Pharma Price Control : Pay 20% Less or Die!!!

I was looking for the companies in the pharma space from a 4-5 years or may be 10 years of investment perspective, as promised in the last blog, when this news hit the wires. One of the major threats that various research firms have highlighted for the Indian Pharmaceutical Industry has been the government's pricing policy regarding the essential drugs. While the industry has been booming in the present, there are prominent hurdles which can drag the growth of the industry lower in the future. The regulated pricing regime for the critical drugs/medicines is one of them.
So, the Department of Pharmaceuticals has gone ahead and given the nod to bring 348 drugs and 614 formulations under the NLEM (National List of Essential Medicines) regime. NLEM would ensure that the prices of these drugs and formulations are kept under check. The estimate is that these drugs would get cheaper by an average of 20% from the present prices. To be specific, 60% of the drugs would have a reduction of more than 20% in prices while the rest would have less than 20%. The committee says that the selection of the drugs have been done as per "the principles and concepts of "Essential" drugs as enunciated by WHO" and as had been followed in the previous lists of 1996 & 2003. By definition, the purpose of essential drugs are intended to be available within the context of functioning health systems at all times in adequate amounts, in the appropriate dosage forms, with assured quality.



Probably the last two expectations of 'appropriate dosage forms, with assured quality' can be met through stringent norms. But the clause of having them available at all times is a little stretched for the regulators to implement. A single formulation or drug is generally manufactured by various players in the industry. How to decide who produces how much? Even if the government assigns some target to each player for a particular drug, since it (Government) won't be involved in the distribution of the medicines from the manufacturers to the retailers, there is ample scope to cook up the books to meet the regulation. Moreover, the demand scenario is changing every year because of the sheer increase in the population and reach of people to healthcare facilities. Can a government act as a project manager of an IT firm (or may be a sales head) to sit at the back of the pharma companies and dictate their targets every year. More importantly, can it take them to task if they fail to meet the targets? By forcing them to price their products lower, there is an incentive for them to cook up their manufacturing numbers! Like several other populist policies of the government, this policy is also intended to do social good. But without fullproof regulatory framework, this could well turn into a nightmare like most other schemes. Worst case scenario, the government would just be pushed to a corner to provide subsidy on the NLE Medicines in the coming years!


Probably, my fears are far-fetched but there are some data which point towards this direction. This was not so apparent when the previous list in 2003 came about. Earlier there were only handful of drugs under NLEM regime and the impact to the businesses were not big. But now with the number jumping to over 300 and some drugs being very expensive, the impact to the businesses will be high. The government is projecting an impact of only 20% to the revenues of the essential drugs which constitutes only 30% of India's Rs 60,000 Cr pharma industry. That boils down to only 6% of revenue loss or Rs 3600 Cr to the pharma companies.



But I have reasons to believe that the number projected by the government has some lapses as usual. Capitaline reported that the aggregate sales of 153 Pharmaceuticals companies grew by 17% YOY in Q1' FY13 to Rs 22094 crore driven by 17% sales growth in domestic players to Rs 20,532 crore. So, if we expect that the same sales figures are maintained (and there is no sales growth for the rest of the year), the top 153 companies account for about 88,000 Cr or so. The actual figure, by rough estimation, should be northwards of 1,00,000 Cr. In fact, the total sales of the pharmaceutical sector was at Rs 1,26,033.86 Cr for the year ended Mar 2012 as per Capitaline website. Well, some of the players are too small to get impacted and some are in businesses which does not get impacted by this policy. Hence a portion of the sales figure can be deducted and a rounded figure of Rs 1,00,000 Cr can be agreed upon, still 40% higher than the government's estimates.
I have doubts over the 30% figure too, quoted by the government for the portfolio of NLEM marked drugs.
This can be established by looking at the category of drugs that are covered under the NLEM:
1. Anaesthetics
2. Analgesics, Antipyretics, Non-steroidal Anti-inflammatory Medicines, Medicines for Rheumatoid disorders
3. Antiallergics and  medicines used in Anaphylaxis
4. Antidotes & Other substances used in poisonings
5. Anticonvulsants/Antiepileptics
6. Antiinfective medicines including antibacterial, antiviral etc
7. Antimigraine Medicines
8. Anti-Parkinsonsism Medicines
9. Medicines affecting the blood
10. Cardiovascular Medicines
11. Dermatological Medicines etc.


There are, in total,  27 such categories. This, I have picked up from the 2003 NLEM document. You can find the document here. In 2011, drugs for HIV and additional drugs for cancer have been added to this list. With the inclusion of 8 new Cancer drugs, the list today stands at 30 drugs for cancer only. Now, when you have included the most common to most expensive drugs in your list, it is a little tough to believe that all these 27 categories of drugs constitute only 30% of the total. I mean, what else do they sell?
Well, it may be possible that Raja Sekhar Vundru,  Joint Secretary, Dept of Pharma,  was talking from the volume point of view. From the value point of view, I think it should be higher than 30%. But, in absence of concrete data to support my point I would stick to the government provided 30% figure. By the way, another estimate from a reputed research house estimates the market size of the NLEM at Rs 29000 Cr and thus the revenue hit is at Rs 5800 Cr. Well, both the estimates are only Rs 2200 Cr apart and in comparison to the kind of money we have been talking in the past few years (Remember 2G, CoalGate), this looks like 'chhutta' (change).
The actual figure will be higher than both the estimates. Why? Because as the medicines become cheaper, their demand would increase. And lets,  for the time being, assume that companies would meet all the demand, their (prospective) revenue hit would be much more than the expected figure of Rs 3600/5800 Cr. Add to that the fact that the pharma companies would do exactly the same thing that the fertilizers companies have been doing so far to get higher subsidies from the government - Over-reporting of their sales to farmers at subsidized prices etc. Now, such an approach would put the revenue-loss to the tune of Rs 10,000 Cr or more and their pitch for government subsidy would go high or else they would threaten to cut down the production of the NLEMs which anyways would not be making them high margins that they are accustomed to. The exit of smaller players, specially in specialty segment drugs, from the market would ensure that the government can be grabbed by its you-know-what to give in to their demands. The larger players can bear the loss due to under-production by focusing more on exports.




