It was the most expensive foreign acquisition by an Indian company in 2006. Dr Reddy's Laboratories had gone to town with its trophy, German branded generics company Betapharm, acquired for $560 million (Rs 2,550 crore). Six years later, the valuation of Betapharm in the company's balance sheet is just $108 million (about Rs 590 crore), a 75 per cent fall.
It is little wonder Dr Reddy's has dedicated a page on its website to the acquisition - 'On events before the Betapharm acquisition and learning'. Managing Director and Chief Operating Officer Satish Reddy sums up the deal on the company website, "Sufficient understanding of the market would have actually helped us, rather than making an acquisition of that nature, overpaying, and then trying to make the best out of it."
Funding the deal, often termed expensive and overpaid, wasn't a problem. The company already had $200 million in cash (about Rs 900 crore). The rest was raised through debt from domestic financial institutions. The debt-equity ratio rose to 1.39 times in March 2006. However, the company went for American depositary receipts the following year, raising Rs 1,000 crore and part-paying the debt raised for Betapharm. The debt-equity ratio then fell to a comfortable 0.59 times.
Dr Reddy's hasn't been faring badly. In the quarter ended September, its sales and profits rose 27 per cent and 32 per cent, respectively. Business prospects in the US, where it launched specialty drugs for schizophrenia, anti-allergy, etc, remain bright.
However, the German acquisition continues to be a drag. For the quarter ended September, revenues from Germany fell 11 per cent. Betapharm's contribution to sales has been falling consistently - from Rs 977 crore in 2008-09 to Rs 518 crore in 2011-12. In the same period, sales of Dr Reddy's rose from Rs 6,861 crore to Rs 9,761 crore, a 40 per cent rise. In 2011-12, Betapharm posted losses of Rs 75 crore.
The problem, of course, has nothing to do with Dr Reddy's. Within months of the acquisition, the German government changed its procurement policy, shifting to a tender-based system for a substantial number of drugs. This reduced drug reference prices. So, what was aimed at securing access to the second-largest generics market after the US turned into a liability. "If Dr Reddy's could have predicted this change, it wouldn't have pursued the acquisition. In hindsight, it was a blunder," says an analyst, on condition of anonymity.
Riding a growth wave in India, Dr Reddy's started its acquisition journey well. After making inroads into regulated generics drug markets, it acquired Roche's API business in Mexico for $60 million (Rs 260 crore) in 2005.
But the Betapharm deal has changed the acquisition strategy of Dr Reddy's. "We realised we should make acquisitions that improved the capabilities within the organisation, against buying a company in some market that merely increased the turnover," Executive Vice-President and Chief Financial Officer Umang Vohra had told Business Standard in an interview.
The company decided not to take the bidding route in any acquisition. It also decided to concentrate on smaller acquisitions. As a result, all companies acquired by the company after Betapharm had ticket sizes of about $40 million and were chosen based on some product, research or manufacturing area that complemented capabilities within the company.
The road ahead won't be an easy one for Dr Reddy's. "We believe continued tender models in Germany would pose challenges for the company due to huge price pressure. The company has highlighted it is planning to defocus on tender-based models and has identified complex generics, which we believe would take two to three years to revive the business," said an analyst.
Given the German market isn't conducive to generics companies, a number of these have scaled down their presence, focusing on profitability - chasing tenders that are more profitable, rather than chasing sales, analysts say.
Even as Dr Reddy's has cut costs through the last two to three years, it is set to go for another round of cost cutting. "The issues relate to the macro environment in Germany, not to Betapharm. Only when the business climate for generics in Germany changes, would there be some meaningful up-tick from Betapharm," says an industry source.
Till then, Dr Reddy's would have to seek solace in its India story.