IIM RANCHI

Dr. Reddys Laboratories

Mergers, Acquisitions and Corporate Restructuring

Rahul Gupta (M108/12) Ankur Saurabh (M012/12) Tarun Gupta (M044/12)

Table of Contents
Case Summary............................................................................................................................................... 2 Identification of Problems ............................................................................................................................ 3 Theories to Solve problems .......................................................................................................................... 4 List of alternative Solutions to the Problem ................................................................................................. 5 Analysis and Identification of the Right Alternative ..................................................................................... 6 Findings and Recommendation .................................................................................................................... 9

Case Summary
The case talks about Indias Dr Reddys Laboratories Limited trying to acquire Betapharm, the fourthlargest generic drug manufacturer in Germany. Germany had the largest generics market growing at 13% in Europe which had the 2nd biggest market after US. So through this acquisition DRL could get immediate access to the German generic market. DRL had realized that organic growth was not enough to become a global mid-sized pharmaceutical player, so through this acquisition DRL expected that it would gain a strategic presence in the European market owing to the high growth of the market and rising public healthcare costs. It is also to be seen that DRL wanted to grow in size and realize its ambition of becoming a US$1 billion mid-size global pharmaceutical company by 2008. DRL's product development skills and low cost manufacturing would benefit betapharm as it would be able to add more products to its portfolio and grow at a much faster rate in Germany. On the other hand, Betapharm (EBITDA margins of around 24%) had intellectual property IP and regulatory infrastructure giving it faster access to European market. DRL was itself recovering from financial challenges. So any failure here would daunt the recovery process, thus care needed to be taken.

Identification of Problems
DRL was just recovering from financial challenges, so failure would dent the recovery. Dr. Reddy had a history of proactive legal component characterized by challenging patents in various courts. Though it had experiences of 4 acquisitions earlier but this would be the biggest, hence the execution risks would be much higher. There was difference in corporate culture. Betapharm was a process driven company given to compliance with systems, procedures and protocol as compared to the relationship-driven Dr Reddy. Hence integrating the two businesses would be a key factor in driving synergies. Underestimation of cultural differences can create a bias which if not taken care of would yield problems; substantially bring down the performance and synergies. Discounts mandated in the European market as more and more generic drugs were coming, so there was a pricing pressure to be seen on generics manufacturers. This implies lower sales realizations. Hence a longer time frame to digest the acquisition. As Betapharm was already into exclusive contracts implies that post acquisition, the task of consolidation of manufacturing would not be easy for Dr. Reddy. Planning should be thorough devoid of any planning fallacy so that proper forecasts are there to estimate time and money needed for integration.

Theories to Solve problems

1. Thorough Preliminary due diligence as the execution risk would be higher in this case. 2. Eliminating biases pertaining to underestimation of cultural differences 3. Eliminating biases pertaining to planning fallacies. 4. Eliminating biases pertaining to conflicts of interest. 5. Operating synergy by optimizing economies of scale and scope. 6. Financial synergy evaluated to estimate the reduction in the cost of capital. Also thorough assessment of financial results of Betapharm needs to be considered (Evaluating EBITDA margins). 7. Strategic Realignment well thought of prior to the execution 8. Resisting the temptation to substantially over-bid the acquisition cost. 9. While drawing the Integration plan, all contract related issues should be resolved to ensure smooth functioning post acquisition.

List of alternative Solutions to the Problem

1) Instead of going for an acquisition of this scale and magnitude, Dr Reddys could go for CoMarketing/Alliances in Europe and USA to increase its Sales and Marketing Presence in these regions. 2) For R&D, Dr Reddys could look at contract R&D model or licensing of R&D which would entail contract manufacturing. 3) The companys financial model, in which it sought private investment for developing the drug in Phase II and for development and marketing efforts in Phase III, was a great way to undertake expensive drug development and marketing process. 4) Dr Reddys could go for Partnership based approach towards their globalization ambitions. They had already signed a $56 million deal with ICICI Ventures to fund the launch of its generic drugs in United Kingdom and a similar model could be employed in Germany also which was the largest generic drug market in Europe. 5) To De-risk drug discovery, Dr Reddys could get into collaborative research. It had already linked with U.K Based Argenta Discovery for development and commercialization of a novel approach to the treatment of chronic obstructive pulmonary disease.

Analysis and Identification of the Right Alternative

The analysis part will cover the calculations about the values of yeast value & controls Inc. and TSE International before the merger. We have used 4 methods to calculate the per share value, which include DCF (discounted cash flow), P/E ratio, Book value and Market value.

DCF (Discounted Cash Flow)

In this method we have taken the PV of the expected cash flows of each company Yeast Valve and Controls Inc.