If government's policies make this sector unattractive then some of the borderline players would exit the industry and the major ones would only comply with the regulations somehow. This would lead to a lot of inefficiencies in the system. With the ever increasing population of our country, the requirement for drugs is only going to increase in the coming days. With major focus on exporting the drugs, my biggest fear is that this policy could lead to more inaccessibility of essential drugs for people of our country and specially the one for whom this policy has been formulated : the political class' favourite Common Man!

But again, as I said, my fears could be far-fetched as the healthcare industry, as a whole, in India, provides huge opportunities for the players starting from the drug manufacturers to healthcare insurers. And probably, they can take up a loss of 10% of their sales if the revenues keep going up at the rate of 17% or so. A lot of our drug companies depend heavily on the generics business about which I have written over here. They all have been seeing splendid growth in their topline and bottomline owing to the expiry of a lot of patented drugs in the period between 2011 to 2015, the median being at 2012. For ex. If we take three of the top 10 players in the pharma sector viz. Ranbaxy, Sun Pharma and Cipla, all of them have posted excellent results based on the growth in their major generics. Cipla has Lexapro and Vancocin, Ranbaxy enjoyed the 180 day exclusivity for Lipitor and Caduet while Sun Pharma made a killing with Lipodox.  With several other drugs about to expire in the next 6 months or so, the sales through FTF (First To File) drugs would be quite robust. Most likely, they would ignore the pain due to the NLEM policy for now. Post 2014, when the pipeline of the patent-expired drugs dry down and the FTF companies' exclusivity periods expire, the pharma sector may not see the similar kind of growth rate. That would be the time of heightened M&A and consolidation in the sector. Companies would be pushed to the walls to save on costs. One such being the NLEM dictated under-pricing of drugs. Some companies would be affected higher than the others as they have different portfolio-weightage for different drugs. Cipla and GSK are expected to be the worst hit under the NLEM regime.
Will our pharma companies would be prepared to face the challenges at that time. More importantly, will the government be ready with a solution to maximize the economic profit of the country?
Definitely, no one but the Time will tell.

Big Pharma : The Cost of Innovation

The years 2011-15 are very important for the big pharma(-ceutical) companies due to what is called as 'Patent Cliff'. Several of them are losing the patent protection of some of their high selling drugs. With a dry pipeline of new drugs which could be patented, the analysts have already started to rerate the pharma companies, especially those who employ huge R&D capital like Merck, Pfizer, Astrazeneca, GSK etc. The concerned companies have also started to cut their R&D quota and related employees. This trend of cutting on R&D, could lead to a grim situation in the coming years as the discovery of new and effective drugs would be affected badly by this attitude. But, the pharma companies have their woes and cribs that the present IPR regime has been causing them Huge Losses!
By present IPR or Intellectual Property Rights regime, it means that any patent remains active for a certain duration during which only the patent holder can manufacture and sale the drug. Once the patent expires, several other players can also sell a version of the drug called Generics. Thus, with the end of exclusive rights to the patent holding company, the competition increases and the price of the drug falls drastically.
Lets see if this really causes loss to the companies or not. To understand this lets first have a little understanding about the patents.
(Just one thought : If it is really causing losses, why are they not bankrupt by now? ;) )


A patent can be of various types with the 'Utility' patents being the most common. They are provided for 'new, non-obvious & useful Process, Machine, Article of manufacture, Composition of matter' etc and is granted for 20 years from the date of application of the patent. Patents are also provided for Design (Design Patents) and are provided for 14 years from the date of patent application.
The patent durations used to be 17 years from the issue date before June 8, 1995. But to accommodate the  recommendations set forth by Trade Related Aspect of Intellectual Property Rights (TRIPS), it has been changed to 20 years from the earliest filing date and the magical date has been set as June 8, 1995.



Lipitor's, world's most selling drug, actual patent expired in Mar 2010 but Pfizer obtained an extension on the patent for another 20 months till Nov 2011. After this, Ranbaxy along with Teva Pharmaceuticals were given the rights to produce the generic version, Atorvastatin calcium, of the world's best selling drug. Walgreen and other four large drug and grocery chains have sued Pfizer for obtaining a fraudulent patent after the expiry of the original patent. They have accused Pfizer of making a deal with Ranbaxy (and Teva) to go slow on the production of the generic so that Lipitor could still make good sales. Pfizer defends saying that they have additional patents on Lipitor's name which run till 2016. Lipitor's sales hit as high as $12.9 Bn in 2004 making it the highest selling drug of all times.


Now Lipitor is one off example where the original innovator has made substantial returns on its investment. But is it true for all companies? Lets have a look at the data compiled by InnoThink Center for Research in Biomedical Innovation. 



