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Action: Sun pursues 100% stake in Taro
Sun Pharma has increased its offer price for Taro (TARO US, not rated)
by 61% to USD39.5/sh to acquire the 34% stake it does not own. As has
occurred on previous occasions, Taro’s minority shareholders have raised
objections that may stall the deal. Strategically, Sun would like to have
100% control as management believes it would bring operational
efficiency; hence, we think it may be willing to pay some premium and
deviate from its extreme conservative approach towards acquisitions in
the past. Considering the Fougera-Sandoz deal as a benchmark and the
potential risk we see to Taro's current earnings, we believe a further
increase in the offer price is possible, but anything beyond USD66/sh is
unlikely. Assuming a payout of USD600-1bn for Taro, we estimate the
acquisition could be earnings accretive for Sun by 5-10%. In this report,
we analyse Taro's portfolio and highlight that price hikes have been sharp
and concentrated. We will watch Fougera under Sandoz, which is the
main competitor for Taro. We believe a 14-20% reduction in Taro's US
sales over time from current levels is a possibility.
Catalyst
Positive: Value-accretive acquisitions, positive surprises from US pipeline;
Negative: Protonix liability, pricing control in India, US pricing pressure.
Valuation: Premium valuation; maintain Neutral
Our 12m target price is INR690/sh based on 20x FY14E EPS. The stock is
trading at 19.3x FY14F EPS and 22.7x FY14F EPS ex Taro vs a sector
average of 16.2x, based on our estimates.
What could the potential price correction be?
Taro's sales have increased by ~USD 200m on an annual basis over the last one year,
largely due to price hikes. Further price increases in the near term can't be completely
ruled out (as Q1FY13 was a surprise), in our view, however, over time, we expect some
correction in pricing and sales from current levels.
Thus far, we haven't witnessed any major drop in pricing as such, but in some products,
a decline in Taro’s market share as lower-priced competition has gained share (Fig 7). In
Fig 8, we list Taro’s top 24 products and the current competitive landscape for each,
based on IMS data. These products contribute 73% to Taro's US sales. In this list we
highlight seven instances where price hikes have been significant (i.e., >130%) and
additional competition is expected to step in the near term (approvals are in place but
product is not in the market). Assuming Taro sees sales declines in these products that
range from 80% to 19% (based on competition), overall US sales for Taro could decline
by 15%, on our analysis. Given the possibility of declines in other products not
considered in the computation, we believe a decline of 14-20% in US sales is a
possibility for Taro in FY13/14F. Based on the Q1FY13 financials, we believe US sales
have an annual run rate of USD560mn; therefore, the sales decline could be USD 80-
110mn, based on our calculation. Currently, our estimates factor in a USD70mn decline
in Taro’s base business over the next two years.
Sun Pharma continues to pursue 100% control of Taro
Sun Pharma announced that it has revised its offer for Taro’s minority shareholders from
USD24.5/sh to USD39.5/sh. Sun currently holds a 66% share of Taro and intends to
acquire the remaining 34%, according to management. Taro’s board has accepted Sun’s
latest proposal on the basis of a report from an independent evaluator. The proposal now
needs to be accepted by majority of the minority shareholders that participate in voting
for the proposal. As has occurred on earlier occasions, some of Taro’s minority
shareholders have raised objections to the proposal and are demanding even higher
valuations. On 13 August, Bloomberg reported that Taro’s minority shareholder, Grand
Slam, wrote a letter to Taro’s shareholders urging them to reject Sun Pharma’s revised
offer. Grand Slam cites comparisons that are being drawn with the valuations of other
listed companies.
At USD 39.5/sh, Taro is valued at USD1.76bn. This implies a cash outflow of
~USD 600mn for Sun Pharma. The latest offer price implies a valuation of 7x annualised
EPS based on the Q1FY13 financials or 7.6x LTM EPS. On EV/EBITDA, we calculate
the valuation at 4.33x annualised EBITDA based on Q1FY13 financials and 4.8x LTM
EBITDA.
We believe it is inappropriate to compare Taro's valuation to Sun Pharma's standalone
valuation or that of other listed Indian companies as there are significant differences in
business mix and growth prospects. Sun Pharma trades at 22x P/E and 14.3 EV/EBITDA
on FY13F base business. Other front-line Indian generic companies we cover are trading
at ~20x P/E and ~13-15x EV/EBITDA on FY13F base business.
In terms of business mix, we refer to the recent acquisition of Fougera by Sandoz.
