Acquisition of Ranbaxy by Daiichi-Sankyo

Project Report On M & A of Ranbaxy ltd. And Daiichi sankyo

Submitted By

Navdeep Singh Momi(2013164)Navneet Singh (2013165)Nikita Agarwal(2013171)Poulami Sarkar(2013201)

Daiichi Sankyo Background:Founded on September 28, 2005 through the merger of Daiichi Pharmaceutical and Sankyo, Daiichi Sankyo delivers innovative products that enhance the lives of millions of people around the world. The recent successes include the antihypertensive agent olmesartan (Olmetec), launched in 2002 by Sankyo and now available in more than 50 countries around the world; the antiplatelet agent prasugrel (Efient), launched in 2009 for patients with acute coronary syndrome (ACS) undergoing percutaneous coronary intervention (PCI); and edoxaban (Lixiana), the first available factor Xa inhibitor in Japan, which launched in 2011 to help prevent venous thromboembolism (VTE). Daiichi Sankyo is based in Tokyo and today has 50 billion yen in capital.Ranbaxy Background: RLL is a public limited company with its registered office in Mohali ,Punjab, India. RLL was incorporated on June 16, 1961 as Lepetit Ranbaxy Laboratories Limited. On August 24, 1966, it changed its name to Ranbaxy Laboratories Limited and on October 28, 1970 changed its constitution from a public limited company to a private limited company. -52- Thereafter, the Target Company reverted to its constitution of a public limited company on September 27, 1973 and was publicly listed on the BSE on February 9, 1974. RLL, a public limited company, together with its subsidiaries, joint venture and associates (collectively referred to as the Group) operates as an integrated international pharmaceutical organisation with businesses encompassing the entire value chain in the marketing,production and distribution of dosage forms and active pharmaceutical ingredients. The Group is also engaged in the business of consumer healthcare.Nature of operations:RLL, a public limited company, together with its subsidiaries, joint venture and associates (hereinafter collectively referred to as the Group) operates as an integrated international pharmaceutical organization with businesses encompassing the entire value chain in the marketing, production and distribution of dosage forms and active pharmaceutical ingredients. The Group is also engaged in the business of consumer healthcare products.