They have taken a simple approach of adding the total R&D expenses of the big pharma companies and divided it by the number of drugs approved during the years 1997-2011. This gives a mind-boggling figure of upto $11.79 Bn per drug that has got the patent protection in all these years. The lowest figure is of $3.6 Bn. Certainly several drugs do not generate this kind of revenues to make good of the R&D expenses as per the presented data. 
However, arguments by Donald Light and Rebecca Warburton negates this style of estimation. They say that the 'New Active Ingredients' patented during all these years might be low (eg. 5 for AstraZeneca) but the patented variations of the existing drugs are the major source of profits for the drug companies and such incremental patented drugs account for 60% of the total US drug budget. There are other arguments too, which if accounted for, would bring down the 'R&D spending per drug' to as low as one-third of the presented data. In all likelihood, it should be between $1 Bn to $4 Bn.
Astrazeneca has been posting an average sales revenue of $30.94 Bn in the past 5 years with a CAGR of 7.24% while the average PAT stood at $7.25 Bn with a profit margin of approximately 23%.
Since the patent of 20 years is counted from the date the patent has been first applied, the effective duration of patents reduces to 10-12 years. It takes time to push the first lot of the drug to the market after the patent is applied for.
Now, to see that if this kind of profit is good enough to make up for the amount invested in R&D or not, we assume that the company sells only 5 patented drugs for the next 10 years, all acquired in the year 2012. This assumption spares us from accounting the increased innovation cost per drug due to increasing complexities in drug R&D. Thus the investment in R&D pegs at $20 Bn taking the higher end of the our estimate of $1 Bn to $4 Bn per drug.



Sales	2012-2022	$432.4 Bn
PAT	2012-2022	$99.45 Bn

An investment of $20 Bn gives about 400% returns on investment in 10 years through one of the most conservative calculations.


So where is the loss to the innovator company? They easily recover their investment on R&D and make huge profits on the patents in the span of 10 years. Here we took the example of a company with highest cost of R&D per drug. The profits increase many folds for someone like Novartis or Merck. The so-called losses due to the limited patents are the revenues foregone due to the introduction of generics based on the patented or 'branded' drugs. The generics are generally priced in the range of 10-30% of the cost of the actual drug. EvaluatePharma estimates 'Sales at Risk from Patent Expirations in 2011-16' at $267bn. For eg. Lipitor's sales sky-rocketed to $9.6 Bn in 2011 but fell by 42% YOY in Q1 2012 after the exclusivity on the drug expired. 


The end of patent-protection of a blockbuster drug leads to a beginning of big gains for the generics companies. The reason is clear. They get a solid market of the patented drug for minimal investment. Thus, the major portfolio of the drug companies consists of Generics. 


Blockbuster drugs like Lipitor, Zyprexa, Levaquin, Concerta & Protonix have seen their patents expiring in 2011 while drugs like Plavix (anti-platelet), Seroquel (antipsychotic), Singulair (asthma), Actos (Diabetes - type 2) and Enbrel (arthritis) ar expiring in 2012.
In fact, Lupin, Dr. Reddy's and Sun Pharma have all got the USFDA approval for selling the  generic version of Seroquel in Sept 12. Similarly, Ranbaxy launched the generic version of Actos in US recently.
Natco Pharma is expected to launch the generic version of anti-ulcer drug lansoprazole in the US next quarter as the 5th player in the $800 mn-a-year market for the drug.
But with the number of patented drugs losing patent going down in the coming years, the new sources of revenues for the generic-based pharma companies are capped in the long term. Thus, an investment in companies which spend heavily on R&D and secure patents for their innovation would fetch more in the coming years than the generics selling companies. However, the timing would be of utmost importance. For eg. Pfizer is set to lose some of its patented drugs which account for about 28% of its revenues by 2013. And in absence of any major discovery, the revenues are expected to fall drastically. An investment opportunity would arise only after the market price of the stock reflects all such negatives.


So what are the companies which should be on radar for a good investment opportunity? Will talk about it next time. :)


References:
http://www.forbes.com/sites/matthewherper/2012/02/10/the-truly-staggering-cost-of-inventing-new-drugs/1/


http://blogs.plos.org/speakingofmedicine/2012/03/07/pharmaceutical-rds-costly-myths/


http://www.dailyfinance.com/2011/02/27/top-selling-drugs-are-about-to-lose-patent-protection-ready/


http://www.marketwatch.com/investing/stock/AZN/financials


https://www.evaluatepharma.com/secure/FileResourceDownload.aspx?id=17eb853b-20fb-4559-85d4-c77f18a5141a

Age Of Empire : ITC, Reliance's quest for EIH!

ITC's investment arm 'Russel Credit' recently bought 57.38 Lakh (about 1%) of EIH at Rs 73 apiece for a total of 42 Cr. raising their stake in the prestigious hotel chain to 15.98%. Russel Credit also owns 72.06% stake in ITC Hotels.

Eastern International Hotels Ltd. (EIH Ltd) is the flagship company of Oberoi group which manages and operates the world renowned Oberoi  and Trident hotels. The company has been seeing a stagnant growth for the past few years and in absence of free cash in the hands of the promoters, P.R.S.Oberoi and kins, there has been very low addition to their room count. Room count is taken as an important parameter in hotel industry to gauge the value of a hotel/chain.

The EIH chain of hotels is the third largest in India after the Indian Hotels of the Tata group and the ITC hotels of ITC Ltd.

ITC, with its diverse interests - one being the hospitality sector, has been increasing the stake in the EIH ltd. since the early 2000s. After it increased its stake to 14.98% which was just below the SEBI norm of 'Open Offer' of 15%, Oberoi group chairman Mr. P.R.S. Oberoi was alarmed of ITC's intentions. At that time, the promoters had a stake of about 46% in the company. According to then prevailing rules, if ITC would have increased its stake to 15% then they had to go for an open offer and acquire a minimum of 20% in the company. The maximum could have been 85%. ITC had the financial muscle to go for acquiring the complete stake! ITC would have got a seat in the management board after the open offer and given ITC's proven expertise in hospitality business, it would have been very much possible that board would have approved EIH's acquisition by the FMCG giant.

When your opponent is too strong for you, what do you do? Fighting a losing battle is not prudent. Calling up a mightier partner is.

