High India pharma valuations price PE firms out of the market

Private Equity Participation in India's healthcare sector was muted last year, with investments totaling just $263 million, the lowest level in five years. But the environment appears to have changed markedly so far in 2012, with $199 million absorbed in barely two months.

Healthcare providers are a natural area of focus given the country's vibrant private market for such services. In early February, IDFC Project Equity reportedly invested INR1.9 billion ($39 million) in Pune-based specialty hospital chain Sahyadri Hospitals, buying out a stake held by ICICI Ventures. This came after Olympus Capital Asia committed INR5 billion DM Healthcare, which operates hospitals, medical centers and pharmacies in India and the Middle East.

Pharmaceuticals has, by comparison, been somewhat neglected. It's not that private equity is uninterested; rather that valuations have become prohibitively high.

The first private equity deal in the space in 2012 came last week as Fidelity Growth Partners India (FGPI) invested INR2 billion for a minority stake in Aptuit Laurus. The four-year-old company manufactures active pharmaceutical ingredients (APIs) for anti-retroviral (HIV-AIDS), oncological and nutraceutical products.

"The three legs of the business require very strong chemistry skills, and the investments from Fidelity will be used to enhance Laurus's innovation to sustain a long-term defensible business" says Raj Dugar, senior managing director at Fidelity India Capital Advisor. "The company is growing very rapidly, with revenues close to $100 million in 2011."

Growth story

There's no doubt that pharmaceuticals is one of India's fastest-growing sectors. According to a report released by McKinsey, 45% of Indians are expected to have insurance cover by 2020, up from 26% in 2010. Once steady population growth is factored into calculations, the country's pharma market is likely to be worth $55 billion by 2020, compared to $12.6 billion in 2009.

Pharma conglomerates from around the world are therefore adding to their presence in India. In 2010, global healthcare giant Abbott Laboratories acquired the branded generics unit of India's Piramal Healthcare for $3.72 billion. Two years earlier, Japan-based Daiichi Sankyo took a 51% stake in Ranbaxy Laboratories for $4.6 billion.

The surge in interest has prompted a surge in valuations as financial and strategic investors alike pursue a limited number of up-to-standard companies. Actis' exit from Paras Pharmaceuticals in 2010 is a case in point. The private equity firm invested about $42 million in Paras in 2006 for a 63% stake, and eventually walked away with $457 million, achieving a 10x return on its initial investment. The buyer was UK pharma company Benckiser Group.

Vikram Utamsingh, head of transactions and restructuring and private equity advisory at KPMG, says the changing landscape has brought more challenges for private equity players. They traditionally target deals of $20-25 million but increasingly find themselves priced out of the market.

"Even small companies are so excited by the recent high valuations and the fact that global businesses want to buy Indian companies," Utamsingh explains. "As a result, when these Indian companies look for an exit, they want to be sold to large strategic players or overseas companies rather than private equity funds."

Deals dry up

According to AVCJ Research, in 2005, there were 14 private equity transactions in India's pharma space, with a total size of $268 million; in 2011, there were only four deals with a cumulative value of $154 million. Average deal size has doubled to $38.5 million in the same period.

Sanjay Sehgal, CEO of East West Capital Partners, a private equity advisory firm with a strong presence in healthcare and life-science sector, is a casualty of this trend. He hasn't made any direct investments in India's pharma market in the past few years, having decided better value for money can be found overseas.

"What we are facing now is very different from the 1990s and early 2000s, when there were a lot of smaller private equity opportunities in the $20-50 million range," Sehgal says. "There were not too many M&A transactions and a lot of investments were supported by private equity firms at attractive entry valuations. Now we have the opposite."

Although both valuation and average deal size have been driven up, industry participants argue that there is still a role for private equity. KPMG's Utamsingh notes that many pharma companies are too small to go public. While entrepreneurs often don't want to sell equity stakes, sometimes they have no choice because debt capital providers charge annual interest rates of 14-15%. At the same time, valuations are also a function of growth rate.

Entry multiples may be high but that has a knock-on effect on exit multiples. Only those who obviously overpay will suffer from multiples compression.

Fidelity's Dugar says the key to success, at a time of high valuations, is to invest into quality companies that produce complex and "difficult-to-make products." He sees Aptuit Laurus, whose product portfolio covers ARV (anti-retroviral) and oncological areas, is just such a company.

"There is still a role to play for companies who have strong chemistry skills and the ability to make complex molecules," Dugar tells AVCJ. "If the company has good innovation - including process innovation - and research skills, it can bring costs down and sustain healthy gross margins."

Nitin Deshmukh, CEO of Kotak Investment Advisor, also sees potential for investors who focus on niche markets ranging from biopharmaceuticals to oncology. The wider pharma industry may have grown at annual clip of 15% over the last few years, but these emerging areas are moving even faster and have the potential to deliver good returns in the medium term.

"Oncology for example, is still largely dominated by multinational players," Deshmukh adds. "Domestic players like Bharat Serums & Vaccines and NATCO are presenting differentiated business models including completely different pricing levels to cater to the India's mass markets."

Increased specialization presents its own challenges, notably a shortage of experts among investors and entrepreneurs. The concern is that there are not enough professionals returning to India having received training overseas in the life-sciences sector. This is the complete opposite to what venture capital investors have seen in the IT industry.

"When we look at the drug companies in the West, their R&D budgets are now under pressure and we can see a trend of outsourcing to China and India," Fidelity's Dugar says. "However, there is still a gap between the demand and supply of talented manpower."

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• Topics
• Healthcare
• Investments
• South Asia
• India
• healthcare
• Pharmaceuticals
• FIL Capital Management / Fidelity Asia Ventures
• Kotak Investment Advisors
• East West Capital Partners
• GPs