Fougera is a specialty dermatology business with 2011 net sales of USD429mn,
somewhat lower than that of Taro (USD590mn LTM sales). Fougera's EBITDA margin
was 40% in 2011 compared to 50.8% for Taro over the LTM. Sandoz acquired Fougera
for a consideration of USD1.525bn, implying a valuation multiple of 8.8x LTM EBITDA. At
8.8x LTM EBITDA, we estimate the valuation for Taro could increase to USD66/sh.
As we highlighted earlier, Taro's financials over the past few quarters have been boosted
by price gains which may not be sustained over the longer term. Thus, Taro's valuation
should be a discount to the Fougera acquisition, in our view. We highlight that based on
IMS data, we think Taro’s US sales could correct by USD 80-110mn over the next few
quarters depending on competitive activity. Assuming the midpoint of a USD95mn
correction in sales and EBITDA and applying a valuation multiple of 8.8x EV/EBITDA, we
arrive at a value of USD 47.5/sh, which implies a 20% increase over the current offer
price.
Will Sun Pharma pay a premium to acquire Taro?
We believe strategically Sun would like to acquire a 100% stake in Taro, as Sun
management believes it could bring significant operational flexibility. The operations of
Taro and the rest of Sun Pharma could be better integrated in terms of resources.
Further, having been involved with Taro for last two years, Sun management has greater
comfort with and understanding of the business, in our view. Historically, Sun has been
very conservative on acquisitions; however for the remaining stake in Taro, we think Sun
may be willing to pay a premium, given potential synergies recognized by management.
Historically, management had stated that it would look for a payback of five years from
an acquisition. If we were to assume Taro could sustain the cash earnings (net profit +
depreciation) reported in Q1FY13 (which is optimistic assumption, given our price hike
discussion above), the current valuation would imply a pay back of just above five years.
Though additional premium cannot be ruled out, we think anything beyond USD66/sh (as
implied for Fougera deal) is unlikely. For instance, according to the August 13 Bloomberg
article, Grand Slam has argued for a price in excess of USD100/sh based on
comparable trading multiple of Sun Pharma and other Indian companies, which is
unlikely to be realised, in our assessment.
Acquisition would be earnings accretive by 5-10%, we believe
Assuming a payout of USD600mn-1bn for the remaining stake in Taro, we believe the
deal would be earnings accretive on our current estimates for Sun. We estimate the
earnings accretion at 5-10%.
Action: Sun pursues 100% stake in Taro
Sun Pharma has increased its offer price for Taro (TARO US, not rated)
by 61% to USD39.5/sh to acquire the 34% stake it does not own. As has
occurred on previous occasions, Taro’s minority shareholders have raised
objections that may stall the deal. Strategically, Sun would like to have
100% control as management believes it would bring operational
efficiency; hence, we think it may be willing to pay some premium and
deviate from its extreme conservative approach towards acquisitions in
the past. Considering the Fougera-Sandoz deal as a benchmark and the
potential risk we see to Taro's current earnings, we believe a further
increase in the offer price is possible, but anything beyond USD66/sh is
unlikely. Assuming a payout of USD600-1bn for Taro, we estimate the
acquisition could be earnings accretive for Sun by 5-10%. In this report,
we analyse Taro's portfolio and highlight that price hikes have been sharp
and concentrated. We will watch Fougera under Sandoz, which is the
main competitor for Taro. We believe a 14-20% reduction in Taro's US
sales over time from current levels is a possibility.
Catalyst
Positive: Value-accretive acquisitions, positive surprises from US pipeline;
Negative: Protonix liability, pricing control in India, US pricing pressure.
Valuation: Premium valuation; maintain Neutral
Our 12m target price is INR690/sh based on 20x FY14E EPS. The stock is
trading at 19.3x FY14F EPS and 22.7x FY14F EPS ex Taro vs a sector
average of 16.2x, based on our estimates.
What could the potential price correction be?
Taro's sales have increased by ~USD 200m on an annual basis over the last one year,
largely due to price hikes. Further price increases in the near term can't be completely
ruled out (as Q1FY13 was a surprise), in our view, however, over time, we expect some
correction in pricing and sales from current levels.
Thus far, we haven't witnessed any major drop in pricing as such, but in some products,
a decline in Taro’s market share as lower-priced competition has gained share (Fig 7). In
Fig 8, we list Taro’s top 24 products and the current competitive landscape for each,
based on IMS data. These products contribute 73% to Taro's US sales. In this list we
highlight seven instances where price hikes have been significant (i.e., >130%) and
additional competition is expected to step in the near term (approvals are in place but
product is not in the market). Assuming Taro sees sales declines in these products that
range from 80% to 19% (based on competition), overall US sales for Taro could decline
by 15%, on our analysis. Given the possibility of declines in other products not
considered in the computation, we believe a decline of 14-20% in US sales is a
possibility for Taro in FY13/14F. Based on the Q1FY13 financials, we believe US sales
have an annual run rate of USD560mn; therefore, the sales decline could be USD 80-
110mn, based on our calculation. Currently, our estimates factor in a USD70mn decline
in Taro’s base business over the next two years.