Oberois called upon the richest man in India, Mukesh Ambani, to act as the White Knight to save EIH from falling into ITC's hands if ITC dared to do such an adventure. RIL, sitting on huge pile of cash and less ideas to deploy them in absence of good business opportunity, threw in some change (Rs1021 Cr for senior Ambani is not more than 'a change' with his net worth running in billions) to acquire 14.12% stake in the hotel company. ITC quickly released the statements that they are only traders in EIH and do not intend to acquire it in future. RiL said that EIH for them is an investment opportunity to diversify and they do not intend to cause issues in the management's working. Too generous both of them!
Since then, RIL has increased its stake in the company to 18.53% and after last Monday's purchase, ITC's stake stands at 15.98%. The promoters stakes are at 35.23%. It should be noted here that SEBI has changed the norms for the Open Offer from 15% to 25% i.e. other companies can buy stake in a company up to 25% without the requirement of going for an open offer. At 25%, one can go for a minimum 10% stake buy and a maximum of 75%.

Now, the real question is Are the two corporate houses (RIL & ITC) saying what they really intend? I doubt.

Reasons why I think ITC will/should acquire EIH Ltd. :

1. They are the No. 2 in the industry and need inorganic routes too to become No.1. Indian Hotels have 12000+ rooms while  ITC has 8000+ rooms. As per its plan, ITC is  looking to add 5000 rooms to its present strength.
2. EIH has huge brand value and a acquisition or merger would be beneficial for the brand of ITC hotels too.
3. Due to the current economic situations, hotel businesses are under valued. It is the right time to acquire if you have deep pockets. ITC is quite aware of this and apart from EIH, it has been increasing its stake in Hotel Leela too (~13%)
4. According to World Travel & Tourism Council (WTTC) estimates, travel and tourism demand in India will grow at 8.2% annually till 2019, the highest growth after China in the big countries league. With Cigarettes business facing the ire worldwide and FMCG business still not in black, Hotels remain one of the safe and profitable businesses for the company.

ITC hotels are not listed and hence the exact impact of the added business of EIH cannot be analyzed here. However, a rough estimate of the hotels sales (present) can be done by taking an average per night charges at Rs 6000/night and with an occupancy rate of 70% throughout the year.

Sales = Rs 6000*0.7*8000*365=Rs1226.4 Cr

At 10% profit margin, it adds around Rs 122.64 Cr to ITC's bottom line.

Indian Hotels garnered Rs 145 Cr in  FY11-12 and thus ITC and EIH put together can easily pip over it to become the most profitable hotel chain in India.

Major hotels under EIH ltd.

                                             

• The Oberois, Mumbai
• The Oberois Udaivilas, Udaipur
• The Oberoi, New Delhi
• The Oberoi, Bangalore
• The Oberoi Grand, Kolkata
• The Oberoi Vanyavilas, Ranthambhore
• Trident, Nariman Point, Mumbai
• Trident, Bandra Kurla, Mumbai

                    Financials

                    *CaptialLine.com

Years	2012	2011	2010
Equity	114.31	114.31	78.59
Networth	2405.9	2355.54	1181.54
Income	1158.49	1142.95	907.45
PBIT	209.41	240.68	189.46
PBT	155.00	85.49	88.58
PAT	122.42	64.54	57.23
EPS	1.98	1.00	1.26
Div%	55.00	45.00	60.00
D/E	0.14	0.51	0.97
Current Ratio	0.83	1.07	1.10
Interest Cover	3.85	1.55	1.88

                    Market Cap : Rs 4472.38 Cr (Sept 18,2012)

                    *Figures are in Rs Crores

Thus, EIH is a profitable business but has been stagnating. And in any case, it does not have the financial might to stand up against ITC. ITC's FY11-12 PAT was at Rs6162.37 Cr.

RIL's FY11-12 PAT stood at Rs 20040 Cr!

RIL is mostly a petroleum-based company with several other interests like retail (Reliance Fresh), Infra (Reliance Industrial Infra), Cricket (Mumbai Indians) etc. But its major concentration has been in one sector only. It had about Rs71,500 Cr free cash on its books as of the year ended March 2012. And it generates upto Rs 4500 Cr profits every quarter. Thus, when RIL bought the stakes in EIH, the media grapevine fell silent about ITC's plan to acquire EIH Ltd. challenging RIL's financial might.

But has Mr. Oberoi called upon a bigger menace than ITC itself?

Reasons why I think RIL will/should acquire EIH ltd.

• EIH could be a strong entry point for Reliance in the hotels business - a diversification opportunity.
• Reliance was brought in as the 'White Knight' in the late 1980s to save L&T from falling in the hands of Manu Chabbaria. Once Manu Chabbaria retreated, Reliance itself attempted to take over the business. It was only when the financial institutions withdrew support and the congress government at the center lost the elections that they gave up on it.
• EIH is a good business and with the hospitality sector going to give consistent results in the coming years, RIL can easily capitalize it to become one of the best in the world.

However, RIL has never been in a consumer facing business unlike ITC. Its retail stores chain is the closest it has been to its consumers and as we know, it’s a very small portfolio in their balancesheet. Thus, it is uncertain how well they could manage the brand EIH.

Another aspect of this game which is a little under wraps as of now is the decreasing stake of the main promoters, the Oberois, in the company. Oberois had more than 46% stake in the company before RIL's purchase of 14.12%. Today, they have only 35.23%. When you are under the threat of being acquired, do you increase your stake or decrease it?

EIH Ltd. is an undervalued business taking in account its future prospects and a likely controlling-stake war in the coming days/years.  

