Case Background

5 key financial problems

2) How will the acquisition of Betapharm help Dr. Reddy’s Laboratories in its overall vision?

Dr. Reddy’s Laboratories (DRL) aspired to be among the top 10 firms globally in the pharma industry.
It realized that to achieve the target it would need to consider inorganic growth by way of
acquisitions to reach its target due to difficulty in organic growth as different markets had different
regulatory and operation standards.

Betapharm, which was a generic drug company based out of Germany, could help DRL fuel its global
expansion. It was the fourth largest manufacturer of generic drugs in Germany. Acquisition of
Betapharm would give DRL access to the German market, which had attractive growth prospects due
to change in insurance policies in favour of generic drugs. Also, it gave DRL further scope to expand
its European market share. Currently it had operation based out of UK only. After USA, the European
market was the second largest pharma market in the world. Within Europe, Germany was the largest
generic drug market at 4.8 billion pounds, which was growing at 13% annually. Betapharm had one
of the best sales forces in the industry and this would give great benefits

Betapharm had a wide product portfolio of 149 established drugs and also 20 odd drugs in the
pipeline. Almost 72% of its products were long term therapy products which ensured stable future
cash flows. It had outsourced all of its manufacturing operations. DRL over a period of time could
use its manufacturing facilities to further enhance profit margins of Betapharm.

3) What are the challenges/ risks for Dr. Reddy in acquiring Betapharm

Before Betapharm DRL had acquired four firms (1 Indian and 3 overseas), but none of them were of
the scale of Betapharm. The execution risks as a result were higher. Also, at the time of acquisition
negotiations Betapharm was recovering from its two setbacks. First was due to the adverse side
effects of its drug ragaglitazar and the second was due to lost legal battle with Pfizer over a drug
which had potential sales of $200 million. A failed acquisition could worsen problems for DRL.

With entry into the German and hence European market DRL would face increased competition
from global pharma majors. It was transforming from a commodity-based mindset & solid mfg
capabilities to a front-end organisation closer to the customer.

Germany was reducing the cost of generic drugs and as a part of its health care reforms by
mandating higher level of discounts. Increase discounts would affect the bottom line of DRL.

Betapharm was a pure marketing player as its production operations were outsourced and as a
result had a different structure compared to DRL. There was a difference in the culture of the two
organisations with DRL being more relationship driven and Betapharm being more process and
protocol driven.

Betapharm had exclusive contracts for its manufacturing operations, consolidation of which under
DRL would not be an easy task.
3) How was DRL planning to fund the acquisition of Betapharm?

Dr. Reddy had place a bid € 480 million or $ 570 million for the acquisition of Betapharm. DRL was to
borrow € 400 million from Citibank and balance was to be funded from its cash reserves. It was an all
cash deal where DRL would get 100% equity ownership of Betapharm. The CFO of DRL had borrowed
50% of the amount against DRL’s balance sheet and 50 % against Betapharm’s balance sheet. DRL
had the option of raising money from the market in excahange of equity as its shareholders had
approved the same. However, DRL did not raise money through equity and was going to used debt
and its surplus cash to fund the acquisition.

1) What factors were to be considered and evaluated by DRL before acquisition of a pharma
company?

Compliance and Regulatory Standards- Different markets in the world had different patent laws and
regulatory standards for generic drugs. Generally developed countries have strict patent laws
whereas emerging markets and under developed economies do not have strict laws. While acquiring
a pharma firm it is necessary to ensure that the parent firm has the capabilities to handle the
regulatory standards to which the firm being acquired is subjected.

Strategic Advantage- DRL was into generic drug business and was aspiring to be a global leader by
expanding its generic market share and also looking at means at developing new drugs from scratch
as it was evident that new drug discovery was the real game. The top generic drug manufacturer in
the world was nowhere close to the top 10 companies involved in new drug discovery. It was
essential that a new acquisition helped DRL achieve its vision by either market diversification or
product diversification

Operational challenges- Due to different regulatory laws there were many challenges in operations
as well. Import/ Exports were not as easy as in general commodity businesses. It was essential for
DRL to address any operational concerns before acquiring a firm.

Organisation Structure and Cultural Differences- Many times companies to be acquired are great on
paper and have excellent asset value, business models and also sales figures. However, due to
difference in organisational structure and cultural differences in the two firms value could be
destroyed if those differences are not taken into considerations and addressed. Hence cultural
differences are one of the most significant factors.

5) how would acquisition of Betapharm be different from previous acquisitions?

Analysis and Interpretation

Valuation of Betapharm-
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.
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