Torrent Pharma's bid for Zentiva could be a step too far

Torrent Pharma seeks to boost its European footprint with the largest outbound transaction in India's pharmaceutical history. But it may not pay off for its shareholders.

On the face of it, Torrent Pharmaceutical's $2.5 billion bid for Sanofi's generic drug subsidiary Zentiva looks like a great deal for India’s 11th largest pharma firm by market cap. Similar product portfolios, new market penetration in 50 countries home to a billion people and an established pharma player in Eastern Europe all points to a sure winner for Torrent.

Zentiva is Europe’s third largest generic pharma company based in Prague, Czech Republic, according to trade database IMS. Zentiva provides medicines in 15 different key therapeutic areas such as cardiovascular, gastrointestinal, anti-inflammatory, pain management, metabolic and blood disorders, which neatly aligns with Torrent’s key product lines domestically. Zentiva was purchased by Sanofi in 2009 for close to $2.6 billion and recorded Ebitda of $150 million in 2017.

With the latest round of bidding due to close on March 28, Sanofi's divestment of the generic drug manufacturer for a similar sum it paid for it in 2009 has also attracted attention from Brazil’s EMS as well as several private equity funds which may push up the price, according to a Reuters report in February.

For Torrent, a larger footprint in the lucrative European market would boost its inorganic growth, after its acquisition of Mumbai-headquartered Unichem Laboratories in November last year for nearly $550 million and the acquisition of the US-based generic pharmaceutical company Biopharm for an undisclosed amount in January this year.

This all looks positive so far.

However, will India’s largest overseas transaction by a drug manufacturer offer such a good deal for investors? For a company with a market cap of $3.4 billion one could argue that it is overstretching itself with a single bite-size of $2.5 billion. Given the European generic drug market is expecting low-to-mid single digit net sales growth into 2020, according to rating agency Moody's data, and in Sanofi’s own words “where geographic synergies are limited and market complexity is increasing”, does this deal represent a step too far for Torrent Pharma?

Staple financing provided by Sanofi’s bankers JP Morgan and Morgan Stanley of around $1 billion certainly makes the offer more attractive to potential buyers, according to a January Reuters report.

The financing will help to reassure equity investors who may be concerned that the price of 16 x 2017 Ebitda seems high when compared to historical norms, data from a 2016 pharma report from  M&A advisory firm IMAP shows.

After several bad experiences between 2000 and 2010, this is the latest sign that Indian pharmaceutical companies are once more looking into Europe over the USA. As investment in the domestic market has increased capacity, there is a case for shipping manufacturing back to India to improve profitability, said Saion Mukherjee, managing director and head of india equity research at Nomura Securities based in Mumbai.

Expectations that the generic business will continue to grow as patents expire in developed markets should also help to soothe investors' minds, with much of Western Europe still a market that lags behind generic drug penetration.

Torrent Pharma's 2017 debt-to-equity ratio of 0.52 is manageable currently, but such a large transaction could push that ratio into more dangerous territory if the market fails to grow in line with expectations.

As the March 28 deadline fast approaches, Torrent Pharma seems to be well placed to grow its business across Europe, with a deal that sees the recent consolidation of the sector continue into 2018 and beyond. But will this foray into Europe cost Torrent Pharma a premium to scale up its business? Or will we see an uptick in activity from Indian pharmaceutical companies looking to build their portfolios in international markets?

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