Age Of Empire: Takeover Wars

IVRCL Infrastructure, which is into BOT (Build, Operate & Transfer) road projects has recently stated that they would not be bidding for any more projects for the next 6 months or so. On top of that, they would be selling out three of their projects by March 2013 to fetch around 2200 Cr to deleverage their balancesheet. The company has also incurred a loss of Rs 124 Cr in the 15-month period ended June'12. Company chairman E Sudhir Reddy says that this is the plan to keep the company afloat. However, this might not be as simple as it looks. Preserving capital and monetizing projects means that the company want to bring in cash on its balancesheet. And most likely would like to increase its stake in the company to ward off any takeover bid by cash-rich Essel Group controlled by Subash Chandra. Essel group, which has interests in infrastructure related projects as well, has increased its stake to 12.27% in IVRCL - higher than the chairman and MD E Sudhir Reddy's 11.8%. By the way, 11.8% is too low a stake in a company as the controlling promoter. The promoters have clearly stated that they would not like to loose the control of the company and also added that Essel Group will not be added to the board of members of the company. Now with a lower stake in the company than Essel, saying this might sound a little awkward, to say the least.

 A few days back when Essel group made that 2.08% purchase in IVRCL, a buzz occurred throughout the media that probably Subash Chandra is looking for an ownership change at IVRCL. This drove the prices of the stock to as high as Rs 75 a share! But after Subash Chandra declined that they do not intend to takeover IVRCL, the prices declined and are now is around Rs 40. The company may look to increase its stake further by buying some small chunk again as the prices have come down. And that too without making any open-offer. SEBI's regulations says that any company having a stake of 25% in another company has to go for an open offer to buy another 10% (minimum) stake in the company. IVRCL's move to strengthen the balancesheet might just prop Essels to increase it earlier than later as the prices would move up as and when the company starts to find buyers for its projects. Then, further promoter buys would drive the stock further up. Decrease in the debt levels and improvement in the economy may just drive the prices to levels at which the Essel group may not find it attractively valued. Thus for a retail investor looking for relatively safe bet in the market, the company, at current prices, provide a good opportunity.

A little more analysis: IVRCL is a Rs 1277 Cr company by market capitalization and is head-quartered at Hyderabad. The company has around 2000 Cr of debt on its books as of today. In the Quarter ended June'12, the company had a sales of Rs 1252.3 Cr but made a negative PAT of Rs. 6 Cr! A big chunk of its operating expenses consists of 'other expenses' of Rs 669 Cr. The  interest expense is at Rs 137.64 Cr which at an EBIT of Rs 147.85 Cr gives a pathetic Interest Coverage Ratio of 1.07. The story has been repeating for the last 5 quarters atleast. On an income of Rs 6239.83 Cr, the PAT was a disappointing Rs 18.08 Cr only in the last 5 quarters. The interest outgo has been a whopping Rs 397.87 Cr. Or an EPS loss of about Rs 15 a share.  This would have meant a tripled or quadrupled (or more) share price from the present levels based on the industry PE. Now, with the company's focus on decreasing the debt, the stock seems all set for a rerating. At Rs 100 or Rs 120, it certainly becomes unattractive for a hostile takeover. And that could be the actual plan of Mr E Sudhir Reddy!

Now, lets have a look at the chart of the company to see when it would be good to make an entry in the stock.

 The stock seems to be breaking out of its long term downward spiral. A confirm signal could be seen only after it breaks the 42-42.5 level comfortably i.e. with better volumes. A movement above 42.5 can take the stock to as high as 47 in the short term and upto 54 odd levels before it decides its next recourse.

The present situation looks scary but the company seems to be taking the right steps. Moreover, history has shown that any such stake war has always created humungous investor wealth. Who can forget the battle between ITC and Ramesh Damani to own the controls of VST Industries. The battle that ensued between them drove the prices of the VST from sub Rs 80 to higher than Rs 120 in a matter of weeks. Ramesh Damani had to give up at that time and this also prompted ITC to increase its foothold in the VST. 10 years later, Ramesh Damani remained an investor in VST but with a valuation of over Rs 530 Cr at the current prices. His initial investment of about 80 Cr in the stake were made good through the dividends that VST has paid over the years!

Read a piece of the then-ongoing battle, here (Mar 2001).

Battle for VST hots up, ITC launchescounter-offer

I also wanted to talk about the stake war that is going on between EIH and RIL on one side and ITC on the other. That is probably a much interesting story to dig into. On one side you have Oberois, the renowned owners of Oberois and Trident chain of hotels. Then you have ITC which runs the second largest chain of hotels in India after the Tata's Indian Hotels. And then you have a multi billionaire with a lot of idle cash looking out for next big investment opportunity to put his money in. He gets an offer from the Oberois to buy out a portion of their stake in the company and stand there as a 'White Knight' to ward off any hostile bid by the FMCG major. The choice of players in this game is quite interesting and presents a lot of angle to be probed, specially about the intentions of the so-called 'White Knight'!

Would cover it in one of the coming articles. :)

HUL v/s Star: Yeh Rista Kya Kehlata Hai?

Hindustan Unilever is a big interest area for many like me. By me, I mean the MBAs who eat and drink marketing. I am not one though.
HUL is the biggest FMCG giant in India with a sales turnover of Rs 22,800 Cr for the year ended March 2012. It is the market leader in categories like Soaps, Detergents, personal care etc. Apparently, it needs a lot of advertisements too to promote its various products. As per a report, FMCG companies have 9 out of 10 Ads on TV. I couldn't agree more. Sometimes, I forget that I was watching some movie before the slew of Ads began asking me to buy soaps, shampoos, detergents, face-wash, fairness cream and what not. The Ads give a substantial revenues (northwards of 40%) to the broadcasters like Star, Sony, Colors, Zee etc. The Ad slots are quite expensive as the competition to grab consumers' attention has intensified many-fold since cable has become affordable long back. A prime time slot of 10 sec Ad fetches the broadcasters something between Rs 80,000 to Rs 1,00,000. During important events like a Cricket World Cup final (or for that matter a Football World Cup Final), the rates go through the roof. A daily soap like 'Yeh Rishta Kya Kehlata Hai' garners more eye-balls (i.e. higher TVRs) hence they go a little expensive than the rest.
Star TV (having a basket of 15 channels) owned by Rupert Murdoch , rules the roost in the Indian Small Screen market with an approximate share of 35%, reaching around 400m viewers weekly. Thus, by default, Star TV and HUL are natural Complementers. HUL spends huge amount on Ads (as much as 12% of its sales) and a huge chunk is diverted towards Star.





