Strides Arcolab::Sale of generic pharma business at US$375mn  Reliance Securities

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Sale of generic pharma business at US$375mn
 Event: Strides sold 94% holding in Ascent Pharma Health, its generic pharma
operations in Australia and Southeast Asia, to Watson Pharma, in all cash
transaction at an EV of AU$375mn (US$375mn for Strides 94% stake). Watson
acquired the remaining 6% stake from the company’s CEO. Assets worth
US$113mn are transferred to Watson as a part of this transaction.
 Rationale: The company would be utilizing the sale proceeds to fund future capital
growth in the sterile injectable sector (major focus area comprising 44% of the
total sales) along with reduction in debt, thereby improving its leverage position.
Strides has chalked out a debt reduction program of US$250mn, which includes
redemption of US$117mn (including YTM) FCCB due in June, 2012 and payment
of US$50mn debt pertaining to Ascent.
 Agreement with Pfizer remains with Strides: Ascent had entered into a distribution
and services agreement with Pfizer Australia to promote and sell the full range of
Pfizer’s established off-patent medicines to Australian pharmacies. This remains
intact with Strides. Under the agreement, Strides will promote and distribute
Pfizer’s off-patent branded medicines to pharmacies via direct distribution channel
as well as sell a number of Pfizer’s branded generics. Pfizer has around 100 drugs
in Australia. We expect this deal to significantly boost the overall revenues of
Strides.
 Impact: The deal is valued at EV/sales of 2.6x and EV/EBITDA of 19.7x with a sale
of US$160mn in CY2011E and EBITDA of US$21mn. It will improve the leverage
as the debt reduces from current US$525mn to US$275mn. Currently Strides has
a D/E ratio of 1.6x (including FCCB). Post the deal, the D/E ratio is likely to reduce
to 1.0x thereby, strengthening the balance sheet. This would reduce the interest
costs by ~US$15-20mn for CY2012, thereby, increasing profitability. Besides, the
goodwill from the books would also be reduced by ~US$50-60mn.
Outlook and Valuation
Strides has emerged leaner and stronger post restructuring its business with a clear
focus on niche specialized segments. The deal emphasizes Strides’ priority to
optimize the shareholder value by focusing on return ratios, targeting better working
capital management and reducing debt level. With the complete focus on high margin
sterile business, potential new launches, abundant capacity available, cash for
upgradation of sterile facilities, we believe the company is expected to witness a sharp
upswing in earnings and is poised for re-rating. We revise our estimates factoring the
sale of the Australian business and anticipate a 10% CAGR growth in revenues and
32% CAGR in earnings with an improving EBITDA margin for CY2010-13E. Since our
price target of Rs485 was achieved (refer our report: “Taking Big Strides” on 1st Dec
2011), post this deal, we recommend Buy on the company with an upgraded price
target of Rs650.
Risks to view
 Higher goodwill than networth could result in potential impairment
 Higher than expected competition in sterile injectables