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Event update: Lupin (Underperformer) - Divests Japan business at attractive valuations

Event

Lupin has entered into an agreement to divest its Japanese subsidiary, Kyowa to Unison for an EV of Rs37bn.

Key highlights

• Lupin has entered into an agreement to divest its Japanese subsidiary, Kyowa Pharmaceutical to a PE fund Unison for an EV of JPY 57,361m (Rs37bn; $530m). The divested business recorded sales of JPY 14,241m in H1FY20 (~11-12% of FY20E consolidated sales). Mgt indicated EBITAM were 15-18%.
• ~15% EBITDA margin implies a valuation of ~13.5x EV / EBITDA. Overall, given that the Japanese business has been struggling with revenue and profitability, it seems like a very good deal for Lupin; Notably, Kyowa is the 5th largest generic company in Japan so that may have enabled Lupin to obtain a premium
• The strategic rationale for the exit was growing regulatory pressures in Japan coupled with increasing competitive intensity in the generics space. The company will however, retain its biosimilar portfolio in Japan including its partnerships with Yoshido and Nichiko for bEtanercept
• With part of the proceeds being used to pare the Kyowa debt (~$176m), we estimate an EPS accretion of ~Rs1 (details in Exhibit 1), indicating a small impact on recurring profitability. Mgt seeks to leverage the cash flows to reduce debt and / or acquire assets in India and US (speciality).
• While balance sheet hasn’t really been a concern, this transaction will significantly strengthen Lupin’s BS. While reduction in balance sheet size, return ratios should also improve going forward.

Valuations & view

The divestment of the Japan business is a pretty good deal financially, despite a reduction in business diversification, given the growing business challenges in Japan. However, the transaction will not impact Lupin’s near term organic growth outlook given that it is largely linked to its ability to overcome the ongoing growth challenges in the US market. Limited visibility on meaningful new launches in US coupled with a high FY20-21 earnings sensitivity to a scale-up in Solosec and gLevothyroxine and gProair approval backed up with ramp-up, reduces margin of safety at current valuations. Outstanding compliance issues across multiple manufacturing units add to the US challenges. Maintain Underperformer rating with target price of Rs702 (21x FY21E EPS).