Courtesy: www.thehindubusinessline.com

The FMCG companies have increased their TV Ad spending since 2008. A look at the figure shows that the companies have increased their spending to an average of 12.1% of their sales for FY11 as compared to 11.9% spent last fiscal.


Reasons for increased ad spending:


1. New product launches
2. Softening of some specific commodity prices
3. Focus on global businesses



But recently, HUL has stopped advertising on Star network of channels. Another FMCG major, P&G has been away from Sony Entertainment Channels for the last 8 months. The reason?



Higher Ad-Slot Rates asked by the Broadcasters.
 
In a year when the consumer sentiments are somewhat damp due to the continuous slowdown in the economy, these FMCG companies have maintained a healthy profit margins. But, going ahead can get tough and they know it well. On top of that, if the broadcasters ask for hefty price appreciations on their Ad-slots, it is deemed to hit the companies in the wrong way.


HUL spends about Rs700 Cr on Hindi GEC TV Ads, approximately 30% of its total Ad outlay. P&G's expense is pegged at around Rs 250 Cr. But its not that the broadcasters get anything they ask for. Just because of the huge spendings that these companies do on TV Ads and also because of the increased competition in the number of channels, they ask for hefty discounts of as much as 40% and get it.






 

The GfK Media research establishes that TV reaches three quarter of the population while other forms like print & online media are still far behind. But the average return on investment through Online advertisements exceeds that through TV advertisements (approx Rs 43 to Rs 75 for every Rs 100 spent)





Now, the interesting question is "Who will win this battle of the market leaders of their own domains?"


Is Star more dependent on HUL or vice-versa?
The answer is very simple but lets put a number to it through a fill in the blanks exercise.


 I call it a Fill in the blanks exercise because there are few data which are authentic and the rest is an approximation or a Guesstimate!


"Media Partners Asia, a Hong Kong-based research group, expects Star’s revenue in India to grow to $530m in the financial year ending June 2010, up 15 per cent, with operating profit of $105m, up 11 per cent."


Based on the above report, I assume a 15% compounded YOY revenue growth & 11% compounded YOY profits growth for Star for year 2010-11 & 2011-12.
Lets have a look at the calculations:

Star's Approx sales for 2012 ( at $1=Rs 55)	Rs 3855 Cr
Star's Operating profits for 2012	Rs 711.53 Cr
Zee's Ad Revenue FY12 @44% of Revenue	Rs 1337 Cr
Giving Star a premium of 15% for Ad-revenue	Rs 1538.5 Cr
HUL's total Ad spending (approx)	Rs 2000 Cr
HUL's Ad spending on Hindi GEC	Rs 700 Cr
Star holds about 35% market share. Lets say HUL spends according to the market share. Star's revenue loss	Rs 245 Cr
As per GfK research, every Rs100 on TV Ads earn Rs 43*, so, Rs 245 Cr earns HUL a revenue of --	Rs 105.35 Cr
Star's sales hit	6.35%
HUL's Expected sales for FY12 (12% growth over FY11)	Rs 25536 Cr
HUL's sales hit	0.41%

        *Incremental Income. A TV presence helps the brand to be present on a consumer's
          mind. For simplicity, here we are assuming that won't be affected in short run for
          a company like HUL.


Thus it is easy to see who is more powerful in this battle of Ad slots.
Probably, a boycott from the FMCG major may prompt the other companies to do the same to the broadcasters. Advertisements still making a major portion of their revenues, they don't have much choice but to fall in line. Any such dispute between Star and HUL or Sony Entertainment  Television and P&G is bound to help the other players  like Zee Entertainment Ltd. from the broadcasters space and ITC, Nestle, GSK in the FMCG space. However, since similar incidents have occurred earlier too, between Star and HUL, a compromise might be just around the corner for the mighties of their land.
Well, till the time, you enjoy your soaps with lesser Ads.  ;)

Bulls Ahead:Mario Draghi's 'Unlimited' Bond Buying

So, the ECB chief Mario Draghi has gone ahead with his earlier declaration of buying unlimited binds of the countries like Spain, Italy and others  which are maturing with in the next 3 years,  to ease the liquidity pressures in these countries. Draghi was facing pressure from the German banker Jens Weidmann of Bundesbank who was against such an easing. Draghi has used the word 'Sterilized' for the bond buying program, hinting that this would not be minting money in 'thin air' but rather an equal amount of money will be pulled out of the ECB and they would be very transparent about which country's bond they are buying. This essentially means a lot of bad assets on ECB's balancesheet.

Now, for how long that would remain there is a question in purists' mind. But for the markets- they have spelled their verdict as of now:

Dow Jones, S&P 500 &  Nasdaq have all reacted positively to the news. S&P 500 has touched its 4-year high at 1430 levels. The same scenario is expected to be reflected in our markets tomorrow.

The move is expected to bring down the interest rates on the government bonds of countries whose bonds would be purchased and thus making life easier for them for some more time.

