, ordinarily through the divestiture of a subsidiary or production facilities and the creation of a new competitive entity or the strengthening of existing competitors . This form of remedy is usually undertaken because it is easy to enforce and does not require long-term supervision by the competition authorities after the combination has been given effect to.   In case of pharmaceutical mergers, structural remedies, in the form of divestiture of a subsidiary or brand of product, seems to have been the preferred mode of modification of mergers across jurisdictions, not only because it prevents adverse effects on competition, but also since it does not require medium or long term monitoring measures .

The European Commission's (EC) approach to pharmaceutical merger cases displays a marked tendency to seek product divestments if market shares exceeded 40-50%.  For instance, in the 2008 merger between Teva and Barr Pharmaceuticals the EC , after due investigation, felt that the parties had significant overlaps in the oncology field in a number of eastern European countries, namely the Czech Republic, Hungary, Poland and Slovakia, and only cleared the merger subject to divestiture in certain oncology products. Similarly, In 2009, the EC cleared the acquisition by Sanofi-Aventis of Zentiva, a generic manufacturer active mainly in central and eastern Europe subject to the divestment of various finished pharmaceuticals in Bulgaria, Estonia, the Czech Republic, Hungary, Romania and Slovakia. In its competitive analysis of that merger, one of the main points taken into consideration by the EC was whether Zentiva produced the equivalent generic product (i.e. based on the same molecule) to any of Sanofi- Aventis' original pharmaceuticals. Ultimately, the EC found that the parties had high combined market shares in a number of markets, and thus required divestments.

In the US, the Federal Trade Commission (FTC), which usually takes the investigatory lead for pharmaceutical mergers, appears to favour structural remedies as well. This can be evidenced from a number of instances where pharmaceutical mergers were only cleared subject to divestiture. For example, in 2006, when Actavis announced its proposed $110 million acquisition of Abrika Pharmaceuticals Inc, the FTC after the process of review found that the proposed transaction would lead to anticompetitive effects in the market for generic Isradipine capsules. Generic Isradipine is a calcium channel blocker typically used to lower blood pressure in patients, as well as treat hypertension, ischemia and depression.

According to the FTC, Actavis and Abrika were the only two suppliers of generic Isradipine capsules in the U.S. and together accounted for 100% of the $3 million in sales in this market in 2006. To assuage the concerns of the FTC and facilitate the approval of the merger, Actavis agreed to divest all of Abrika's assets and rights necessary to manufacture and market generic Isradipine capsules to Cobalt Laboratories Inc . Similarly, in the 2007 acquisition of E. Merck oHG by Mylan Laboratories Inc. in a deal worth approximately $6.7 billion, the FTC was of the opinion that the proposed transaction was likely to substantially lessen competition in five generic drugs markets where the newly formed entity would have achieved excessively large market shares by virtue of the merger. The Merger was subsequently approved only on the condition that Mylan would divest all of the rights and assets to Merck Generics' products in each of these five areas to Amneal Pharmaceuticals LLC .

Behavioural remedies, on the other hand, may be in the form of commitments by the parties to terminate exclusive agreements which would otherwise have foreclosure effects post merger, acceptance of price-caps on particular products for specified periods of time, or remedies to facilitate market entry through the grant to competitors of access to infrastructure, platforms, key technology, production or R&D facilities or through the licensing of intellectual property rights, Behavioural remedies may be difficult to control and enforce . While rare, the proposition of behavioural remedies for pharmaceutical mergers is not completely unheard of. In China, the MOFCOM accepted certain behavioural and quasi structural remedies in the Novartis/Alcon merger, wherein the parties gave commitments not to re-enter a particular market for a period of five years and the termination of an existing exclusive distribution agreement n another market .

Interestingly, some people wonder why need the CCI burden itself with the task of wrecking its brains with the nitty gritty of the merger when there is another statutory authority, National Pharmaceutical Pricing Authority (NPPA), controlling nearly 30 percent of the medicines being sold in domestic market and having further powers to fix prices of any medicine if it finds the prices unreasonable. In such a scenario, there being hardly any possibility of an abuse, the deal ideally should ne let alone. These people should understand that invoking of public interest by NPPA is an exception rather than the rule. In contrast, CCI has to be a real time monitor of the price movement and the likely abuse of market power in different market segments including pharmaceutical market segment.

Therefore, if the CCI is of the opinion that the proposed combination results or is likely to result in AAEC but that these adverse effects can be eliminated through modifications to the combination, it may choose to propose either structural or behavioural remedies with chances of them being structural being quite high in keeping with the trend in most jurisdictions. Although, with the matter being still before CCI with the final outcome being awaited, nobody has a business to pre judge the issue but approval of the deal with appropriate modifications appears to be the most likely scenario.

The author is the Chairman of K. K. Sharma Law Offices, and a former Director General and Head of Merger Control of Competition Commission of India