Initial Public Offering. Should you subscribe to Gland Pharma IPO?

Gland Pharma, a Hyderabad-based generic injectables Indian pharmaceutical company, is raising ₹6,480 crore at the higher end of the IPO price band (₹1,490 to ₹1,500 per share).

The offer, open from November 9 to 11, comprises a fresh issue of up to ₹1,250 crore and a 22.5 per cent offer for sale by the company’s promoters and other shareholders.

Applications will be accepted in multiples of 10 shares, and not less than 35 per cent of the issue will be reserved for retail investors.

Subsequent to the IPO, the current 74 per cent stake of the Chinese promoter, Fosun Singapore, will go down to 58.3 per cent. According to the company, along with the reduction in stake of the other selling shareholders, the offer for sale will help it comply with SEBI’s free-float requirements and pharma FDI norms. Proceeds from the fresh issue will be utilised for capital expenditure and working capital needs.

Gland Pharma is a business-to-business (B2B) player in the fast-growing generic injectables space, within the otherwise highly competitive broader US generics market that has faced price erosion. Its B2B model offers it many advantages, given its relatively small scale of operations from a global perspective.

This is reflected in the company’s strong financials – high operating profit margins, double-digit growth in revenue and profit, almost no debt, and high cash balance. Gland Pharma is also expanding its production capacity for both formulations and APIs (active pharmaceutical ingredients), the latter to strengthen backward integration.

Though not cheap, Gland Pharma looks reasonably priced, compared with global peers. At ₹1,500, it discounts its trailing 12-month (ended June 2020) earnings by almost 26 times and the FY20 earnings by 30 times. Global peers such as Recipharm AB and the Lonza Group AG trade at trailing 12-month P/E multipleof 34 times and 56 times, respectively (average of daily trailing PE ratios of the last one month). According to Gland Pharma, it has no listed peer in India. Comparison with the S&P BSE Healthcare Index can offer some perspective. The index currently trades at a higher trailing 12-month P/E of 50 times.

Given the positives on the business front and the reasonable valuation, investors could consider subscribing to the Gland Pharma IPO. There are, however, a few risk factors, too, that investors must take note.

Also, given the negative China sentiment, the possibility of the stock coming under pressure can not be ruled out.

About the business

Starting as a contract manufacturer in 1978, Gland Pharma has grown into a largely B2B generic injectables company selling products in 60 countries.

The US and India, its two biggest markets, contribute nearly 63 per cent and 15 per cent of its revenue. The company has a B2C (business to consumer) presence only in India where it markets its products to end-customers such as hospitals, nursing homes and government facilities

Gland Pharma operates seven manufacturing facilities — four for finished formulations and three for APIs, the latter for captive consumption — in Hyderabad and Visakhapatnam in Andhra Pradesh. The company’s facilities are USFDA-approved and have never been issued warning letters by the drug regulator.

Its injectable product portfolio broadly covers sterile injectables, oncology and ophthalmics. The company’s raw material sourcing is diversified. A fourth of its API requirements is met captively and the rest is sourced externally including 34 per cent from China, a fourth from India and 16 per cent from Europe.

Gland Pharma’s B2B business comprises the intellectual property (IP)-led, technology transfer and contract manufacturing models which account for 69 per cent, 27 per cent and under 1 per cent of its revenue, respectively.

Under the IP-led model, Gland Pharma develops or co-develops products that are licensed out to its marketing partners, that is, large established pharma companies, for commercialisation. Here, of the 267 ANDAs (generic drug filings) filed in the US, 101 are owned by Gland Pharma and the rest by its partners.

In the B2B technology transfer model, the product is partially developed by the partner and the technology for manufacturing, testing and packaging is transferred to Gland Pharma. The IP-led model offers an operating profit margin differential of 10 percentage points over the technology transfer model.

Advantages at play

As a B2B player, Gland Pharma enters into long-term contracts with its marketing partners, which provides greater certainty of revenue and predictability of cash flows compared with if it were to handle the marketing on its own

By supplying products to several companies, it is able to manufacture on a large scale, helping it derive the benefit of economies of scale. According to the company, 85 per cent of its production cost is fixed and a higher capacity utilisation allows better cost management. A partly captive supply of APIs, too, helps. This is likely reflected in the company’s high operating (EBITDA) margins of 33-36 per cent in the last three financial years.

Furthermore, while the hyper competitive US generics market has seen price erosion, the injectables space (particularly for complex products) offers scope for profitable growth. According to IQVIA, a global healthcare data analytics firm, the global generic injectables market is estimated to be worth $133 billion in 2020. The US generic injectables market, which accounts for 35 per cent of this, is expected to grow at 16 per cent CAGR during 2020-25.

Also, building an injectables manufacturing capacity requires significant capital expenditure and involves high manufacturing complexity along with the need to adhere to stringent quality standards. These serve as high entry barriers, thereby restricting, to some extent, the pace and number of new entrants.

While continuing to focus on the US, which is the largest pharmaceutical market, Gland Pharma also plans to expand its geographical presence by making inroads into China, the second-largest market. It has already filed six products for the Chinese market in FY20. Here, it will be leveraging on Fosun Singapore’s presence in, and knowledge of, the Chinese market for handling regulatory matters and later on, marketing its products.

Gland Pharma is also undertaking capacity expansions at its production facilities. While the exact extent of the additional capacity is not known, the new capacity is expected to include complex injectable products and new delivery formats such as pens and cartridges. The company plans to raise its in-house API capacity to strengthen its backward integration.

Strong financials

From FY18 to FY20, Gland Pharma grew its revenue by 27 per cent CAGR to ₹2,633 crore. During the same period, the company’s operating profit expanded by 34 per cent CAGR to ₹956 crore. This was driven by product launches and cost savings on older products. The company launched 96 products in FY19 and FY20. In the June 2020 quarter, revenue grew 31 per cent to ₹884 crore and operating profit by 57 per cent to ₹413 crore year-on-year. Gland Pharma also has a strong balance sheet.

It has almost zero debt and has sufficient cash on its books to fund its capital expenditure plans. As of June 2020, it had a cash (and cash equivalents) balance of ₹1,529 crore. Its return on capital employed has gone up from 13 per cent in FY18 to 21 per cent in FY20.

Points to note

The company’s financial performance has been impressive since FY18. While the company may continue to perform well, the pace of growth and the high margins may not necessarily sustain. This will largely depend on the company continuing with its pace of product launches, as also the complexity of the products it launches. That apart, concerns have also been raised regarding the company’s Chinese promoter holding.

The company, however, does not see the Indo-Chinese relations impacting its business. Further, according to the company, the US-China trade negotiations should have no bearing on its business with US pharma companies, given that it is regarded as an Indian company.

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