Consolidated financial statements of Ranbaxy Ltd

Rationale of merger:Both Daiichi Sankyo and Ranbaxy expect the transaction to create substantial synergies in the long term. The companies benefit from their strikingly complementary businesses, which they believe would bring considerable cost savings in their diversification initiatives, which will be aimed at establishing a strong presence in all pharmaceutical therapeutic areas. For instance, Daiichi Sankyos strength in proprietary medicine is believed to be complemented by Ranbaxys leadership in the generics segment, thus providing the combined business with a broader product base, therapeutic focus areas and well distributed risks. Additionally, both companies have a wide global reach, which is expected to further expand after the merger. Ranbaxys addition can boost Daiichi Sankyos position from 22 to 15 by market capitalization in the global pharmaceutical market. Daiichi Sankyo sees this step as critical to the achievement of its objectives outlined in its Mid-term Management Plan. Daiichi Sankyo has targeted $13.1 billion (JPY1.5 trillion, 1USD=114.2JPY) in sales by 2015 and to increase its operating profit margin by at least 25% and overseas sales ratio by at least 60%. Strengthening its ability to discover new drugs and bolstering its R&D pipeline also feature as objectives in Daiichi Sankyos Mid-term Management Plan. The sales target for fiscal 2010 is $7.5 billion (JPY860 billion, exchange rate: 1USD=114.2JPY) and an operating profit of $2.10 billion (JPY240 billion, exchange rate: 1USD=114.2JPY), of which 25% of its expected sales is in local currency. Daiichi Sankyo expects that its return on equity will increase from 6% to 10% in fiscal 2010 as a result of the merger.SWOT ANALYSIS OF THE DEAL:Strengths:Ranbaxy Largest pharmaceutical company in India Localized operations in 49 countries; sales in 125 countries Sales CAGR of 16.2% in 2002-2007 based on dollar sales Strong expertise in intellectual property and global regulatory affairs 180-day marketing exclusivity for four drugs with an annual sales potential of $8 billion First to file status for 18 drugs with annual sales potential of $27 billion Focus on innovative research in anti-infectives, anti-malaria, metabolic disorders, respiratory diseases and urology Strong alliances with major global proprietary drugs manufacturers (such as the ongoing drug development collaboration with GlaxoSmithKline, which was expanded in 2007; and the joint research partnership with Merck in the anti-infectives segment; the co-marketing agreement with Ferring International for its endocrine drug; marketing agreement with Natco Pharma in Yemen; alliances with Krebs and Jupiter for fermentation-based products and peptides respectively) Strong marketing expertise in one of the most competitive markets viz. India R&D expertise scientists, strong generics business, developing innovative drugs business, expertise in process chemistry Daiichi Sankyo Strong presence in the Japanese prescription drugs market Growth driver potential in blockbuster Olmesartan (anti-hypertensive), Loxonin (anti-inflammatory) and Levoflaxacin (anti-bacterial) drugs Research collaborations with global pharmaceutical majors, such as the collaboration with Eli Lilly for developing the high-potential Prasugrel anti-platelet agent for the treatment of acute coronary syndrome due for launch in fiscal 2008 Opportunities:Daiichi Sankyo has committed a maximum of 20% of its annual sales towards research and development. The company has hitherto conducted research only with antibody (protein-based) drugs, which have limited applicability despite their effectiveness in the targeted location. However, Daiichi Sankyo has now shifted its focus towards low molecular (chemical-based) compounds, which have wider applicability, for all its new drugs. Daiichi Sankyo is also striving to bind antibody drugs on to low molecular compounds and deliver them into the body so that the benefit of targeted effectiveness is realized for a wider range of ailments. Daiichi Sankyo plans to implement this approach in many of its therapeutic areas, including cancer. The shift towards low molecular compounds is in line with Daiichi Sankyos integration plan that has