Event update: Aurobindo Pharma (Outperformer) - Sandoz business acquisition – Value accretive

Event

• Aurobindo has entered into a definitive agreement with Sandoz Inc USA (Sandoz), to acquire its dermatology and oral solids business

Key highlights

• Aurobindo will acquire a portfolio of ~300 products across dermatology (30% of sales) and oral solids (70% of sales). Portfolio includes authorised generics and in-licensed products. Aurobindo also acquires 3 US located manufacturing units (including 2 derma units).
• The target business had sales of $1.2b for CY17 and $0.6b for 1HCY18. Post completion, first year sales are expected to be $0.9bn (post impact of expiration of some in-licensed products and portfolio rationalisation) with margins in-line with Aurobindo (IDFC estimate 22-23%). It does not consider any potential divestment due to USFTC requirements.        
• Aurobindo will pay $0.9b in cash including near term earn outs and an additional $0.1b potential earn out on pipeline products in later years.  Aurobindo will also acquire $225mn of net working capital as part of the transaction reducing the overall net consideration. The purchase will be funded entirely by debt. Aurobindo is effectively paying <1x sales for this transaction. Assuming Q1FY20 deal closure, we estimate proforma full year EPS upside of ~Rs9.5/share in FY20. We estimate that the payback period could be <5 years with peak debt / EBITDA < 1.5x.
• Post this acquisition Aurobindo will become the 2^nd largest generic player in US with performa FY20 US sales of ~$2.3bn. Management sees multiple avenues for value creation through better negotiating power with Big 3 distributors,           realizing cost synergies in manufacturing and SGA as well as opportunities to market AGs etc. This will help to mitigate future price erosion risks and enhance profitability.
• The transaction is expected to be closed by Q1FY20 post the completion of customary closing conditions including USFTC clearance.

Valuations and view

This Sandoz business acquisition, arguably near the bottom of generic cycle, is positive for Aurobindo strategically as well as financially. Owing to significant distribution consolidation in US generics, scale is becoming increasingly key to compete effectively. With this acquisition Aurobindo becomes the second largest US generics player and adds niche dermatology segment to its strong Oral Solids and Injectables portfolio. This has significant long term competitive advantage.

With proforma consolidated US sales of $2.3bn by FY20E, Aurobindo will be potentially the largest pure-play generic company from India (Sun being the only other close competitor). Given the growth challenges being faced by almost all the large generic companies, this high revenue base is likely to create concerns around Aurobindo’s ability to meaningfully grow its US / consolidated revenues from FY21 onwards. Management’s ability to satisfactorily address this investor concern will be key to a meaningful re-rating. Notably, in the past, Aurobindo management has been indicating that it believes that monetization of its R&D investments in complex generics (microspheres, peptides, vaccines, biosimilars, etc) will help the company sustain organic growth momentum beyond FY20. The task, while not unsurmountable, just got tougher with this proposed acquisition. Improving traction in EU is adding to growth momentum and adds solidity to the business. Reiterate Outperformer. Aurobindo is our preferred pharma pick.