The Hindu Business Line : Betapharm blues for Dr Reddy’s

Three years back in February 2006, Dr Reddy’s Laboratories (DRL) had acquired Betapharm Arzneimittel GmbH (Betapharm), the fourth-largest generic pharmaceutical company in Germany, from the 3i Group PLC (3i) for €480 million (approximately Rs 2,250 crore). The acquisition was expected to provide DRL an entry into the high-margin German generic business. While it has done that, the deal hasn’t been as benign on DRL’s margins and profitability.

Right deal

The acquisition scored high on synergies. Betapharm’s front-end German presence complemented DRL’s domestic manufacturing advantage as well as its pipeline of generic and innovative products. For DRL, it meant ready access to the German generics business - the second-largest generic market in the world after the US - where it was almost non-existent.

Added to that, the deal was also a good diversifier as DRL’s US generics business then was under pressure. For Betapharm, being acquired by DRL was expected to be a perfect launch-pad for expanding its presence in the European market. Dr Reddy’s, however, paid a tad too much to land the deal, pegging Betapharm at about 2.9 times its FY05 sales. That it wasn’t alone in its quest for the German company and other Indian companies such as Ranbaxy, Wockhardt and Nicholas Piramal had also submitted bids to acquire Betapharm, as also global majors such as Teva and Sandoz, may have called for such competitive bidding. Funding the deal wasn’t a problem, as it was ready with $200 million cash; the remaining debt was arranged from domestic financial institutions. That, however, upped DRL’s debt-equity to 1.39 times for the year-ended March 2006.

In the subsequent year, through an ADR issue of about Rs 1,000 crore and part repayment of the debt raised for Betapharm funding , DRL brought its debt equity down to 0.59 times. But even as the acquisition did not dig into the company’s pockets - — its current debt-equity currently is at a comfortable 0.46 times — it proved a drag on its margins and profitability. How? A few months after the acquisition, the entire backdrop of the German generics business changed drastically.

Bad timing

While at the time of the acquisition Betapharm was highly profitable and enjoyed double-digit operating profit margins its revenues since have come under significant pressure. What was earlier a high-margin branded generics market turned into a low-margin volume play, driven by the introduction of Government reforms.

Within months of acquisition, the Economic Optimisation of Pharmaceutical Care Act was introduced, reducing drug reference prices. Another law introduced in April 2007, further lowered the realisations by empowering insurance companies to enter into contracts with suppliers of generics. It also incentivised doctors and pharmacists to prescribe generic drugs covered by such rebate contracts.

In between, supply chain issues with Betapharm’s contract manufacturer Salutas also played havoc. While that has now been addressed byshifting manufacturing to India and, separately, by also securing 33 contracts with German health insurer, AOK, the changed market dynamics forced the company to mark down the value of Betapharm. It took an asset impairment charge of over €270 million over the last three years. Betapharm’s value in DRL book stands at about €210 million (in FY09) as against the €480 million it paid to acquire it.

Not wonder that despite growing its revenues at a CAGR of about 10 per cent since 2007, Betapharm continues to be a drag on DRL’s margins and profitability.