More than that it’s an assurance to the investors that ECB and others will do whatever it takes to preserve the Euro. That, in turn, means a slow growth for few more years where the commodity prices would be high due to ECB's easy money in the system.

However, the term 'Easy Money' may not be appropriate this time as Draghi has hinted, time and again, that the troubled nations would be provided easing only under certain 'Conditions'. The conditions are pretty clear for everyone to see.

So, the whole story in a gist goes on like this:

A lot of debts which are going to get matured by 2015 have been scaring the markets, banks and certain countries. Spain, Italy etc. are unable to service their huge debt piles and hence would have defaulted. The event is certainly 3 years hence, but markets react much before the actual events. No support from the ECB and ilk would have made the investors wary and they would have started to sell the bonds they hold in these countries. This would have meant that the prices of the bonds would have crashed. Countries like Germany and France hold huge chunks of the papers in these countries through their banks. The crash in the bond market would mean huge losses to their own banks and for several banks the losses could be terminal. What is called as The Domino Effect would have followed from there on. The German and French banks would start to sell their stable bonds in other countries to make up for the losses. That would lead to a rise in the bond yields of those countries and they would find it tough to raise capital due to high borrowing costs. The liquidity crunch and the pressure on the banking system would be the other effects of such a huge bond sale. It would lead to bank runs in the 'now' stable countries and this is the biggest fear of the governments all over the world.

However, few people have different views and they argue that the fear is unwarranted. A systematic eurozone breakup could be the ultimate solution and it could be handled without ruining everything.

Well, now the ECB would be buying the risky bonds and providing the troubled countries much needed money in lieu of tighter fiscal goals (read austerity). Prolonged austerity would lead to slower growth in the coming years.

As has been seen in earlier easing, a large chunk of such liquidity rush finds its way to the emerging economies like India. The inflows would help to trim the Current Account Deficit (CAD) which is hovering at an uncomfortable level of 4.3%. So, in the coming days, we can see big rallies in our stock markets. A huge rally followed ECB's first bond-buying of 489 Billion Euros.
The sensex jumped from the levels of 15400 to 18500 in a matter of 2 months (21st Dec 2011 - 21st Feb 2012). 

However, the next round of bond buying didn't cheer the street much. But now, with US showing revival and sensex itself showing some signs of life, there is a fair likelihood that the highs of 2012 could be breached in this rally. The amount is, as per Draghi, unlimited. But since unlimited is also limited, an estimation among the experts pegs the quantum at around 750 Billion to 1.5 Trillion Euros. This is huge money and only a small chunk of it is enough to push us 1000-1500 points above the present levels.

So, what should be your likely bets? Banks and Financials! As any such proceeding impacts them before hitting on anything else. Look out for SBI, ICICI, HDFC, YES Bank. Axis Bank & PNB are still very weak on charts but the rally would not think about it for now. Next up will be rate sensitives  like Autos, Metals, Realty and Infra stocks. Look out for Maruti, Tata Motors, Hero Motocorp in Autos, Hindalco & Tata Steel (Horrible charts/fundamentals though) in metals, HDIL, Shobha Developers, DLF, Oberoi Realty in realty and the usual IVRCL, GMR Infra, Lanco Infra, RIIL in the infra space. The defensives should underperform now. There can be reversals in stocks like Lupin, HUL & ITC.

As Udayan Mukherjee Says, "It's time to get back to the stock markets" ;)

The Impending Daemon For India, Inc. : FCCB Redemptions

The story is very simple. During the golden days, these companies over-leveraged their balance-sheets with the borrowed money to fuel their growth (which looked pretty natural at those rose-tinted days). They borrowed money from all possible measures - through stocks, commercial papers, bonds etc. For the borrowers, it was 'necessary' to expand as soon as possible and for the lenders, these were one of the best investments they could have ever made. India Inc. was on steroids and growth seemed like our birth-right!
With the incident of 15th September 2008, nothing remained the same!



Before the crisis days, several debts were raised on a long term basis to invest in the upcoming projects mostly power and infrastructure related. The immediate pangs were not felt during the peak of the crisis. But by 2009, a lot of such bonds started to mature and the companies were falling short of the money to repay them. They issued more bonds, either the zero-coupon bonds or with a minimal coupon interest (read FCCBs) to pay the previous bonds as they expected the crisis to be short-lived. Three years down the line, the crisis is still sticky and the downturn of the last two years coupled with high interest rates have sapped the cash out of the balance-sheets of such companies. 2012-13 is the year when most of the FCCBs are getting matured and the stock prices of such companies being much lower than the redemption price of the FCCBs, they are facing a unique problem that can scare the best of the fin(-ance) brains!


A little background about FCCB:  FCCB stands for Foreign Currency Convertible Bonds. The 'Foreign Currency' referred here is generally (not always) US Dollars. These bonds are a measure for the companies to raise capital in lieu of a promise to repay the lenders either in the form of equity or in cash at the time of maturity. An FCCB can be issued as a Zero Coupon bond (i.e. the bond is issued at a discount and fetches no interest year on year, but is redeemed at its face value on maturity) or at some coupon interest rate.

To understand the nuances of the above definition and the havoc created by the 'Four Letter Word starting with an F', I have taken an example of a big cement and infrastructure conglomerate Jaiprakash Associates Ltd.' of Nodia based Jaypee Group. They recently raised $150 Mn fresh FCCBs to repay their previous FCCB liabilities. Since the news broke out, the stock has been falling continuously in the markets (Over 17% in the past 7 sessions).




So, lets try and understand what went wrong for Jaiprakash Associates so much so that they are now bound to sell their assets one by one!

The company raised $400 Mn in August 2007 at a USD-INR rate of 40.35 which equalled Rs 1614 Cr. The lenders may convert the bonds to equity shares at a fixed price of Rs 165.17 a share on the date of maturity.




