Skeletons In The Closet.

     If there’s one company in India that can truly be considered the bellwether of the pharmaceutical industry, then that company, without a shadow of a doubt, would be Ranbaxy. With a global presence in over 30 countries and exports totalling hundreds of millions of dollars to several more, Ranbaxy has come to epitomize everything that the ideal Indian MNC would stand for. It was and for that matter, continues to be the dominant player in the India’s highly fragmented pharma sector, cornering a commendable market share of just under 6%. Ranbaxy is also one of the few pharma companies that straddle the entire length of the pharmaceutical value chain; from active pharmaceutical ingredients (APIs or the ingredients for drug - making), all the way up to specialised drugs. For over a decade, the company reported revenue and earnings that hit and beat Street estimates. Ranbaxy also spent close to a billion dollars to acquire over half a dozen companies in Europe, Africa and the USA in the short span of a few years, enabling it to bolster its global presence. But what goes around comes around. In 2008, in a deal worth $4.6 billion, Ranbaxy was gobbled up by Daiichi Sankyo.  

     It was an acquisition that was anything but ordinary. The events that transpired after the buyout turned out to be a wake-up call for the entire pharmaceutical industry and the fallout of the deal called into question corporate governance throughout India. For, when Daiichi paid $4.6 billion to acquire Ranbaxy, it got something else as well in the deal, a little something that it hadn’t bargained for. Daiichi may not have known it then, before it signed on the dotted line, but deep within the confines of the laboratories of Ranbaxy, a major scandal was brewing and it would turn out to be one that would change both the face and the fate of the company forever.

The Sell Out.

     In mid-2008, barely a few months before global economic meltdown occurred, a $4.6 billion deal took the Street by complete surprise and sent shockwaves through the Indian pharmaceutical industry. Malvinder and Shivinder Singh, the Indian promoters of Ranbaxy, announced that they had entered into an agreement with the Japanese pharmaceutical colossus, Daiichi Sankyo, to offload a majority stake in their company for a consideration of around Rs. 23,000 crores or roughly Rs. 730 per share. Management control of Ranbaxy would pass on to Daiichi but Malvinder Singh would continue as the chairman and CEO of the company for a period of 5 years and Shivinder Singh would be the COO. It was a winning partnership or so everyone thought.

     Dalal Street, on its part, cheered the deal and sent the Ranbaxy scrip to greater heights. When a foreign company acquires an Indian company, it generally is an omen for good things to come – higher earnings, healthier profit margins, greater access to global markets and superior corporate governance. The markets expected no less from Ranbaxy and all these great expectations were reflected in Ranbaxy’s soaring stock price. After all, if the company had performed so spectacularly on its own prior to 2008, then a Ranbaxy coupled with Daiichi could easily metamorphose into a global pharmaceutical powerhouse that would rank in the same league as Pfizer, Johnson & Johnson and Sanofi Aventis.

     Daiichi, much to Dalal Street’s surprise, did not usurp management control of Ranbaxy immediately after the deal was signed. In hindsight, it probably should have. The Japanese perhaps believed that with Malvinder Singh at the helm, Ranbaxy would continue its power trip and emerge a stronger, nimbler and healthier company in 5 years’ time. What Daiichi didn’t know was that by then, the Singhs would have been long gone from the company and in a mere matter of months, Ranbaxy would begin to unleash one nasty surprise after another.

Tokyo, We Have A Problem.

     In late 2008, the collapse of Wall Street sent markets into a tizzy worldwide and stock prices began to fall like the winter wheat. Even though the pharmaceutical industry wasn’t directly impacted by the economic crisis, pharma stocks began to plunge and Ranbaxy was no exception. In the midst of all this, in what was considered a shocker of an announcement, Malvinder Singh and Shivinder Singh both announced that they were putting in their papers and resigned from the company. Ranbaxy was now under the complete control of Daiichi Sankyo but it wouldn’t be long before the Japanese would discover just how big a mistake the entire acquisition would turn out to be.

