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Israeli drug giant eyes Cipla, Dr Reddy's

Gauri Kamath | May 13, 2005

For several weeks now, there has been a persistent buzz in the $8-billion Indian pharma industry. It is that Teva, the world number two in generics from Israel, is getting ready to emerge from the shadows in India with a big-bang acquisition of a large local drug maker.

The line-up of possible candidates reads like the Indian industry's who's who: Cipla, Dr Reddy's and Aurobindo Pharma, to name a few. It may not be long before a deal is inked.

And guess who is helping them size up the candidates? Businessworld has learnt that it is former Ranbaxy CEO D S Brar. (It's something Brar would prefer not to admit.)

Now, any talk about Teva makes pharma CEOs -- not just in India, but around the globe -- sit up and take notice. With reason, too. From less than $100 million in revenues in 1985 to $1 billion a little over a decade later, Teva's performance has been trailblazing.

This Faridabad centre owned by Teva is its third largest for bulk drugs, after those in Israel and Hungary. Photograph: BusinessworldSo far, the $4.8-billion Israeli behemoth has operated below the radar in India. For nearly a decade, it has bought raw materials from Indian companies. Yet, few know the extent of its sourcing activity in India.

It has had an Indian arm for the past year-and-a-half; yet not many have a clue about its plans.

But Teva is now ready to shift gears in India. In the last year, senior executives from Teva's headquarters in Petach Tikva, Israel, and from its Asia-Pacific regional office have made several trips to India.

The company is apparently sizing up Cipla, Aurobindo, and Dr Reddy's, to name a few companies. (Aurobindo seems the most likely candidate, but the company denies it is up for sale.)

The trigger is simple: Teva needs a large, low-cost Indian manufacturing back end to keep feeding its phenomenal growth engine in lead markets like the United States. If that's in a country with a large home market, so much the better.

The $54-billion global generics business, Teva's bread and butter, is largely dependent on low-cost manufacturing. And India, home to the lowest-cost drug producers, is now a sourcing destination that no global manufacturer can ignore.

"If people didn't look at India, I would say they were foolish," says Yusuf K Hamied, chairman and managing director of the Rs 2,242-crore Cipla.

Already, many of Teva's US-based competitors, like Ivax and Watson, have forged partnerships with Indian manufacturers. French brokerage CLSA says 10 US drug makers have allied with Indian companies for over 200 products.

This could spell trouble for Teva -- it's a market leader in the US, which accounts for over 60 per cent of its sales. Though it has the industry's richest generic products pipeline, there's every chance that armed with an Indian sourcing advantage, its US rivals could play catch-up.

Also, Indian players like Ranbaxy, Dr Reddy's and Sun Pharma have made inroads into the US market by themselves.

"Increasing price competition from the Indian generic players is likely to reduce (Teva's) margins," says Wall Street research firm Mehta Partners in a March report. Even Sandoz, the world generics market leader and Teva's closest rival, is preparing to leverage India better.

More importantly, the generics opportunity remains huge. The next wave of blockbuster patent expiries in the US and west Europe starts from 2006. In less than a decade from then, branded drugs worth $80 billion are set to lose their patent protection.

What can Teva do to stay competitive? The most obvious answer is to snap up an Indian firm. "It makes eminent sense for them," says a senior executive who works for one of Teva's competitors. Teva clearly has the resources. The Nasdaq-listed company's market capitalisation of around $20 billion is four times that of India's largest drug maker Ranbaxy, and ten times that of Cipla.

Will Teva eventually ink a deal? True to form, a Teva spokesperson in Israel chose not to respond directly to BW's questions on a possible deal in India, but answered some other questions.

The real clues on Teva's plans for India lie in the manner the company grew into a formidable force in the global pharma market, despite hailing from an emerging market like Israel.

The history

"Teva has grown mainly through acquisitions," says Tarun Shah, analyst at Mehta Partners' Indian arm.

Under former CEO Eli Hurvitz, Teva went on a takeover spree in the 1980s and 1990s in Israel, North America and Europe. That transformed it from a mid-sized manufacturer in Israel to the number one in the global industry. It also moved quickly to consolidate production in some regions to get economies of scale.

Another thing set Teva apart from most of its peers -- the company made, and still makes, a lot of its own raw materials or bulk drugs. In this fiercely competitive industry, vertical integration is a magic wand.

Many of Teva's rivals in the US lack this and are dependent on suppliers. They have to split margins with the suppliers, giving them lesser control over costs. Teva, on the other hand, not only uses its raw materials in its medicines, but also sells to competitors.

In 2004, its bulk drugs sales were close to $1 billion.

There's more. While Teva's American competitors have been content staying in the US, Teva has expanded beyond the US, and now wants to be equally dominant in Europe.

"Teva is a tough bargainer. Because it's in so many parts of the world, it knows the whole (generics) situation better than a US company that's only in the US," says Hamied, which has supplied to Teva and also to US-based generics companies.

With an eye on the future, Teva is now building a drug discovery-led business with the intention of ultimately transforming into a research-driven company. That's not unlike any of the Big Pharma companies like Novartis (which owns its rival Sandoz).

But generics continues to be its main business by far and this market is getting more competitive.

In the US, prices of some new launches have nearly halved overnight. In west Europe, governments are keeping a tight leash on prices.

In these conditions, Teva has announced it wants to double sales in four years and double profit even earlier. This pace of growth would call for producing much higher volumes at a cheaper rate. "It can't do this without acquisitions," says an analyst with a foreign brokerage.