WACC Calculation Debt/(Debt+Equity) Cost of debt Marginal tax rate Beta Risk Free Rate (30 yr Bonds) Market Risk Premium (Geometric) Equity/(Debt+Equity) Cost of equity

0 0.0% 40.0% 0.64 5.98% 5.5% 100% 9.5%

Equity Beta D/E 0.85 0.96 0.65 0.09 0.8 0.64 1.1 0.72 0.75 0.64 0.65 0.01 0.85 0.19 Average Beta Equity Beta for Yeats

Asset Beta 0.54 0.62 0.58 0.77 0.54 0.65 0.76 0.64

0.64

Historical 1999 Total Revenue % growth rate Net Income % of revenue D&A % of revenue CapEx % of revenue Change in WC % of revenue Free Cash Flow % of revenue Year Present Value Factor PV of Free Cash Flow
49364
n/a

2000
59600
20.7%

2001
66000
10.7%

Projected Year Ending 2002 2003 2004

73200
10.9%

Stable
92700
3.0%

81200
10.9%

90000
10.8%

5575
11.3%

8347
14.0%

8634
13.1%

9792
13.4%

11106
13.7%

12576
14.0%

12953
14.0%

1508
3.1%

1660
2.8%

1828
2.8%

2012
2.7%

2212
2.7%

2432
2.7%

2503
2.7%

2433
4.9%

1826
3.1%

2011
3.0%

2213
3.0%

2433
3.0%

2675
3.0%

2781
3.0%

0
0.0%

3492
0.6%

3867
5.9%

4289
5.9%

4757
5.9%

5273
5.9%

5431
5.9%

4650
9.4%

4689
7.9%

4584
6.9%

5302
7.2%

6128
7.5%

7060
7.8%

7244
7.8%

1 0.913 4283

2 0.834 3825

3 0.762 4041

4 0.696 4266

5 0.636 4489

5 0.636 71095

WACC Terminal Growth Rate

9.5% 3.0%

Equity Value NOSH Share Price

91998 1440 $ 63.89

Using DCF the share price of YVC has come out to be $ 63.89, which is way above the present share price of $39.75. Hence the share of YVC are undervalued as of now as per DCF. TSE International

WACC Calculation Marginal tax rate Beta Risk Free Rate (30 yr Bonds) Market Risk Premium (Geometric) Equity/(Debt+Equity) Cost of equity 40.0% 0.70 5.98% 9.6% 100% 12.7%

Equity Beta D/E 0.85 0.96 0.65 0.09 0.8 0.64 1.1 0.72 0.75 0.64 0.65 0.01 0.85 0.19 Average Beta Equity Beta for Yeats

Asset Beta 0.54 0.62 0.58 0.77 0.54 0.65 0.76 0.64

0.70

Historical 1999 Total Revenue % growth rate Net Income % of revenue D&A % of revenue CapEx % of revenue Change in WC % of revenue Free Cash Flow % of revenue Year Present Value Factor PV of Free Cash Flow
2187208
n/a

2000
2329373
6.5%

Projected Year Ending 2001 2002 2003

2480785
6.5%

2004
6.5%

Stable
3086558
3.0%

2642037
6.5%

2813769
6.5%

2996658 230143
7.7%

164041
7.5%

176101
7.6%

189036
7.6%

201323
7.6%

216097
7.7%

431295
14.0%

26800
1.2% 0.0% 0.0%

27950
1.2% 0.0% 0.6%

29770
1.2% 0.0% 0.0%

31700
1.2% 0.0% 0.0%

33170
1.2% 0.0% 0.0%

35960
1.2% 0.0% 0.0%

83337
2.7% 3.0% 5.9%

190841
8.7%

204051
8.8%

218806
8.8%

233023
8.8%

249267
8.9%

266103
8.9%

514632
16.7%

1 0.887 181057

2 0.787 172271

3 0.699 162790

4 0.620 154514

5 0.550 146363

5 0.550 2918136

WACC Terminal Growth Rate

12.7% 3.0%

Equity Value NOSH Share Price

3735130 62694 $ 59.58

The share price of TSE international is also way higher than the current share price of $21.98, hence she shares of TSE are also undervalued as of now. There are certain weaknesses of DCF valuation a) b) c) d) Focuses on long term values Unusual opportunities are missed The model is dependent on the correctness of the input variables Valuations using DCF are sensitive to the assumptions of perpetuity growth rates and discount rates.

P/E Ratio
Company Cascade Corp. Curtiss Wright Flowserve Idex Roper Tecumseh Thomas Watts Average P/E Median P/E Earnings Share Price (Avg) Share Price (Med) P/E 8.2 10.3 11 14.6 16.3 7 10.7 10.4 11.0625 10.55 3.87 42.81188 40.8285

Findings and Recommendation

We recommend that Dr Reddys should go for the acquisition of BetaPharm. As per our findings, Betapharm was a fast growing company with growing EBITDA margins, sales and stable selling &administrative expenses. 2005 Sales Sales and General Expenses EBITDA Margin
All Figures in million INR

2004 6341 2929

2003 5853 3006

7633 3065

27.6%

19.0%

14.9%

We can clearly see that Betapharm would add value to Dr Reddys as its financials are in the right place, it was the 4th largest Generic drug manufacturer in Germany and it had strong growth potential. It was the manufacturer of choice for the long-term treatment drugs and based on its growth potential as well as relative position in Germany we recommend that Dr Reddys should purchase BetaPharm.