The Hindu Business Line : Matrix Labs: Hold

INVESTORS may retain their holdings of the Matrix Labs stock, which trades at about Rs 190. From our earlier `buy' call on the stock, when it was trading at around Rs 140 (adjusted for the bonus and the stock split), gains have been muted compared to several other mid-cap pharma plays. Matrix appears to be another idea the street has glossed over, if its returns are any indication.

Matrix has travelled quite a way since the time it hit pay dirt three years ago with its non-infringing process for citalopram, for supply to the European market. The effort since has been to reduce its reliance on a single product. Citalopram, which brought in half of revenues in FY03, accounted for 22 per cent of sales in FY05. Matrix has also strengthened its presence in the anti-retrovirals (ARV) segment (medicines to combat AIDS); this category accounted for 26 per cent of its revenues as of end FY05. Custom Research and Manufacturing Services (CRAMS) chipped in with about 15 per cent of the revenues as at end FY05.

Slew of acquisitions

However, what has kept the spotlight on Matrix is its seemingly insatiable appetite for acquisitions. Though its merger with Strides Arcolab was called off on issues regarding valuation, it does not appear to have diminished Matrix's drive to expand its global footprint through the acquisition route.

In recent times, Matrix has acquired the Belgium-based Docpharma for $263 million (about Rs 1,200 crore), making it the largest cross-border deal in the pharma space; bought a 60 per cent controlling stake in the China-based Mchem, which is focused in the ARV space; purchased a 43 per cent stake in a Switzerland-based research outfit called Explora; and inked agreements with South African major Aspen for two joint ventures, one in India and the other in South Africa.

What to expect

Clearly, the Docpharma acquisition will occupy centre-stage, given its magnitude and the opportunities it offers in the European market. Docpharma has no manufacturing facilities; it acts like a distributor and marketer, and is the third largest generics outfit in Belgium with a presence also in the Netherlands and Italy. Docpharma has a basket of 80 products to be launched over the next few years.

Matrix's manufacturing expertise in India and the Belgian unit's front-end presence are expected to provide synergistic benefits. The Belgian market, especially, holds good potential, with generic penetration of only 5 per cent.

From Docpharma's results, it is clear that about 45 per cent of its revenues for the year-ended June 2005 came from the hospital equipment division. How this division, which does not complement Matrix's operations, will confer any benefits is still unclear.

Further, Matrix intends to fund the acquisition through a combination of cash on hand and borrowing.

Even if one assumes that Matrix deploys its cash chest of Rs 400-odd crore generated in FY05 (after adjusting for debt repayment of Rs 90 crore) into this acquisition, it would need to bankroll a further Rs 700 crore to put the acquisition through.

Interest costs associated with the borrowing and the upfront marketing expenses associated with the formulations business should, in our view, temper earnings growth.

The ARV market

This is clearly a market that holds sizeable potential, with several programmes — the recent one being the US President, Mr George Bush's $15-billion PEPFAR — aimed at fighting HIV/AIDS. Matrix had inked an agreement with the Clinton Foundation in 2003 for the supply of ARVs (such an agreement Ranbaxy, Cipla and Aspen was also signed). Now, with the acquisition of Mchem, which manufactures ARV intermediates, Matrix will have a better handle on costs; its revenues, too, will receive a fillip, courtesy its India-based JV with Aspen. Though margins in this business may not be as lucrative as, say, the supply of citalopram, its steady flow and the size of the opportunity should make for a sound revenue stream.

CRAMS initiative

Matrix expects CRAMS to be another growth driver and that it would contribute to a third of revenues a few years down the line.

Matrix has acquired a formulations facility at Nashik, which should serve as its entry vehicle for the regulated markets (for formulations) of the US and Europe. With the US FDA approval expected next fiscal, we expect this facility to make a meaningful contribution only in the medium term. Till such time, supply of bulk will play a pivotal role in the outsourcing theme.

Outlook

We note that current valuation, at about 18-19 times expected per-share earnings for the consolidated entity, is at the upper end of the spectrum; however, given the clutch of initiatives that Matrix is pursuing, we think that downside risk is minimised to an extent.

We see no reason to consider exposures now, and would rather wait for greater visibility on operations in Europe, consequent to the Docpharma acquisition, before contemplating an entry into the stock.

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