The options

Which local companies would make sense for Teva? One of the first names that cropped up in industry circles is Cipla. (For the record, Hamied said there was "no chance" of any such deal happening.)

Cipla has large-scale bulk drug and finished medicine facilities that make everything from antibiotics to AIDS medicines for scores of markets. Some of these units enjoy tax benefits.

Cipla is also the fourth largest drug maker in the world by volume. Among its crown jewels are a strong, well-established respiratory franchise and technology. It also owns the largest number of US bulk drug registrations.

But Cipla has partnered away its pipeline. It has signed up marketing deals for nearly 100 products with Teva's rivals in the US.

So why would Teva buy a company contractually bound to support its competitors? Pre-emptive strike, some suggest. "Perhaps, if Teva bought Cipla, then Ivax and Watson would no longer be comfortable dealing with it," suggests one analyst.

That would give Teva control over the pipeline and leave the competition high and dry. It is also possible that Cipla hasn't committed some lucrative products to anyone yet.

The other name doing the rounds is Aurobindo Pharma, predominantly a bulk drugs producer. It does not have the product range of a Cipla and is not a dominant force in the Indian finished medicines market.

But it has built up large, international-standard manufacturing capacities for some high-volume products like antibiotics.

If it bought Aurobindo, Teva could add capacity at a cost lower than it would incur in expanding the existing plants. Unlike Cipla, Aurobindo doesn't yet have wide-ranging partnerships for the US market.

The Rs 1,947-crore Dr Reddy's name has also been dropped in this guessing game. Apart from its vertically integrated facilities, the company has patent challenges pending on blockbusters that, if won, will generate a windfall. (That also makes it a riskier bet, since it could lose too.)

It owns technology in the US to make some high-value, differentiated products in niche areas like dermatology, and has invested in a drug discovery arm.

Teva is said to be evaluating some more local firms like the Chennai-based Orchid and Ahmedabad's Intas.

What's the upshot of all this? If Teva does indeed buy a major local firm soon, it could validate the India story and prompt other US and European companies to follow suit.

"There is no place like India for generics R&D, and manufacturing of either bulk or formulations," says Lanka Srinivas, executive director at the Rs 1,341-crore Aurobindo Pharma.

India has a combination of cost and speed that is a huge asset in the off-patent drugs market. Apart from cost-effective factories, the country has an army of chemists that is churning out generics faster than you can say 'copy'.

A senior executive at a leading Indian drug maker says this advantage makes India compare favourably even with other low-cost sourcing destinations like Hungary and Israel, where Teva has some of its manufacturing operations.

That's something Teva would have learnt first-hand in the last year and a half, when it ran an Indian company. In a low-profile deal in 2003, Teva bought up one of its suppliers -- a small, loss-making raw materials manufacturer of the JK Group -- for $8 million.

Industry sources say that Teva meant to secure the source of an important raw material. But the company, rechristened Regent Drugs, has proved to be more than that.

It has been integrated into Teva's global bulk drugs operations and is growing. It employs roughly 250 people in R&D and manufacturing in Faridabad, Haryana and Gajraula, Uttar Pradesh, respectively.

A head-hunter says Teva has hired about 50 scientists last year, many of them from major Indian companies and multinationals. The head of R&D, Vinod Kansal, was a senior scientist at Vadodara-based Indian firm Alembic before joining Regent Drugs last year.

"Acquiring a company has deepened our understanding of Indian capabilities on the industrial and individual levels," says a Teva spokesperson in Israel. Emboldened, it is setting up a new R&D centre at Noida and expanding its manufacturing facility at Gajraula.

Teva's competitors, too, are stepping on the gas. Industry watchers say it's only a matter of time before some of the Indo-US marketing ties turn into mergers or acquisitions. "Something will happen in the next 12-18 months that will change the landscape," says Tommy Erdei, director (healthcare banking) at ABN Amro, UK.

If that happens, Teva will face much stronger competitors who combine the best of both worlds.

Teva's Indian operations are still too small to make any difference to its overall margins. Till now, its direct investments in India have been a minuscule $15 million, with another $2 million for the new R&D centre.

An acquisition can change that. The next few months will reveal what the Israeli giant really has up its sleeve.

It's Sandoz vs Teva at the top

In February, Sandoz dethroned Teva to become the largest generics player after its $8.3-billion acquisition of Germany's Hexal and the latter's controlling stake in Eon Labs, a US generic drug maker.

Daniel Vasella, the 51-year old chairman of Sandoz's $28-billion parent company Novartis, believes that the off-patent drugs industry will double to $100 billion by 2010. And he wants Sandoz to lead that expanded market. No wonder Novartis paid over three times Hexal's sales to its promoters.

This deal has put the spotlight back on Teva. An executive at a US-based generics company says: "The pressure is definitely on them [the Teva team] to regain the No. 1 position."

Reports suggested possible Teva targets -- US companies Impax, Ivax and Barr. In the past, Teva and Sandoz have often bid for the same companies.

Analysts say Teva was interested in Hexal too. Last year it bought Sicor, a US company that Sandoz was eyeing.

But Israel Makov, CEO of Teva, says his company is under no pressure from Sandoz's latest acquisition.

"We don't see any need to respond. We actually welcome it, because consolidation is ultimately good for the generic industry," he told an Israeli Web site.

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