been outlined in its overall R&D strategy. Weakness:Daiichi Sankyo, at the other end, has suffered a heavy increase in selling, general and administrative (SGA) expenses to the tune of 10% from fiscal 2006 levels to JPY357,330 million ($3128.9 million). During this period, the sales growth was a mere 0.4% and excluding one-time effects, was still only 1.5%. Over the five-year period to fiscal 2007, Daiichi Sankyo recorded a decline in sales by a CAGR of 0.7% while the CAGR for SGA expenses was 0.74% in the same period. There also were unused R&D expenses to the tune of JPY8 billion ($70 million) in fiscal 2008. Although the companys SGA expenses declined by about 9% in fiscal 2008, sales in the year witnessed a 5% decline due to a stagnant market and sales erosion from generic drugs.Threats:Ranbaxy faces allegations by the US FDA for repetitive fraudulent conduct. According to the FDA, Ranbaxys move to use APIs from unapproved sources has resulted in the availability of misbranded and counterfeit drugs in the market. Subsequently, the FDA questioned Ranbaxy on the potency of its drugs, which are alleged to be adulterated, and called for an internal review of the companys Indian manufacturing operations. Ranbaxy has been under FDA scrutiny for about three years now and its operations for the US market at the Paonta Sahib plant have been suspended since 2006. Aside from this, Ranbaxy faces patent infringement lawsuits by global branded drug manufacturers AstraZeneca and Pfizer. Post-merger Synergy Analysis:Daiichi Sankyo and Ranbaxy launch hybrid business in Brazil to expand business of both companies:Daiichi Sankyo Company, Limited (hereafter, Daiichi Sankyo) and Ranbaxy Laboratories Limited (hereafter, Ranbaxy) on April 17, 2013 announced synergy in Brazil to expand the business of both companies in the country. As part of this synergy, Ranbaxy will support Daiichi Sankyos Brazilian subsidiary, Daiichi Sankyo Brasil Farmaceutica Ltd. (Hereafter, Daiichi Sankyo Brazil), to enter the branded generics market, in addition to its established business of providing innovative products. Ranbaxys Brazilian subsidiary, Ranbaxy Pharmaceutical Ltd. (hereafter, RFL) would continue to independently promote Ranbaxys generic products and also enter into branded generics in Brazil. The pharmaceutical market in Brazil is the biggest in Latin America, and it is expected to become the fourth biggest in the world in 2016. In Brazil, Daiichi Sankyo has built up its market presence with innovative pharmaceuticals through Daiichi Sankyo Brazil. On the other hand, Ranbaxy markets its generic products in Brazil through its subsidiary, Ranbaxy Pharmaceutical Ltd. With the announced synergistic collaboration, the Daiichi Sankyo Group will expand its presence in Brazil through its hybrid business model promoting innovative, branded generic and generic pharmaceuticals. Daiichi Sankyo has not been able to manage Ranbaxy. The whole picture is not that bright, as former Ranbaxy Laboratories chairman Malvinder Singh has rubbished Daiichi Sankyo's claim that crucial facts about the US authorities' probe were concealed at the time the company was sold by his family, and attacked the Japanese firm for mismanaging the Indian drug maker. Ranbaxys management described as 'baseless' Daiichi Sankyo's allegation about 'certain Ranbaxy shareholders' concealing and misrepresenting critical information concerning the investigations conducted by the US authorities.Structure of the Deal:On 11th June 2008, Daiichi Sankyo made an offer to purchase more than 50.1% voting right in Ranbaxy which included 34.83% stake of promoters, 9.4 % of preferential shares and an open offer in which they are going to acquire the voting rights up to 20%. Daiichi offered a share price of INR 737 with a transaction value of around $4.6 billion, valuing Ranbaxy at $8.5 billion. Daiichi ended up acquiring 63.92% shares of Ranbaxy by Nov, 2008. Including transaction costs the deal costs Daiichi $4.98 billion and they recorded goodwill of $4.17billion. If Daiichi Sankyo fails to meet with adequate shareholder response during the open offer, it has the option to exercise a preferential issue of warrants that can increase Daiichi Sankyos stake in Ranbaxy by another 4.9%.

