Sun Pharma - Event Update - Motilal Oswal

SUN PHARMA: Acquires controlling stake in Taro; Positive development; 9% accretion in FY12 EPS likely

- Sun Pharma (SUNP IN, Mkt Cap US$8.8b, CMP Rs1,938, Buy) has completed the acquisition of a controlling stake in Taro Pharma post the favorable ruling from the Israeli Supreme Court some weeks back.

- Taro's promoters have abided by the ruling and have transferred their stake in Taro to Sun Pharma as per the terms of the Option Agreement entered into in 2007. As a result, Sun's economic interest in Taro has increased to 48.7% and its voting rights to 65.8%.

- In connection with the closing of the Option Agreement, all the parties have settled all outstanding litigation among themselves.

Implications

- Sun taking a controlling stake of 48.7% in Taro was expected post the Israeli Supreme Court ruling. Including pending warrants, Sun's stake can go up to ~52% with 67-68% voting power.

- Taro has reported US$187m revenues for 1HCY10 (up 3%), EBITDA of US$36.9m (up 6%) and Adj PAT of US$28.6m (up 7.4%). For CY09, Taro had reported revenues of US$360m, EBITDA of US$66.4m and Adj PAT of US$51.9m. It has a net debt of US$25m.

- Sun has already invested US$105m in acquiring Taro shares till date (excl Taro promoter's shares). Based on preliminary calculations, acquisition of Taro promoter's share will cost Sun an additional US$38-40m while warrants will entail another US$22m.

- Hence, Sun will have to spend an additional US$60-62m to take its stake up to 52% with 67-68% voting power. Total cost of acquiring this stake will be ~US$165-167m for Sun. Including the net debt of US$25m, the acquisition will cost Sun ~US$190-200m.

- The above calculations assume that all the other shareholders of Taro (besides the Taro Promoters) will continue to hold Taro shares.

- Annualizing the 1HCY10 financials of Taro, the acquisition can add incremental EPS of Rs6.8/sh (adjusted for extra-ordinary items) to Sun's FY12 EPS of Rs74.7/sh implying an upside of 9% to our FY12 EPS.

- About 90% of Taro's sales come from the US markets. It has expertise in the dermatology and paediatric segments and has about 170 scientists involoved in product development. One of the key attractions is Taro's capabilities of developing and manufacturing of ointments, creams, lotions in the semi-solids category. Taro's existing portfolio in the US includes ~100 ANDAs (across 50-60 products). This is likely to complement Sun's existing product pipeline in the US.

- Taro promoter's can technically request the Israel Supreme Court for a review of the ruling and can also use the pending litigation in USA to further delay the process for Sun.

Background

- Sun & Taro promoters had entered into an agreement May-2007 which allowed Sun to acquire Taro promoter's shares. Sun had also provided immediate funding to Taro.

- Later, Taro promoters terminated their agreement with Sun and declined to offer their shares to Sun and the two parties went into litigations in Israel and in the US. The Israeli Supreme Court ruling is a part of the litigation.

Valuation and view

- An expanding generic portfolio coupled with change in product mix in favor of high-margin exports is likely to bring in long-term benefits for Sun Pharma. Its ability to sustain superior margins even on a high base is a clear positive.

Key drivers for future include:

1. Ramp-up in US business and resolution of US FDA issues at Caraco & Cranbury facilities.

2. Monetization of the Para-IV pipeline in the US

3. Launch of controlled substances in the US

4. Successful acquisition of Taro & Sun's ability to improve Taro's profitability (currently lower than Sun)

- We expect core FY11 EPS at Rs61.8 (up 34.7%) and FY12 EPS at Rs74.7 (up 20.9%) resulting in 28% core earnings CAGR for FY10-12 albeit on a low base. Including Para-IV upsides, we expect FY11 EPS of Rs79.3 (up 21.6%).

- The stock is currently valued at 31.4x FY11E and 25.9x FY12E core earnings. Including upsides from Taro acquisition, the stock is valued at 23.8x FY12E core earnings. Earnings growth is likely to improve post the resolution of Caraco's US FDA problems.

- With the Taro acquisition going through, we believe the next catalyst to the stock's performance will be early resolution of Caraco's US FDA issues.

Source : Equity Bulls

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