Sun Pharma continues to pursue 100% control of Taro
Sun Pharma announced that it has revised its offer for Taro’s minority shareholders from
USD24.5/sh to USD39.5/sh. Sun currently holds a 66% share of Taro and intends to
acquire the remaining 34%, according to management. Taro’s board has accepted Sun’s
latest proposal on the basis of a report from an independent evaluator. The proposal now
needs to be accepted by majority of the minority shareholders that participate in voting
for the proposal. As has occurred on earlier occasions, some of Taro’s minority
shareholders have raised objections to the proposal and are demanding even higher
valuations. On 13 August, Bloomberg reported that Taro’s minority shareholder, Grand
Slam, wrote a letter to Taro’s shareholders urging them to reject Sun Pharma’s revised
offer. Grand Slam cites comparisons that are being drawn with the valuations of other
listed companies.
At USD 39.5/sh, Taro is valued at USD1.76bn. This implies a cash outflow of
~USD 600mn for Sun Pharma. The latest offer price implies a valuation of 7x annualised
EPS based on the Q1FY13 financials or 7.6x LTM EPS. On EV/EBITDA, we calculate
the valuation at 4.33x annualised EBITDA based on Q1FY13 financials and 4.8x LTM
EBITDA.
We believe it is inappropriate to compare Taro's valuation to Sun Pharma's standalone
valuation or that of other listed Indian companies as there are significant differences in
business mix and growth prospects. Sun Pharma trades at 22x P/E and 14.3 EV/EBITDA
on FY13F base business. Other front-line Indian generic companies we cover are trading
at ~20x P/E and ~13-15x EV/EBITDA on FY13F base business.
In terms of business mix, we refer to the recent acquisition of Fougera by Sandoz.
Fougera is a specialty dermatology business with 2011 net sales of USD429mn,
somewhat lower than that of Taro (USD590mn LTM sales). Fougera's EBITDA margin
was 40% in 2011 compared to 50.8% for Taro over the LTM. Sandoz acquired Fougera
for a consideration of USD1.525bn, implying a valuation multiple of 8.8x LTM EBITDA. At
8.8x LTM EBITDA, we estimate the valuation for Taro could increase to USD66/sh.
As we highlighted earlier, Taro's financials over the past few quarters have been boosted
by price gains which may not be sustained over the longer term. Thus, Taro's valuation
should be a discount to the Fougera acquisition, in our view. We highlight that based on
IMS data, we think Taro’s US sales could correct by USD 80-110mn over the next few
quarters depending on competitive activity. Assuming the midpoint of a USD95mn
correction in sales and EBITDA and applying a valuation multiple of 8.8x EV/EBITDA, we
arrive at a value of USD 47.5/sh, which implies a 20% increase over the current offer
price.
Will Sun Pharma pay a premium to acquire Taro?
We believe strategically Sun would like to acquire a 100% stake in Taro, as Sun
management believes it could bring significant operational flexibility. The operations of
Taro and the rest of Sun Pharma could be better integrated in terms of resources.
Further, having been involved with Taro for last two years, Sun management has greater
comfort with and understanding of the business, in our view. Historically, Sun has been
very conservative on acquisitions; however for the remaining stake in Taro, we think Sun
may be willing to pay a premium, given potential synergies recognized by management.
Historically, management had stated that it would look for a payback of five years from
an acquisition. If we were to assume Taro could sustain the cash earnings (net profit +
depreciation) reported in Q1FY13 (which is optimistic assumption, given our price hike
discussion above), the current valuation would imply a pay back of just above five years.
Though additional premium cannot be ruled out, we think anything beyond USD66/sh (as
implied for Fougera deal) is unlikely. For instance, according to the August 13 Bloomberg
article, Grand Slam has argued for a price in excess of USD100/sh based on
comparable trading multiple of Sun Pharma and other Indian companies, which is
unlikely to be realised, in our assessment.
Acquisition would be earnings accretive by 5-10%, we believe
Assuming a payout of USD600mn-1bn for the remaining stake in Taro, we believe the
deal would be earnings accretive on our current estimates for Sun. We estimate the
earnings accretion at 5-10%.
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