     The first sign of trouble came, only a few months after the Singhs’ resignations, in the form of a cautionary letter from the United States Food and Drug Administration (the US FDA). A large chunk of Ranbaxy’s export revenue came from the USA and apparently, the company had been violating manufacturing norms and falsifying production data at its manufacturing facilities at Paonta Sahib and Dewas, where the drugs that were shipped to the USA were manufactured. Ranbaxy, on its part, neither gave a satisfactory reply to the FDA’s letter nor did it take any steps to set right its drug production. Ranbaxy’s indifference, however, didn’t go down too well with the FDA, which ordered a suspension on production at the two plants in question. Furthermore, in a lethal blow to Ranbaxy, the FDA imposed an embargo on all its exports into the USA and that embargo would be lifted only when Ranbaxy rectified all its manufacturing violations. That, however, was just the beginning of Daiichi’s nightmare.

     With Daiichi Sankyo now steering Ranbaxy, the company began giving a greater thrust to its exports and overseas business, whence its second problem arose. Adverse foreign currency movements began to hit Ranbaxy hard and most of the forex transactions under the Malvinder Singh management hadn’t been properly hedged, both of which now began to snowball into hundreds of millions of dollars in forex losses for the company. Moreover, with the company now firing its exports engine on all cylinders, Ranbaxy was focusing less on the domestic market and as a result, competitors like Cipla, Lupin and Sun Pharma were eating into its market share and growing at Ranbaxy’s cost.

     The Ranbaxy acquisition had begun to weigh down on Daiichi in ways that the latter could not have possibly imagined – a clampdown on two of its manufacturing facilities, a ban on exports to its bread-and-butter American market and crushing foreign exchange losses. With the markets now punishing the stock, Ranbaxy’s valuations began to crumble and all of a sudden, Daiichi’s acquisition of Ranbaxy came under intense scrutiny. With so many skeletons falling out of the closet, analysts began to question whether Daiichi had fully carried out its due diligence prior to the acquisition or to be more specific, whether Daiichi had carried out any due diligence at all. Now, it began to dawn on Daiichi Sankyo and Dalal Street that the Singhs’ sell out and unexplained departure from Ranbaxy might have had a dark but logical explanation after all.

Detoxification.

     When Daiichi Sankyo took over management control of Ranbaxy, it inherited a whole host of problems with it – operational and financial. Aside from the manufacturing violations, data falsifications and forex losses, Daiichi began to discover that Ranbaxy’s financials weren’t exactly in the pink of health. Ranbaxy was debt-heavy due to the string of acquisitions that it had made in the past and its interest outflow was eating into its margins. Furthermore, accounting jugglery and window dressing appeared to be a couple of tricks that Ranbaxy had used liberally in the past. Moreover, there were ominous rumours swirling within the company about past losses that had been ratcheted up and buried away in various group companies and now, it was Daiichi Sankyo that was charged with the task of exhuming the bodies. In its first quarter under the Daiichi management, Ranbaxy reported a loss of over Rs. 2000 crores. In the subsequent quarters, hundreds of crores of rupees were written off. Apparently, Daiichi had decided to swallow a bitter pill and clean up Ranbaxy’s books once and for all.

     With Ranbaxy’s clinical trials and research needing more cash and in order to take the company to the next level, Daiichi began injecting cash directly into Ranbaxy. Slowly, Ranbaxy’s forex losses began dipping and the company’s financial health began to improve but the FDA ban still hung over Ranbaxy like a dark storm cloud. Up until then, Daiichi’s tango with Ranbaxy had been nothing less than value – destructive but now, the tide was beginning to turn in Daiichi’s favour. Ranbaxy, much to Daiichi’s delight, had an ace up its sleeve, one that would help it go a long way in redeeming itself.

A Shot In The Arm.    