Structure of Deal Summary Transfer of 34.80% shares Equity + Warrants = 63.92% of stake in Ranbaxy Transfer of 20% shares through open offer

The Deal: FinancingOn June 11, 2008, the Acquirer entered into a Share Purchase and Share Subscription Agreement (the SPSSA) with (a) Mr. Malvinder Mohan Singh; (b) Mr. Shivinder Mohan Singh; and (c) Others (collectively referred to as the Sellers) and RLL. Under the SPSSA, the Sellers have committed to sell to the Acquirer their collective holding of 129,934,134 fully paid-up equity shares (the Sale Shares) representing 34.81% of the total current issued, subscribed and fully paid-up equity capital of RLL at a price of Rs. 737/- (Rupees Seven Hundred Thirty-Seven only) (the Negotiated Price) per fully paid up equity share in cash (the Acquisition). The total consideration payable for the Sale Shares is Rs. 95,761,456,758 (Rupees Ninety-five billion seven hundred sixty-one million four hundred fifty-six thousand seven hundred fifty-eight only). As per the stock exchange filings by RLL, the Sellers belong to the promoter group of the Target Company. The SPSSA also provides for the issue and allotment by RLL to the Acquirer (the Subscription) of 46,258,063 fully paid-up equity shares of face value Rs 5/- each (the Subscription Shares) representing 11.03% of the post-equity-issuance, subscribed and fully paid-up equity capital of RLL and the issuance of 23,834,333 warrants of RLL (the Warrants), each Warrant exercisable for one equity share of face value Rs 5/- each of RLL. The subscription price for each Subscription Share and the exercise price of each Warrant is Rs. 737/- (Rupees Seven Hundred Thirty-Seven) (the Subscription Price) (including a premium of Rs. 732/- per share). Pursuant to the signing of the SPSSA, the Acquirer proposes to acquire up to 92,519,126 fully paid-up equity shares of face value Rs. 5/- each from the remaining shareholders (other than the parties to the SPSSA) of the Target Company (the Offer Size), representing 20% of the Emerging Voting Capital of RLL at a price of Rs. 737/- (Rupees Seven Hundred Thirty-Seven only) (the Offer Price) for each fully paid-up equity share of RLL, payable in cash and in accordance with the Regulations, subject to the terms and conditions mentioned in the Offer. This Offer is neither conditional nor subject to any minimum level of acceptance. The Acquirer will acquire all the shares that are validly tendered in accordance with the terms of the Offer, up to 92,519,126 equity shares at the Offer Price.Valuation: Daiichi Sankyo followed the DCF method to value the Ranbaxy stocks in June 2008, with the following assumptions: Sales will grow at 12% for 10 years (McKinsey projections for Indian Pharmaceutical industry) and then slowed down to 8% for 5 years. In order to account for the losses caused due to FDA (Foods and Drugs Association) action against Ranbaxy we have lowered the growth rates for 2008 and 2009 to 10% because Ranbaxy had made alternative arrangements through its US its subsidiary Ohm Labs in the US. NOPAT Margin maintained at 14% for 10 years and then lowered to 10%. The company is making continuous efforts to decrease the working capital so we assume they would decrease it till 25%. The Net Long Term Assets to Sales ratio would fall down to 45%.DCF Valuation = 254.6FTF Value = 106Investment in Associates = 5.03Total = 365.63With these assumptions we came to a value of INR 254.6; however this value does not incorporate the value the strong FTF pipeline that Ranbaxy had. This FTF pipeline is valued at around INR106/share. Going further we also need to adjust the value for investment in associates for market value wherever information is available. The effective price as per our calculation for Ranbaxy in June 2008 should be INR 365.63.This shows how much premium Daiichi paid above the intrinsic value of Ranbaxy, with an acquisition price of INR 737, they paid almost a premium of 100% over the intrinsic value. Following are shareholding pattern, valuation multiples, offer price as per SEBI SAST and Share price chart of both the companies.Table: Valuation of RanbaxyAssets and LiabilitiesValue Attributed (Rs. Cr)

Book Value of Assets and Liabilities 3470

Inventories 88

Tangible Assets (Land)440

Intangible Assets (Leasehold Land)260

Intangible Assets (Increase in Current Products etc. to fair value)1805

In process R&D expenses304

Deferred Tax Liability-881

Minority Interest-1981

Goodwill17995

Total Consideration21500

Goodwill in USD$ 4.01 Billion

Total Consideration (in USD)$ 4.9 Billion

Shareholding Pattern

SHARES HELD BYPRE %POST %CHANGE %

SINGH34.82-(100)

SINGH FAMILY19-(100)

MUTUAL FUND5.562.58(53.59)

BANKS1.710.32(58.47)

INSURANCE COMPANY14.399.19(36.13)

F.I.I12.324.41(64.49

GENERAL PUBLIC12.119.5361.40

DAIICHI SANKYO-63.9263.92

Time line of Acquisition of shares:DATE OF ACQUISATION

PARTICULARSNO OF SHARES% OF SHARE HOLDINGVALUE(in crores)

15 Oct 2008Acquisition of shares under open offer pursuant to regulation 10 & 12 of SEBI @ Rs 737 per share91277598206727

20 Oct 2008Acquired by preferential allotment of warrant @Rs 737416225859.123068

20 Oct 2008Acquisition from promoter company(first tranche)9351389920.496892

7 Nov 2008Acquisition of shares from the promoter @ Rs737(2nd Tranche)6530912114.314813

Valuation MultiplesEV/EBITDAEV/EBITEV/EBIT(1-t)

