Merger of Foreign Companies with Indian Companies

 INTRODUCTION:-
Introduction: Mergers and acquisitions (M&A) is the area of corporate finances,
management and strategy dealing with purchasing and/or joining with other companies.
Mergers and acquisitions are increasingly becoming strategic choice for organizational
growth and achievement of business goals including profit, empire building, market
dominance and long term survival. The term mergers and acquisitions encompass varied
activities of stake acquisition and control of assets of different firms. Besides, there are
several motives for different types of mergers and acquisitions seen in corporate world.
In a merger, two organizations join forces to become a new business, usually with a new
name. Because the companies involved are typically of similar size and stature, the term
"merger of equals" is sometimes used. A merger is a transaction which brings changes in the
control of different business entities by a single business unit which can take decisions as
whole. Two companies together are more valuable than two separate companies
Merger takes place when the times are tough for some companies. The strong companies will
buy the companies which cannot survive alone, to gain a greater market share and to create a
more competitive environment. A merger takes place when two firms, of about the same size,
agree to go forward as a single new company rather than remain separately owned and
operated. This kind of action is more precisely referred to as a "merger of equals." Both
companies' stocks are surrendered and new company stock is issued in its place.
One plus one makes three- this equation is the special alchemy of a merger or an acquisition.
In an acquisition, on the other hand, one business buys a second and generally smaller
company which may be absorbed into the parent organization or run as a subsidiary. A
company under consideration by another organization for a merger or acquisition is
sometimes referred to as the target. Acquisitions are often made as part of a company's
growth strategy whereby it is more beneficial to take over an existing firm's operations. An
acquisition may be friendly or hostile. In the former case, the companies cooperate in
negotiations; in the latter case, the takeover target is unwilling to be bought or the target's
board has no prior knowledge of the offer. Acquisition usually refers to a purchase of a
smaller firm by a larger one.

 Types of Merger & Acquisition

From the perspective of business structures, there is a whole host of different mergers. Here
are a few types, distinguished by the relationship between the two companies that are
merging:
 Horizontal Merger: - A merger that takes place between companies belonging to the
same industry. The companies have businesses in the same space and are generally
competitors to each other. A horizontal merger is a feature of an industry which consists
of a large number of small firms / fragmented industry. It is a merger with a direct
competitor and hence expands as the firm's operations in the same industry. Horizontal
 mergers are designed to achieve economies of scale and result in reduce the number of
competitors in the industry.
 Vertical Merger: - A vertical merger is a merger between companies that produce
different goods or offer different services for one common finished product. The
companies operate at different levels in the supply chain of the same industry. The
motivation behind such mergers is cost efficiency, operational efficiency, increased
margins and more control over the production or the distribution process. The
combination of two companies which are operating in the same industry but at different
stages of production or distribution system. If a company takes over its
supplier/producers of raw material, then it may result in backward integration of its
activities.
 Conglomeration: - A merger between companies that operate in completely different
and unrelated industries. A pure conglomerate merger is between companies with totally
nothing in common. A mixed conglomerate merger is between companies looking for a
market or product extensions. These mergers involve firms engaged in unrelated type of
activities i.e. the business of two companies are not related to each other horizontally or
vertically. The purpose of merger remains utilization of financial resources, enlarged debt
capacity, synergy of managerial functions and is thus favoured throughout the world as a
means of diversification.
 Amalgamation: - Amalgamation in relation to companies means the merger of one or
more companies with another company or the merger of two or more companies to form
one company in such a manner that
 All the property of the amalgamating company or companies immediately before the
amalgamation becomes the property of the amalgamated company
 All the liabilities of the amalgamating company or companies immediately before the
amalgamation become the liabilities of the amalgamated company
 Shareholders holding not less than 3/4th in value of the shares in amalgamating
company or companies become shareholders of the amalgamated company by virtue
of the amalgamation.
 Acquisition: - An acquisition may be only slightly different from a merger. In fact, it
may be different in name only. Unlike mergers, all acquisitions involve one firm
purchasing another - there is no exchange of stock or consolidation as a new company.
When an acquisition is a ‘forced’ or ‘unwilling’ acquisition, it is called a takeover. When
managements of acquiring and target companies mutually and willingly agree for the
takeover, it is called acquisition or friendly takeover.

