Accumulate Ranbaxy Laboratories - Elara Capital

• Rating : Accumulate
• Target Price : INR527
• Upside : 15%
• CMP : INR460 (as on 5 July 2010)

R&D hive off to be EPS accretive

Hives off discovery-led research unit, to be merged with Daiichi

Ranbaxy has hived off the discovery-led research unit of its R&D department to be merged with Daiichi Sankyo India Pharma Pvt Ltd. We believe that the company's restructuring of the internal business is in-line with our expectations as Daiichi plays a key role in the world of New Drug Discovery Research (NDDR).

Deal to transfer IP assets, employees

As per the deal, Ranbaxy would transfer intellectual properties of the on-going research of current molecules as well as around150 employees of this unit. In return, Ranbaxy would receive some upfront consideration which is yet to be disclosed by the management. However, the deal would not transfer the R&D building to Daiichi's 100% subsidiary as it would remain with Ranbaxy for development-led R&D activities including R&D for new drug delivery and vanilla generics. R&D deals with Glaxo for late-stage molecule development programme and phase-III clinical trials of anti-malarial drugs (Arterolane + PQP) also remain with Ranbaxy.

Core business margins to improve post hive-off

Ranbaxy spends around 6% of its sales on R&D; of this, 20-25% is being spent on discovery-led R&D. In 2009, the company incurred USD22mn in NCE research out of the total R&D expenditure of USD108mn. We expect 20-25% of the overall R&D spending to be saved post the NDDR unit hive-off. It would improve the EBITDA margin by 100bps YoY for 2010-12. However, the full benefit of a lower R&D cost would be reflected in the net profit as NCE-based R&D expenses would have attracted 200% tax-benefits.

Valuation: First tangible sign of synergies

We find the restructuring exercise between the parent (Daiichi Sankyo) and the subsidiary (Ranbaxy) as a first sign of synergies between these two post-acquisition. Apart from a one-time cash flow from Daiichi as upfront consideration, the company would improve our EPS estimate by 9%, 8%, and 6% for 2010, 2011, and 2012 respectively. Post the hive-off, the EBITDA margin would also expand to 16.6%, 17.3% and 17.9%, respectively. Hence, we have revised our target price to INR527, rising the upside potential to 16% at the current market price. We maintain Accumulate.

Source : Equity Bulls

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