Pharmaceuticals9.5711.9818.99

Ranbaxy Laboratories Ltd. Peer group

Enterprise ValueEV/EBITDA

(in thousands USD)2014next 12 mth

Ranbaxy Laboratories Ltd2 326 8406.857.64

Novartis AG199 985 33411.111.23

Dr. Reddy's Laboratories6 797 81612.9813.91

Lannett Co Inc605 68114.2819.17

Impax Laboratories Inc1 100 15914.9216.34

Depomed Inc361 733N/AN/A

Salix Pharmaceuticals Ltd4 231 6849.159.77

The offer priceThe Offer Price of Rs. 737/- per equity share is justified in terms of Regulation 20(4) of the SEBI (SAST) Regulations as it is higher of the following:

A) The negotiated PriceRs 737

B) The subscription PriceRs 737

C) The highest price paid by the acquirer for any acquisition[including by the way of allotment in a public or rights or preferential issue] of equity shares of the target company during the 26 weeks period prior to the date of the public announcementNil

D) The average of the weekly high and low of closing prices of the equity shares of the target company on NSE during the 26 weeks preceding the date if public announcementRs 444.08

E) The average of the daily high and low prices of the equity shares of the target company on NSE during the two weeks preceding the date of the public announcementRs 533.51

Share price chart of both companies: Ranbaxy

Daiichi Sankyo

Shareholders Reaction:The market reaction to this announcement was positive only during the open offer period, post that both the stocks plunged to almost 50% of their pre-transaction values. In Feb 2009 in response to FDAs action against Ranbaxy share price of Ranbaxy was almost 1/3 of what Daiichi Sankyo had paid. Later the Ranbaxy stock moved up considerably but Daiichi was still trading a low levels.To reflect the fact that the market price for the shares of consolidated subsidiary Ranbaxy was way lower than the acquisition price, Daiichi recorded 351.3 billion one-time write-down of goodwill associated with the investment in Ranbaxy. This led to a considerable net loss for Daiichi in fiscal 2008.The write down itself signifies that the shareholders money, the retained earnings were wiped out in this acquisition and hence the southwards movement of stock price was as expected. The market expectations from Daiichi were low due to this write-down.Conclusion:Initially the Ranbaxy deal seemed a win-win, allowing both companies to use each others networks and technological power. The deal seemed very lucrative for Daiichi Sankyo due to the access to best FTF pipeline, access to the generics product line, access to new markets and an opportunity to diversify away from Japan into the emerging markets. However looking at the post acquisition financial statements of these companies we realize that this deal was a failure and Daiichi is trying its best to make the acquisition work in its favour.In the immediate year after the acquisition Ranbaxy reported a loss of INR 9,512.05 million and Daiichi in spite of diversifying its geographic footprint booked a loss of 215,499 million and they also made a onetime goodwill write-down of 351.3 billion for investment in Ranbaxy. These losses were mainly rooted in Ranbaxys poor performance owing to the FDA ban and bad decision in hedging currency risks.The pre-acquisition due diligence should have understood that Emerging markets are lucrative but corporate governance and integrity are surely not to be assumed in these markets. Valuations in these markets are way higher than their real potential and valuation in strongly regulated industries like pharmaceutical is strongly linked to regulations in the major markets. For the export oriented companies developed markets with stricter regulations are the main revenues streams due to higher margins; however the regulations in these markets are stricter unlike merging nations. Ranbaxy also had ease in clearing the Indian drug regulations but failed to clear the US FDA regulations and hence its US subsidiary Ohm Labs had to pitch in.Other factors such as top-management retention rates, organizational structure, internal firewalls and proper use of financial instruments to hedge risks should have been analyzed before the deal.

13 | PageSection-D