 Merger And Amalgamation Of Indian Companies With Foreign Companies: -

Under Section 394 of the erstwhile Companies Act 1956, the merger of a Foreign Company
with an Indian Company (Inbound Merger) was allowed but the merger of an Indian
Company with a Foreign Company (Outbound Merger) was not allowed. On April 13, 2017,
the Central Government amended the Companies (Compromises, Arrangement and
Amalgamations) Rules, 2016 and inserted rule 25A. Further, through S.O. 1182(E) dated
April 13, 2017, Section 234 of the Companies Act, 2013 also came into effect, which allows
the merger of an Indian company with a foreign company. This means that, now both
inbound and outbound mergers are allowed.
The Ministry of Corporate Affairs of the Government of India (“MCA”) by way of a
notification has notified Section 234 of the Companies Act, 2013 (“Act”) enabling cross-
border mergers with effect from April 13, 2017. The MCA has also notified the Companies
(Compromises, Arrangement and Amalgamation) Amendment Rules, 2017 (“Amendment”)
to make suitable changes to the Companies (Compromises, Arrangement and Amalgamation)
Rules, 2016 (“Rules”), to operationalize the said provision.
In view of these notifications, an inbound merger (i.e., a merger of a foreign company into an
Indian company with the Indian company as the surviving entity) as well as an outbound
merger (i.e., a merger of an Indian company into a foreign company situated in certain
permitted jurisdictions with such foreign entity as the surviving entity) is now possible. This
is of course subject also to the host jurisdiction of such a foreign company permitting such
schemes with an Indian company. It is important to note that implementation of the provision
on cross-border merger fulfills one of the recommendations of the Expert Committee on
Company Law under Dr. Jamshed J. Irani, which was constituted to suggest corporate law
reforms in India.
Such merger will be subject to approval of the Reserve Bank of India (“RBI”), India’s
central bank and administrator of exchange control regulations, and compliance with the
provisions of the Section 230 to 232 of the Act.
Only recently, on December 7, 2016, merger related provisions of the Act (i.e. Sections 230-
233, 235-240 of the Act) were made effective which replaced similar provisions of the
Companies Act, 1956 (“1956 Act”). However, Section 234 (which enables cross-border
mergers) was not brought into force. As a result, until now, Indian companies desirous of an
outbound cross-border merger were unable to undertake such a transaction.
The newly notified Section 234 provides that the provisions of Chapter XV (Compromises,
Arrangements and Amalgamations) of the Act shall apply, mutatis mutandis (with
appropriate changes), to an inbound or outbound cross-border merger. The provision
envisages a scheme of amalgamation providing for, amongst others, payment of
consideration, including by way of cash or depository receipts or a combination of those.
Further, it is important to note that a cross-border merger may be subject to multiple parallel
scrutiny and will have to be approved by the RBI, the jurisdictional National Company Law
Tribunal (“NCLT”), and if applicable the relevant sectoral regulator in India, and the
relevant competent authorities in the foreign jurisdiction, if necessary in such jurisdiction.
Section 234 also empowers the Central Government to frame rules in consultation with the
RBI to deal with such mergers. In exercise of this power, the MCA has notified the
Amendment, amending the Rules, with effect from April 14, 2017 by inserting a new Rule
25A to operationalize Section 234. Based on the new Rule 25A, the following are the
mandated steps for Indian companies involved in a cross-border merger:
 Prior approval of RBI for undertaking any cross-border merger;
 Surviving entity to ensure valuation by a valuer who is a member of a recognized
professional body in its jurisdiction and in accordance with internationally accepted
principles on accounting and valuation. In this regard, a declaration is required to be
submitted by the transferee company along with the application to RBI for obtaining its
approval for the merger;
 Procedure as specified in Section 230-232 of the Act to be undertaken (similar to as
applicable to a domestic merger);
 In case of outbound cross-border merger, foreign entity involved should be from a
permitted jurisdiction.
Further, any cross-border merger under Section 234 will have to comply with the
requirements as laid down in Sections 230-232 (requirements applicable to domestic
transactions). This will include procedural requirements such as, for e.g., filing an application
before the jurisdictional NCLT, conducting meeting of shareholders/creditors, notification to
income tax authorities, other sectoral regulators etc., publication of advertisement in respect
of the merger, etc.
Additionally, in line with Section 234, the Amendment requires that any further amendment
to the relevant rules on cross-border merger should be undertaken only after consultation
with RBI.
 New Rules related to Cross Border Merger: -
 In cases of cross border merger, prior approval of the Reserve Bank of India (hereinafter
referred to as "RBI") is mandatory.
 The notification imposes responsibility on Transferee Company to have valuation of
merger by professional of recognized professional body and to ensure that such valuation
is as per internationally accepted accounting and valuation principles. Also declaration of
that shall be attached at the time of making application to the RBI.
 The company shall file application to the jurisdictional National Company Law Tribunal
(hereinafter referred to as "NCLT") as per provisions of Section 230-232 of the
Companies Act 2013 and Companies (Compromises, Arrangement and Amalgamations),
Rules 2016.

