Sun Pharmaceutical- Target Price (INR) 950 USD550mn payout is a mild hurdle on the M&A path: Avendus

SUNP and TEVA have admitted to patent infringement on gProtonix. Of
the windfall USD2.15bn payoff to PFE, the burden for SUNP falls at
USD550mn, payable in 2013. The payout a) Is significantly higher than
the cUSD105mn provision of 2QFY13; b) And cuts SUNP’s consolidated
net cash by c50%, the balance is held by TARO, to which SUNP has no
direct access; c) It reduces SUNP’s ability for an immediate big‐ticket
acquisition and even smaller, bolt‐on deals; and d) Though smaller in
impact, SUNP’s INR‐denominated cash reserves continues to take a hit
from the weakening INR. Our Jun14 TP is lowered to INR950; maintain
Hold. An immediate, knee‐jerk reaction is likely, led by the expected
impact on acquisition plans in the near future. However, with strong
cash flows, SUNP’s long term funding capabilities stay intact.

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SUNP settles on gProtonix after admitting patent infringement
Cutting short a federal trial, which commenced on 03June, SUNP and TEVA
have admitted to infringing the 4,758,579 patent on Protonix. The “at‐risk”
launch of Jan08 has now concluded with a settlement. PFE and its partner will
receive USD2.15bn from TEVA and SUNP, USD550mn of which is SUNP’s share.
In 2QFY13, SUNP had made a part provision of INR5.8bn, which at the current
USD/INR is cUSD100mn, cUSD450mn woefully short of the payout.
Cash balance takes an immediate hit…
At its investor call toward end of May13, SUNP referred to a cash balance of
USD1.3bn. Consolidated net cash as per the Mar13 B/S is at INR62.2bn. At the
year‐end rate of the USD/INR, the net cash thus stands at cUSD1.2bn. Of this,
TARO holds cUSD530mn, to which SUNP has no direct access. So that leaves
SUNP with cUSD620mn, c90% of which (USD550mn) will now flow to PFE. As
per the agreement, SUNP has to pay the settlement amount in 2013.
… which the slide in the INR aggravates
The arithmetic changes with the slide in the INR. At INR58/USD, SUNP’s own
cash (i.e. net of TARO) deteriorates further. We believe SUNP holds a significant
portion of its cash in INR. Even if we assume 50% to be held in USD‐terms, it
shaves of cUSD20mn from SUNP’s cash balance. In essence thus, the
settlement would be just about covered from SUNP’s accessible cash balance.
Immediate buyout ability faces a hurdle, tipping scales on leverage
As SUNP has maintained that tapping into TARO’s cash requires the latter’s
approval, the company may land up taking on a higher leverage on its books to
facilitate a medium‐to‐big‐ticket acquisition. In the very near term, even for
smaller, bolt‐on acquisitions if any, SUNP may need to lean on leverage.
EPS cut on yield loss; strong cash flow unlikely to derail LT plans
We cut our FY14f‐FY16f adjusted EPS by up to c3% on loss of interest income.
Our Jun14 TP is revised to INR950; maintain Hold. We expect a knee‐jerk
reaction in the immediate term, driven more by the effect the payout could
have on SUNP’s ability to pursue an acquisition in the near future. SUNP’s cash
flow, however, stays strong and the payout is unlikely to derail the company’s
long term fund raising capabilities.