The vanishing industry

Foreign interest in local companies could boost valuations of pharmaceutical stocks
Why are Indian pharmaceutical companies selling out to multinational corporations? After Ranbaxy Laboratories promoters divesting their stake and Piramal Healthcare selling its formulation bussiness, the low-profile Paras Pharmaceuticals is the latest to cash out. If this trend continues, there will not be many homegrown Indian companies or brands left. There is nothing surprising about acquisitions in the pharmaceutical space. Indian companies too have swooped on mostly distressed assets abroad to gain access to new markets, technology or products. The restrictive pre-reforms era capped foreign holding in pharmaceutical companies at 49%. This cramped foreign companies’ ability and enthusiasm to grow the market or introduce new products. Second, the stifling Drug Prices Control Order imposed MRP ceiling on drugs categorised as essential, squeezing margin. Foreign companies could do nothing but fret as Indian companies prospered by reverse engineering patented drugs and selling them for a fraction of the price of the original. Not only that, many license holders ‘loaned’ manufacturing to others. Liberalisation enabled many MNCs to convert their Indian affiliates into full-fledged subsidiaries. Being in charge of their operations in India increased their comfort in introducing latest innovations in the Indian market. A large number of patented drugs became ripe for picking, prompting Indian companies to shift focus from the tightly controlled domestic market to overseas potential.

The biggest obstacle for Indian pharmaceutical companies to fully tap the ongoing opportunities is capital, particularly long-gestation funding. Legal challenges from patent holders to generics marketed in the western markets have drained many front-ranking companies. Besides drugs that manage to clear the scrutiny of patent holders and regulatory bodies have only six months to profit before other imitators are let in. Introduction of patented products is lengthy and resource guzzling process without any certainty of success. Many pharmaceutical companies have separated their R&D units as these started proving a drag on their bottom lines. The Indian sector is, thus, facing the twin challenges of penetrating the generics markets in the developed economies and trying to create new products that would earn them fat margin. Both these problems require attaining scale. The regimented market and disregard for process patent till a few years ago meant that most pharmaceutical firms have remained stunted in growth. As a result, the sector is proliferated with small- and medium-scale units. Till recently investors too seemed wary of these stocks. Despite the support from parent that made them attractive, MNC affiliates had limited growth prospects due to their reluctance to introduce blockbuster drugs due to pricing caps and competition from copycat products from Indian manufacturers working on thin margin and opaque functioning.

Much has changed over the last decade. Many drugs have been taken out of pricing control. The opening of the generics export market has unshackled the industry. At the same time, this has exposed its inadequacies: lack of innovations, processing capacity in need of upgradation to become compliant with best global practises, and regulatory pressures at home and abroad. The growth options for the pharmaceutical sector are, therefore, limited. Emulate the tech industry and because a process outsourcing hub and supplier of intermediates or turn attention to over-the-counter products and build them into brands in the local market. Many manufacturers have chosen contract research and manufacturing for third parties. The lure of the unexploited rural market and the booming lifestyle segment have provided an impetus to some others and even attracted fast-moving consumer goods companies to over-the-counter products. It was not only the Indian market that was transforming. Seismic shifts were also taking place in the developed markets. Many global players concentrating on the patented product market were faced with the prospect of drying up of revenue stream. On the other side, there were openings in the generics market. This presented them with two choices: produce the generics themselves or outsource them. Some preferred to buy out generics capacity in emerging markets to service the developed as well as the domestic markets. Snapping up of local OTC brands is but an extension of the MNCs’ strategy to make up for the lost time during the pre-reforms era. A known brand makes the task of establishing footprints in the domestic market so much easier. It can also complement and supplement the existing product basket of the acquirer. Unwittingly, the rich valuation of recent deals could also unleash capital infusion, thereby triggering a re-rating of the sector.
MOHAN SULE