 Jurisdictions in which Outbound Mergers are allowed: -

 A jurisdiction whose securities market regulator is a signatory to the International
Organization of Securities Commission's Multilateral Memorandum of
Understanding or a signatory to a bilateral MoU with Securities and Exchange
Board of India; or
 A jurisdiction whose Central Bank is a member of the Bank of International
Settlements; or
 A jurisdiction, not identified in the public statement of the Financial Action Task
Force as:
- Jurisdiction having a strategic anti-money laundering or combating the financing
of terrorism deficiencies to which counter measures apply; or
 - Jurisdiction that has not made sufficient progress in addressing the deficiencies or
has not committed to an action plan developed with the Financial Action Task
Force to address the deficiencies.

 Compliance under Section 230-232 of Companies Act 2013 and Companies

(Compromises, Arrangement and Amalgamations), Rules 2016: -
 Firstly, the Company, seeking to undergo such Cross-Border Merger, must be
authorized to carry out amalgamation through its Memorandum of Association. If
it is so authorized then a draft scheme for amalgamation is to be prepared for
approval in Board Meeting.
 After obtaining prior approval of the Board, followed by approval from the RBI,
an application for should be filed by the Indian Company with the NCLT in form
NCLT-1 seeking an order in favor of calling a meeting of members/creditors for
approving the proposed Merger and Amalgamation. Copy of the scheme, affidavit
verifying petition and notice of admission along with material disclosures relating
to company such as latest financial position, latest auditor's report, and pendency
of proceeding against company is also required to be submitted. The Tribunal has
the right to either accept or dismiss the application.
 It is pertinent to note that if a Scheme of corporate debt structuring is to be filed,
the same should be accompanied with documents such as inter alia the Creditor
Responsibility Statement, valuation report in case of shares, tangible, intangible
asset by a registered valuer.
 Once the Tribunal allows the Company to hold the meeting of members/
creditors, notice of such meeting along with scheme, details of company, details
of board meeting, impact of such merger etc. is to be given to each
member/creditor/debenture holder not less than 30 days before date fixed for
meeting. Such notice shall also be published in newspapers, on the website of the
company, Stock Exchanges, The Securities and Exchange Board of India
(hereinafter referred to as "SEBI").
 It is pertinent to note that notices must mandatorily be given to the statutory
authorities such as Central Government, Registrar of Companies, and Income Tax
authorities. Notices may also be sent to RBI, SEBI, and other sectoral authorities
as may be required by the Tribunal so that they may make a representation 30
days from date of receipt of notice.
 Members may vote on the matter within 30 day of receipt of notice vote in the
meeting through person, proxy, postal ballot or electronic means. The report of
the results of meeting shall be filed with the Tribunal within 3 days. If the scheme
is approved by the majority of members/creditors, then a Petition for confirming
compromise, arrangement shall be made to the Tribunal within 7 days of filing of
report of result.
 The Tribunal after being satisfied that the procedure specified has been complied
with, shall pass the order to sanction the scheme and make provisions related to
matters such as transfer of whole or part of undertaking, property, liability of
Transferor company to Transferee Company, allotment of shares by transferee
company, payment of consideration to the shareholders of the merging company
in cash, or in Depository Receipts, or partly in cash and partly in Depository
 Receipts, transfer of legal proceedings, transfer of employees, dissolution of
transferor company etc. The Company should file such order of the Tribunal with
the Registrar of Companies within 30 days.

 CONCLUSION:-
The notification of the provision on cross-border merger and the Amendment is a welcome
development. Although there remain a few issues as highlighted above, cross-border mergers
will present an additional structuring avenue for undertaking corporate transactions in an
efficient and flexible manner. Further, such a move should improve the accessibility of
companies to access capital in overseas market. However, considering the involvement of
multiple agencies and laws (primarily RBI and NCLT in India, and the competent authority, if
applicable, and the laws of the relevant foreign jurisdiction), the timelines and implementation
will have to be calibrated in order to achieve the commercial objective.
Internationally, cross-border mergers have remained a relatively uncommon phenomenon;
however, they have received some traction in multilateral single markets like the European
Union, where a formal legal framework for undertaking cross-border mergers was introduced in
2005 and migration of companies is possible due to recognition within the legal and tax
framework. Based on the learnings in the European Union, it appears to be a success although
certain scope of improvement exists. It is important that MCA and RBI analyze the available
knowledge internationally on implementation of legal framework for regulating cross-border
mergers and fine-tune the domestic legal framework. One can be cautiously optimistic that cross-
border mergers may turn-out to be an efficiency enhancing avenue for corporates in India.

