Monday, 2 April 2012

Piramal Healthcare: Gazing Through Crystal Ball - Part I

In value investing, gazing through crystal ball is highly injurious and rather considered to be poles apart from the basic tenets of value investing. However, in certain situations such as unknown and unknowable events (UU events), it is important to not be bogged down by the sheer scale of uncertainty and think simple and straight to make sense of the fluid situations. It is very much possible that some of the outcomes may vary considerably from assumptions, however, at least the whole exercise leads to a structured thought process that may give some "sense" on the probable outcomes.

Success of the whole process will depend on focusing on conservative outlook rather than going gung-ho about the growth or taking management's estimates (which, many a times are very aggressive) on its face value. As described in my earlier article "Piramal Healthcare: In the territory of unknown and unknowable", PHL is surrounded with a lots of uncertainty about how future will pan out for the company. This post is a modest attempt to wade through numerous uncertainty to derive some "feel" on how future might look like 5 years down the road. 

Even though I have tried my best to derive numbers based on some of the published information on industry growth rate, past track record and some of the activities happening in the same space/sector, at some places, I have put numbers based on my "hunch", which inherently is subjective. Again numbers that are arrived at are not sacrosanct and are just very broadly indicative. The core principle still remains that it is better to be approximately right than precisely wrong.

Methodology that I have worked upon is derive a topline number for each of the five business and adding them up to arrive at total revenue for PHL at the end of 2016-17. Then based on revenue numbers, predict EBITDA and PAT  based on historical PAT/EBIDTA margins from existing businesses and EBIDTA/PAT margin for new business based on comparison with peer businesses. Once, we arrive at PAT numbers, divide PAT by possible number of outstanding shares to arrive at probable EPS. Multiply derived EPS with appropriate P/E valuation to arrive at possible price. 

I will try to divide the post in two parts. In Part-I, i will cover CRAMS, Crtical Care and R&D business. In Part-2, I will cover OTC, NBFC and real-estate business and evaluate value for the enterprise based on analysis of businesses.

CRAMS Business:
in 9M FY12, PHL's CRAMS business had revenue of 962.5 crores and is likely to be 1400 crores in FY12. PHL is currently 5th largest CMO in the world with 7 manufacturing facilities spread across India, UK and North America. According to ICRA report, from FY2009-2012, CMO business in India is likely to grow at CAGR 44% as compared to global CRAMS market growth of 14%. In the next 5 years (i.e. 2012-2017), global CRAMS market is likely to grow in the range of 12-14% due to high patent expiry, increasing spread of generics business leading to high focus by larger pharma MNC on cost reduction through outsourcing and increasing focus on low cost research alternatives. Even though growth rate differential for Indian CRAMS market and global CRAMS market is not likely to as high as 3 times (14% vs. 44%), growth in Indian CRAMS market is going to be significantly higher than global average due to number of reasons. To be conservative let's take 20% growth for 5 years (1.5 times global growth of 13%) and assume that PHL being leader in the industry will at least match industry growth. Hence PHL's CRAMS business growing at 20% CAGR for 5 years with base year revenue of 1400 crores will result in revenue of 3500 crores. 

PHL's management has indicated CAGR 37% for 5 years with investment of 2700 crores. According to management a significant part of this growth will come through acquisitions. If we reduce the acquisition part assuming largely organic growth (management has indicated 19% organic growth rate), PHL would require probably half the projected investment i.e.around 1300 crores.

Critical Care Business:
PHL current is the third largest player globally in inhalation anesthetic drugs market with the only company having distinction of all encompassing product portfolio of anesthetic drugs. It's current market share in inhalation anesthetic market is close to 10% (improved from 4.5% in FY08 click here) in USD 1.1  billion market. 

  • PHL has recently settled case with Baxter in USA, which will allow it to launch desflurane in USA and Europe. 
  • It has also applied for license to launch sevoflurane in EU which is likely to begin in FY12. Sevoflurane is the largest selling anesthetic drug in the world. 

Thus if we assume PHL will get another 2.5% market share in the market with these launches and capitalizing on very encouraging response to its earlier launch of sevoflurane in USA and inhalation anesthetic market growth of 5% CAGR (as predicted), PHL's revenue from this segment will be around USD 175 million in next 5 years (1.1 billion * 1.05^5 * 12.5%).

Another lucrative segment in which PHL has made entry is in injectible anesthetics by acquiring propofol business from Bharat Serum. Total market potential for Propofol is USD 800 million (click here) worldwide. If PHL leverages its existing sales network for inhalation anesthetics to market propofol, conservatively, it can increase its market share to 8-10% of the increased market size ( assuming 7-8% growth) resulting into revenue of USD 90 million  from it. 

PHL is leader in plasma volume expanders with 70% market share in polygeline based plasma expanders. Potential market size for blood plasma volume expander is USD 300 million (click here). However, i am not sure about the exact size of this segment in overall critical care mix. I assume it at 10-12% and have no idea on growth rate so I take the number as USD 25 million (it was close to 60 crores at the time of acquisition in 2008).

Thus total revenue from critical care business can be estimated around USD 300 million , i.e. around 1500 crores. PHL management has indicated investment of INR 1500 crores. In my calculation, I have not factored in major contribution from acquisition hence Investment of INR 1000 crore is assumed instead of management guidance of 1500 crore. 

Research Division:
This is one business area that is exposed to positive black swan and hence can completely change the growth profile of the company. However, I have tried to be as conservative as possible to arrive at numbers based on highly predictable outcomes only. 