     Lipitor or Atorvastatin is the world’s largest selling anti-cholesterol drug and in November 2011, after a 17 - month exclusivity with Pfizer, the drug was going off patent and Ranbaxy had a six month exclusive time frame, up until May 2012, to produce and market it. Pfizer, of course, could continue to make and sell its own versions of Lipitor. As far as Ranbaxy was concerned, Lipitor represented a $500 million bounty but the FDA still hadn’t cleared its manufacturing facilities at Paonta Sahib and Dewas. Ranbaxy, however, was desperate to capitalize on its window of opportunity and like that old saying goes - where there is a will, there is a way. And Ranbaxy found that way.

     Ranbaxy began manufacturing Lipitor at its plant in New Jersey and a marketing agreement was signed with Mylan Laboratories to sell Lipitor worldwide. Even though this meant that Mylan would have a share in the takings from the Lipitor sales, it also ensured that the legal tangle with the FDA wouldn’t rain on Ranbaxy’s parade. In that span of six months, Pfizer and Ranbaxy were the only players in the Lipitor market and Pfizer rapidly began losing market share, as Ranbaxy priced its versions of Lipitor below those of Pfizer. The end of the six month period saw Ranbaxy cornering over 60% of the Lipitor market, even as other pharma companies began rushing in to grab their share of the lucrative and fast-growing market.

     Ranbaxy managed to net a windfall gain of at least $400 million from its exclusivity period and Lipitor continues to be a major component of its revenue to this day. The success with Lipitor, which was the booster dose that Ranbaxy sorely needed, sent its stock surging and analysts began declaring that the company’s troubles were now behind it. Apparently, Ranbaxy was back with a bang. But one swallow does not a summer make and if Daiichi was under the impression that Ranbaxy’s woes had been laid to rest and that Lipitor had heralded a new era for the company, it couldn’t have been more wrong. Inside Ranbaxy’s closet, another skeleton was lurking and this one would prove to be the scariest and most dangerous of them all.

Judgment Day.    

     In early 2012, Ranbaxy began the process of giving its tarnished image a complete makeover. In order to obtain a clean chit from the US authorities and resume operations at its Paonta Sahib and Dewas facilities, it signed a consent decree with the US FDA. It agreed to comply with the FDA’s manufacturing norms and began rectifying its manufacturing facilities that were under the FDA’s scanner. Soon, the facilities were inspected and subsequently approved by the American authorities and Ranbaxy began manufacture and export operations once again. But as far as the US FDA was concerned, it was not about to let Ranbaxy off the hook lightly. The FDA wanted to make an example out of Ranbaxy so as to serve as a deterrent to any other pharma company that had any funny ideas of flouting manufacturing norms or falsifying data records. The announcement made headlines the world over, even as the Indian pharmaceutical industry gasped at the severity of the penalty. The US FDA had decided to slap Ranbaxy with a penalty of $500 million. Indeed, Ranbaxy was about to pay for its sins and in a big way at that.

     Ranbaxy’s penalty of $500 million (around Rs. 2500 crores) was large enough to negate all the gains that it had made from its Lipitor sales until then. The scale of the penalty saw the company’s stock trapped in a tight bear grip for several days. After all, a cash outflow that large was almost equal to twice the amount of Ranbaxy’s annual profits. In a prudent and conservative move, Daiichi decided to bite the bullet and account for that potentially lethal blow in one sweep. A quarterly loss of over Rs. 2600 crores was declared and Ranbaxy announced that its parent company had set aside enough cash from its vast reserves, in order to cover its penalty. Indeed, it was by far the first instance of accounting prudence and transparency that Ranbaxy’s books had witnessed in a long time.