 CASE STUDY : Daiichi Sankyos Ranbaxy Acquisition Analysis:-

With the spiraling up healthcare charges and government expenditure on public healthcare, many
developed countries are trying to promote generic drugs. The demand for generics is also
complemented by wider access to healthcare in developing economies. This coupled with the
expiry of many patented drugs around the corner, many brand name pharmaceutical companies
tried to acquire generic drug companies, in this paper we try to analyze one such acquisition.
On 11th June 2008, Daiichi Sankyo the third largest pharmaceutical company in Japan made an
offer to buy control stake in Ranbaxy, the largest drug-maker by revenue in India. The purchase
price of INR737 represented a premium of 53.5% over Ranbaxy's average daily closing price on
the National Stock Exchange for the three months ending on June 10, 2008 and 31.4% over
closing price on June 10, 2008. In this paper we would analyze why Daiichi Sankyo must have
picked Ranbaxy and Daiichi's Strategy behind the acquisition. We also try to do the valuation of
Ranbaxy at the acquisition time and whether Daiichi paid a hefty premium over its intrinsic
value.
Post-acquisition Daiichi Sankyo's stock moved southwards, later in this paper we try to address
this shareholder reaction. The acquisition was termed bad and Daiichi had a one-time writing
down of $3.45 billion off its balance sheet. We also analyze what might have gone wrong in this
cross-border transaction, issues such as lack of proper due-diligence on Daiichi Side and lack of
transparency on Ranbaxy side.

INTRODUCTION:-
The pharmaceutical industry develops, produces, and markets drugs licensed for use as
medications. Pharmaceutical companies can deal in generic and/or brand medications and
medical devices. They are governed by a variety of geography specific laws and regulations
regarding the patenting, testing and ensuring safety and efficacy and marketing of drugs.
Its origins can be traced back to the nascent chemical industry of the late nineteenth century in
the Upper Rhine Valley near Basel, Switzerland when dyestuffs were found to have antiseptic
properties. Many of the modern pharmaceutical companies started out as Rhine-based family
dyestuff and chemical companies e.g. Hoffman-La Roche, Sandoz, and Novartis etc. Over time
many of these chemical companies entered into pharmaceuticals business and gradually evolved
into global players. The industry expanded rapidly in the sixties, healthcare spending
skyrocketed as global economies prospered in this period. In the seventies the industry evolved
further with the introduction of tighter regulatory controls, especially with the introduction of
regulations governing the manufacture of 'generics'. The new regulations abolished permanent
patents and allowed patent protection for branded products for fixed periods only, and a new
competitive segment 'branded generics' evolved in the pharmaceutical space. With the patent
expiries of many blockbuster drugs nearby and increasing demand for cheaper drugs, many
pharmaceutical companies are trying to offer a generic drug portfolio as well. The fastest way to
add this portfolio is the inorganic way; let's look at one such case wherein a Japanese
Pharmaceutical giant acquired a large bracket Indian Generic drugs company.