1) Contracts with Merck: This contract with Merck is related to develop new drugs for two new oncology targets provided by Merck. PHL will get USD 175 million for each target associated with the developmental progress. PHL will be involved in carrying out all the work till the proof-of- concept (i.e. Phase II). According to PLSL FY11 AR, one of the target was near the end of preclinical in March 2011 while the other target was in the lead selection stage. Total value, if Merck decides to take process till phase-2 is USD 350 million. 

Contract with Eli-Lily: This contract deals with select group of pre-clinical candidate in metabolic disorder with PHL's scope of developing the molecule through end of phase-2. Total contract value is USD 100 million which is to be linked to milestones of success in Phase-1, 2 and 3. As per PLSL's FY11 report, one of the molecule was nearing the end of phase-1 while another one was in the beginning of phase-2 in March 2011. 

In all, total contractual value is USD 450 million (150*2 + 100). If we assign 20% probability considering progress made so far, expected value of contracts is at least (0.2 *450) = USD 90 million i.e. 450 crores. In addition, if the molecule is commercialized successfully, PHL will receive royalty on global sales and exclusive rights to market products in India and neighboring countries. However, at this point it can not be accurately quantified.

2) Commercialization of Tinefcon & BST-Cartgel:

Both these drugs have completed phase-III and have applied for commercialization in US (Tinefcon) and Europe (BST-Cartgel). It is likely to be commercialized in FY12. 

BST Cartgel: It has market size of USD 250 million in Europe and USD 500 million in rest of the world (page 25). Currently PHL plans to launch it in Europe and thereafter tap rest of the world market. Typically any product achieves peak sales (25-30% of market size for small/medium market size) in 7 years from launch (click here). Considering launch of BST-cartgel in 2012 in Europe and in 2014 in rest of the world, possible sales can be conservatively estimated at 15% and 10% respectively. This will mean revenue of USD 40 million and USD 50 million from europe and rest of the world. This will total to around USD 90 million i.e. 450 crores. 

Tinefcon: Tinefcon is a patented product launched by PHL for treatment of psoriasis. this product has been launched in USA recently and is made from natural extracts. From whatever reviews I have seen on this product, it seems to be working very well. Total market size for Tinefcon is USD 250 million (slide 20). If, PHL reaches sales of 20% of market size by 2017 (typically in 7 years product hits peak sales which is 25-30% of market size), its revenue will be around USD 50 million, i.e. Rs.250 crores.

3) Out-Licensing of Diabetic molecule P1736:

P-1736 is developed by PHL from scratch for Type-II diabetes treatment. Type-II diabetes drug is one the fastest growing therapy area in the world. Current market size is close to USD 24 billion which is likely to reach USD 44 billion by 2020 (click here). PHL has completed Phase-2 trials for P1736 which is a significant milestone for PHL. PHL management has clearly indicated that they would like to out-license the molecule as they do not have competent resources and infrastructure to support a very large Phase-3 trials for this molecule (click here). 

Many large pharma companies in-license molecule from smaller companies and then develop it to commercialization level. This reduces risk for them as they will avoid time/cost in all the activities leading to phase-1/Phase 2. Generally out-licensing arrangement has three components i.e. upfront payment, milestone based payments and royalty on global sales if molecule is commercialized. Typically value of a molecule increases as it advances through phases (i.e. preclinical-phase-3). Out-licensing value of a molecule is also closely linked to market size, potential competition in the same area and in-licensing company's research pipeline. 

In the all encompassing commercial arrangement in out licensing, upfront payment is the most certain part and hence I will try to arrive at potential upfront payment that PHL can expect from P-1736. Recently Glenmark out-licensed  its molecule GBR 500 at the end of phase-1 trial to Sanofi-Aventis  for USD 613 million with upfront payment of USD 50 million (click here). GBR 500 had market size of roughly USD 3 billion. Similarly, Targetcept signed deal with Astrazeneca for its molecule (TC-5214) at the end of phase-II for upfront payment of USD 200 million (Click here). TC-5214 had market size of USD 25 billion. For more details on out-licensing deals click here

Even though these upfront payment numbers are deal specific and depends on lots of factors including other commercial terms in the deal, it can be safely assumed that upfront payment of 1% of market size of a molecule can be obtained (in case of Glenmark 1.7% while in case of Targetcept 0.8%). If we consider USD 24 billion market size, and Mr.Piramal is able to clinch a deal at least as good as Targetcept (not considering his superior deal making ability), one can expect USD 200 -250 million as upfront payment which is equivalent of Rs. 1000 crores

In all, from research division side, PHL can expect around 2150 crores (450 + 450+ 250+1000) of revenue without considering any significant upside from their lead molecule P-276 or any royalties and marketing rights on any of the products. Total investment as envisaged by management is around 600 crores, however I am putting that number to slightly higher side of 800 crores considering the fact that R&D activities may have cost overruns due to inherently risky nature.


  1. nice opinion.. thanks for sharing...

    1. Hi,

      Thanks a lot.

      Best Regards
      Dhwanil Desai

  2. You have put in substantial hardwork in the post .......... kudos ......

  3. great insight, any update given new data on vodafone exits for piramal of between 70-83 billion? Also the Decision Resources acquisition?

    1. Hi Anon,

      I think vodafone disclosure reaffirms Mr.Piramal's assertion about 18-20% return expectation from the deal. In my opinion it is a very smart deal as from the numbers, assured return of roughly 10% while upside can be significant (depending upon IPO valuation) with number of exit options with Piramal.

      There is still not much information about decision resource in terms of profit margins and other financials so I have not yet factored that in PHL's valuation.

      Best Regards
      Dhwanil Desai

  4. Brilliantly done. You need to be made a member of PHL Board :-)