The calculation goes on like this:


Invested $ (in 2007) :  $1000
Conversion rate: 40.35
Invested in Rs (in 2007): Rs 40350
Conversion price of equity: Rs 165.17
No. of shares that would be given (if converted) : Rs 40350/165.17 = 244.2938 ~ 244 shares


Thus, any one willing to convert the FCCBs to Equity shares will get only 244 shares. The investors bought the FCCBs thinking that the share would appreciate much more than Rs 165.17 in the next 5 years or so (It closed at Rs 121.45 a share on 31st Aug 2007). Then they would convert the FCCBs to equity shares.


For Ex. Lets say in the next 5 years (after the issue) the stock appreciated by a CAGR of 20%. Then by the end of 5 years, it would be trading at
                          [Rs 121.45{1+(20/100)}^5] = Rs 302.21.
(An appreciation at a CAGR 20% was quite normal during those booming phases and most of the companies raised their FCCB issues giving such lofty projections.)
For the investor, it would still be available for Rs 165.17 and hence it would earn a return of 81.97%.



As per today's closing, JP Associates is trading at Rs 64.55 a share. Conversion of the FCCBs to equity would fetch the investor a meager Rs(64.55*244)= Rs 15750.2 against Rs 40350 that he originally invested.
But this is where the depreciated rupee comes into the picture. The FCCB issues were done in Dollar denomination and hence the present value of Rs 15750.2 is equal to $283.37 only!!!

So, the original investment has depreciated by a whopping 71.66% in the past 5 years. For a retail investor, he would have no option but to accept the scenario and curse his fate for making such a lousy investment. FCCB gives the investors much more safety here.


The power of 'Not to convert them into Equity shares and redeem them at a premium of 47.7%' i.e. the investment of $1000 fetches you $1477 today. In rupee term (as per today's rate - 31/08/12) it would be Rs 82091.66 against the raised amount of Rs 40350.
(The 47.7% premium is for the specific issue of Jaiprakash Associates. Different companies may have different terms for FCCB redemption)


So, if you have to choose between an amount of $1477 and $283.37 - What would you choose? ;)


Now this is where they are facing the trouble. World as a whole is facing a downturn and India is grappling with corruptions and scams. Development in Infrastructure sector is grinding lower and lower and the company has been reporting lower sales and lower PATs for the past 3 years. Change of Mayawati government in UP is also not serving the company well as the Gaurs (Promoters) are not a favorites of Mulayam Singh Yadav. The huge debt burden has decreased their Interest Coverage Ratio and the company is finding it tough to raise fresh capital.

Year	Mar'2012	Mar'2011	Mar'2010
Net Sales	12783.3	13030.12	10088.91
PAT	1026.38	1167.78	1708.36
Net Worth	12103.75	9194.81	8196.8
Total Debt	16778.41	18530.55	17908.7

They recently raised $150 Mn to repay the upcoming FCCB redemption. But the numbers quickly show that they have raised only about Rs 830 Cr while they have to pay about Rs 3268 Cr! In fact they have paid a part of this amount already. Hence the actual figure is about 400 Cr lower. But still they need to raise around Rs 2000 Cr and that too at a higher interest rate. Generally, the companies have started to hedge the currencies after the slide that Indian currency saw. It will use its hedged dollars but in all likely hood that will also fall short depending upon the price at which it was hedged.
The company has to pay another $200 Mn in March 2013.


The company made a PAT of Rs 1026.38 Cr only in FY12. Thus, its capability to service such huge FCCB redemptions from its operating profits are only limited. In all certainty, the company is going to incur fresh debts on its already debt ridden balancesheet (Approx Rs 44000 Cr). That would lead to an increase in the interest costs of the company and in all likelihood, a lower net profit. The other way out will be the sale of assets. In fact, they are in process to sell their 51% stake in the cement plants of Gujarat and Andhra Pradesh which would cut down their debts by Rs 4000 Cr or so.
Obviously, the  assets won't fetch them good valuations at a time of distress and risk-aversion. Moreover, the buyer knows who is more needful. These would further decrease the company's net-worth in the coming years.



 Jaiprakash Associates' FCCB Issues:



Year End	Type	Amount	Purpose	Maturity Period	Maturity Time
2006-03	FCCB	Rs 1100 Cr	Project	7 Yrs	2013-03
2007-08	FCCB	Rs 2223 Cr	Project	5 Yrs	2012-08
2008-10	ECB	Rs 333 Cr	Import of Capital Goods	5 Yrs 4 Mn	2015-02
2009-02	ECB	Rs 556 Cr	FCCB Buyback	6 Yrs 4 Mn	2015-06



The story is almost identical for several other Indian companies too who raised US Dollar denominated Bonds during the happy times and are now grappling with the double blow of stagnating growth and rupee devaluations. Almost all of them are trying to raise the money through External Commercial Borrowings (ECBs) or Qualified Institutional Placements (QIPs). Without these tools, most of them will default or will be so cash strapped they would struggle in their day to day operations.  But raising ECBs are costly. The interest rates varies from 6-8% for such borrowings and thus this only shifts the day to gallows.



Company	Value	Date
Everest Kanto	$35 Mn	Oct-12
Tata Steel	$875 Mn	Oct-12
Suzlon Energy	$452 Mn	Oct-12
Pidilite Industries	$400 Mn	Nov-12
GTL Infra	$300 Mn	Nov-12
First Source	$275 Mn	Dec-12
Reliance Comm	$500 Mn	Mar-13



The list is pretty long and some companies are in a bigger mess than the others. The CFOs of these companies are going to have a hard time raising money in such environment.
The question is Can India, Inc. get its act together before the daemon devours it?