Acquisition of Betapharm by Dr. Reddy's Laboratories - Case Study

Kumar Devavrat, Jose Mannala, Mukesh Kumar, Somanshu Mallan (PGDIM 13, NITIE)

Introduction
On February 15, 2006, Dr. Reddy's Laboratories Limited (DRL), a leading Indian pharmaceutical company, acquired the fourth-largest generic pharmaceutical company in Germany, Betapharm Arzneimittel GmbH (Betapharm) from the 3i Group PLC (3i) for US$570 million (€480 million). The sale deal also included the 'beta institut for sociomedical research GmbH' (beta Institut), a non-profit research institute founded and funded by betapharm to conduct research on issues related to social aspects of medicine and health management. The acquisition was hailed as the biggest overseas acquisition made by an Indian pharmaceutical company. The synergies from the acquisition were expected to benefit both DRL and Betapharm.
Stated above is the vision with which DRL went for the acquisition of Betapharm. This document will analyse Betapharms’s acquisition by DRL and try to answer the following questions:
• Understand and discuss the rationale behind the acquisition of Betapharm by Dr. Reddy's Laboratories.
• Detailed analysis of the case from M&A point of view.
Understand and appreciate the role of mergers and acquisitions as a growth strategy.
Initial contacts/discussions
Indian pharmaceuticals majors Ranbaxy, Wockhardt and Nicholas Piramal had also submitted bids to acquire Betapharm Arzneimittel in addition to global majors like Teva, Sandoz and certain Turkish companies, along with private equity players.
Announcement
The Hyderabad-based company Dr. Reddy’s signed a definitive agreement with 3i, the private equity house that controls Betapharm, on Thursday, 16th February 2006, to
acquire 100 per cent equity of the German drug major. In a press release Dr Reddy's said the transaction, subject to customary closing conditions, was expected to close in the first week of March 2006.
Valuation
At the time of acquisition Betapharm was highly profitable, with estimated EBITDA margin of 24-26%. With assumptions and available industry data, we have done a quick NPV valuation of betapharm and arrived at a value of €550-560 million (or Rs 380-400 per share) assuming WACC of 12% and a sustainable growth rate of 5%. The payback period is likely to be 6-7 years - ICICI Securities.
Analysts expected the betapharm acquisition to add $ 200 million to Dr Reddy's topline immediately and the company's shares jumped 9.38 percent to hit its 52-week high price on the Bombay Stock Exchange - Wednesday, March 15, 2006

Claimed Synergies from the Acquisition

Not only is Dr. Reddy's non-existent in Germany, but the market has deep-rooted sales and distribution networks that makes inorganic expansion there tough and expensive for an outsider. 2
- Saion Mukherjee, Research Analyst, Brics Securities,in July 2006
The synergies from the acquisition were expected to benefit both DRL and betapharm. Through this acquisition DRL could get immediate access to the German generic market, the second-largest generic market in the world after the US. Germany also accounted for 66 percent of the generic market in Europe (Refer to Exhibit I for a list of the major generic markets in Europe). The acquisition was expected to help DRL gain a strategic presence in the European market as the generic drug market in Europe was expected to show strong growth due to rising public healthcare costs.
It was also expected to help DRL realize its ambition of becoming a US$1 billion mid-size global pharmaceutical company by 2008. betapharm was expected to benefit from the acquisition as it would be able to add more products to its portfolio and grow at a much faster rate in Germany. Besides, the acquisition would help it to utilize DRL's global product development and marketing infrastructure to expand its presence in the European market in the long run. Dr. Wolfgang Niedermaier (Niedermaier), CEO of betapharm, commented, "Dr. Reddy's impressive pipeline of generic and innovative products and its high quality standards combined with competitive manufacturing costs will help further develop our position in the German market and offer an entry platform for the European market.
Its extensive and well-recognized corporate social responsibility activities perfectly fit with our successful corporate philosophy and business model. We see Dr. Reddy's as our partner of choice to build a successful joint future and continue betapharm's growth and success story."
Though DRL was not the highest bidder, it clinched the deal largely due to the perceived synergies between the two companies. DRL's strong commitment to corporate social responsibility (CSR) initiatives too helped swing the deal in its favor as betapharm identified with such initiatives through the activities conducted by beta Institut.
However, some analysts were of the opinion that DRL had paid too much to 3i for the acquisition as the value of the acquisition was estimated to be more than three times the annual sales of betapharm. Their argument was strengthened by the fact that another Indian pharmaceutical major, Ranbaxy Laboratories Limited7 (Ranbaxy), which had also aggressively competed for the acquisition and was a pre-sale favorite to bag the betapharm deal, pulled out at the last minute quoting the high price. DRL, however, justified the premium price saying that the advantages from the acquisition were manifold. A few also expressed their doubts as to whether DRL could leverage any benefits in the short term as betapharm was reportedly emerging from a lean period.

A few months after the acquisition, there were already early signs of trouble, as the Economic Optimisation of Pharmaceutical Care Act (AVWG) took effect in Germany on May 1, 2006. Though the act was expected to increase the scope for the use of generic drugs, it also put some price caps in place, which affected the margins of betapharm. Analysts opined that the payback to DRL from this acquisition would take a few years longer than previously expected. It was reported that DRL, which had plans for more acquisitions in Europe after the betapharm acquisition, had shelved its plans of any further acquisitions in Europe

Financing of the deal

DRL had its war chest ready with a $200 million cash and remaining debt arranged from domestic FIs. DRL funded the acquisition through a combination of internal accruals and borrowings.
Closure of the deal
Dr. Reddy's Laboratories, announced the completion of 100 per cent acquisition of Betapharm Group, Germany's fourth largest generic pharmaceutical firm, with a total enterprise value of 480 million Euros on Mar 07, 2006
Subsequent performance
Dr Reddy's share price shot up by 9.3% to close at Rs 1,281 on February 16, 2006, when it announced the $560 million Betapharm deal. Shares were trading higher at Rs 1,600 in early May.
With the German government reducing prices of drugs in the range of 10-20%, the pricing environment became a little negative for the company in the first quarter, and the returns were on the lower side in Sep 2006. Of late DRL’s subsidiary, betapharm, has returned to its usual sales levels at $51 million, and lower selling, general & administrative (SGA) expenses led to better-than-expected operating margin adjusted for one-off opportunities. Betapharm has achieved a 600 bps improvement in its active pharmaceutical ingredients (API) margins, which the management attributed to a better
product mix, citing Amlodipine Besylate as one of the key products being sold.

Advisors to the Buyer and Seller

Seller: 3i appointed Investment banks Sal Oppenheim and Bear Stearns to advise it.
Sal Oppenheim is one of the leading German investment banks for the domestic market, with a special focus on medium-sized companies and the public sector.
The Bear Stearns Companies Inc. (NYSE: BSC) is the parent company of Bear, Stearns & Co. Inc., a leading global investment banking, securities trading and brokerage firm.

Buyer: Freshfields Bruckhaus Deringer has advised company Dr. Reddy's on the acquisition of Betapharm.

Freshfields Bruckhaus Deringer is a leading international law firm. With over 2,400 lawyers in 27 offices around the world, they provide a comprehensive worldwide service to national and multinational corporations, financial institutions and governments.

References:

2. www.bloomberg.com/news
3. www.nicholaspiramal.com/pressrelease
4. http://www.icmr.icfai.org/casestudies/catalogue/Business Strategy/BSTR249.htm
5. http://www.genengnews.com/news/bnitem.aspx?name=17622028