     With the spectre of the US FDA penalty now interred, Ranbaxy was well and truly back in business and business was about to pick up. A slew of new drugs were launched and Ranbaxy followed those launches up with an exclusive sale of a new drug, Actos. Even though Actos doesn’t come close to Lipitor in terms of revenue potential, it nevertheless is an important part of Ranbaxy’s drug portfolio. Ranbaxy began strengthening and adding to its distribution network, both at home and abroad, in a bid to reclaim lost territory at home and enter uncharted waters abroad, especially in Africa’s underserved markets, which are bound to see explosive growth in the years to come. Ranbaxy did face another setback along the way when glass fragments were discovered in some shipments of Lipitor that were bound for the US market (apparently, the rupturing of the glass lining of a tank in one of Ranbaxy’s facilities was to blame) but the company recalled those shipments and resolved the issue in time, even though it did lose a significant portion of its market share in the process.      

The Fallout.    

     The $4.6 billion Ranbaxy-Daiichi deal, which is by far the largest in the Indian pharmaceutical sector, ushered in a phase of consolidation in the industry. It set the stage for the equally large Piramal Healthcare – Abbott Laboratories deal. It was another case of the Indian promoter cashing out but Abbott, quite unlike Daiichi’s experience with Ranbaxy, has managed to seamlessly integrate Piramal Healthcare into its fold. Daiichi Sankyo, to its credit, has more or less managed to set Ranbaxy on the right path and align it with its global strategy, after a long and arduous struggle. The acquisition hasn’t begun to pay off yet for the Japanese behemoth but the future does look promising. The comforting factor is that Daiichi has substantial cash reserves on its books, which would come into play if Ranbaxy does start coughing up any more nasty surprises. Dalal Street, on its part, has adopted a cautious, wait-and-watch approach with the Ranbaxy stock, which seems to be trapped in a narrow range. The scrip hasn’t yet been awarded the premium valuation that so many Indian companies with a foreign management boast of but once the perception of and the outlook on Ranbaxy change, its stock has huge upside potential. A share buyback or a delisting of Ranbaxy by Daiichi might even be on the cards in the near future.    

     Meanwhile, what became of Malvinder Singh? Well, he used the war chest from his cashing out of Ranbaxy to fund and expand his ventures, Fortis Healthcare and Religare Financials. Fortis, which is on its way to becoming a major healthcare player, is on a hospital acquisition spree in India, Singapore, Australia and New Zealand. Religare has already made its mark in the financials space. Even though accounting transparency and corporate governance did not prominently feature among Malvinder Singh’s corporate principles, at least in Ranbaxy’s case, he did manage to cash out at the top of the market, when Ranbaxy’s valuations were at their peak. And when it was all said and done, when the dust had settled and the blood had dried, it was Daiichi Sankyo that was left holding his Pandora’s Box.

    

A New Life.

     In recent quarters, Ranbaxy has started clocking robust earnings and profits, showing healthy year-on-year growth rates. With the company now strengthening its foothold in the domestic market and growing its exports business at the same time, Ranbaxy may have finally turned the corner. It continues to have the strongest portfolio of over-the-counter (OTC) products, with marquee brands such as Revital and Volini. It has filed several FTFs (first-to-file applications) and ANDAs (abbreviated new drug applications) for its upcoming drug launches. Moreover, Ranbaxy has over 80 new and potential blockbuster drugs in its pipeline, at various stages of research and development, some of which could present as large and lucrative an opportunity as Lipitor, over the course of the next decade going forward. Indeed, it might just be a matter of time before Ranbaxy regains its lost lustre and glory. From Daiichi’s viewpoint, that would be just what the doctor ordered. 

     The Ranbaxy acquisition has surely left behind a shaken but wiser Daiichi Sankyo. The entire tryst with the Ranbaxy deal and its fallout, if nothing else, has taught Daiichi a valuable lesson in due diligence that it will put to practice when it pursues any further acquisitions. In future, conducting due diligence of its takeover targets before a buyout will not be something that Daiichi Sankyo will dare to take lightly…..lest any more skeletons tumble out when it opens the closet door.