Daiichi Sankyo before Acquisition (Year ending March 2008):-

Daiichi Sankyo was Japan's 3rd largest pharmaceutical company, established by the merger of
Sankyo Co., Ltd. and Daiichi Pharmaceutical Co., Ltd in September 2005. Daiichi was mainly a
brand, R&D oriented pharmaceutical company with revenues of 880 billion yen ($8.8 billion) in
FY 2007-08. The company was cash rich and had around ¥574 million in cash and cash
equivalents. Its portfolio comprised of pharmaceuticals for hypertension, hyperlipidemia, and
bacterial infections, the Group was also engaged in the development of treatments for thrombotic
disorders and focused on the discovery of novel oncology and cardiovascular-metabolic
therapies.
With the shrinking Japanese market the company had a clear inclination towards overseas sales,
the Overseas Sales/ Net Sales had steadily increased from 33% to 40% from 2005-2008,
however markets other than the traditional Japan and North America were the ones which were
showing real movement. The company clearly aimed to build Asia, South and Central America
markets. Daiichi already had business operations in 21 countries and aimed to be a Global
Pharma Innovator by 2015. In India they were already underway forming a Sales subsidiary. The
Company also was trying to concentrate on its core pharmaceutical business by spinning off non-
pharmaceutical businesses from the group. One of the mid to long-term goals of Daiichi was to
increase its presence in novel therapeutics in oncology arena; on these lines they also acquired a
German company named U3 Pharma AG.
Ranbaxy before the Acquisition (Year Ending December 2007):-
Ranbaxy Laboratories Limited, India's largest pharmaceutical company, was an integrated,
research based, pharmaceutical company producing a wide range of quality, affordable generic
medicines, used across geographies. The Company than served customers in over 125 countries
and had an expanding international portfolio of affiliates, joint ventures and alliances, operations
in 56 countries. Ranbaxy's revenues and bottom lines were continuously on the rise since 2001,
the R&D expenses were stable around 6%. In FY 2007 the company had revenues of 69,822
million INR ($1.5billion) excluding other income. The earnings of the company were well
diversified across the globe; however the emerging world contributed heavily to the revenues
(Emerging 54%, Developed 40%, others 6%). However the Japan market, with low generics
penetration contributed just $25 million to the top line. The company had just begun to re-orient
its strategy in favor of the emerging markets.
Ranbaxy had been on shopping spree in the previous year acquiring BeTabs South Africa,
additional stake in Zenotech Laboratories, 14.9% in Jupiter Biosciences India and 13
Dermatology products from Bristoll Myers Squibb in the USA. The company was still open for
acquisitions and growth through inorganic activities. To take advantage of the upcoming R&D
outsourcing story Ranbaxy also demerged the New Drug Discovery Research under Ranbaxy
Life Science Research Limited (RLSRL). Ranbaxy also had developed great partnerships with
companies focused on research and manufacturing in specialty and niche areas, two of which
were collaborative research programs with Glaxo Smith Kline. Ranbaxy also had signed some
exclusive in licensing agreements with Global companies, Sirtex Australia being one of them. To
optimize its First to File (FTF) opportunities and hence ensure the revenue flows, the company
entered into 3 independent litigation settlements with GlaxoSmithKline (GSK) for Valacyclovir
and Sumatiptan and with Astellas Pharma for Tamsulosin.
The company entered into segments such as Bio-generics, Oncology, Penems, Limuses,
Peptides, etc. due to the high potential they offered. On the operational front too the company
was aggressive and had reduced the working capital by almost 3% of sales. The company
undertook the modernization and capacity expansion in plants in India, Romania, Malaysia,
Nigeria and South Africa. The company also discontinued operations in some of their inefficient
plants in India.
The product, patent and API portfolio of the company was strong. The company made 526
product filings and received 457 approvals globally (Annexure A gives a detailed overview of
the product, API and Patents in 2007). The company also continued its effort to develop effective
herbal drugs that could comply with international quality standards.

The Deal
On 11th June 2008, Daiichi Sankyo made an offer to purchase more than 50.1% voting right in
Ranbaxy which included 34.83% stake of promoters, preferential shares and an open offer.
Daiichi offered a share price of INR 737 with a transaction value of around $4.6 billion, valuing
Ranbaxy at $8.5 billion. Daiichi ended up acquiring 63.92% shares of Ranbaxy by Nov, 2008
(details are provided in Annexure B). Including transaction costs the deal costed Daiichi $4.98
billion (details are provided in Annexure C) and they recorded goodwill of $4.17billion (details
are provided in Annexure D).
For Daiichi Sankyo, in addition to the traditional high-risk/high-return business model employed
in developed-country markets, Ranbaxy's generic business model would help them build a
"hybrid business model" with a mix of patented and generic drugs. The deal also required the
current CEO/Promoter Malvinder Singh to stay with the company for 5 years.
The deal financing was through a mix of debt and existing cash resources of Daiichi Sankyo.
With the acquisition Daiichi got access to Ranbaxy's basket of 30 drugs for which the company
had approvals in the US, including 10 drugs for which Ranbaxy had exclusive sales right to sell
for six months after the expiry of their patents. The deal gave Daiichi an access to best FTF 180
day exclusivity pipelines in the industry. Ranbaxy had already de-risked its FTF pipeline through
a series of settlement with innovator companies; this in-turn lowered the litigation expense and
removed uncertainty with regard to the launch date of these generic drugs. It also helped in better
planning of inventory, launch quantities and supply agreement.

DAIICHI'S GAIN FROM THE DEAL:-

The era of Generic drugs
Most of the pharmaceutical companies in developed world have been concentrating on the
patented drugs market, and hence were more R&D oriented. But recently the generic drugs
market has received more attraction because of:
Dates of patent expiry of blockbuster drugs discovered during 1990s are nearing.
Governments and Insurers are encouraging use of generic drugs to control the spiraling up
healthcare costs
With saturation occurring in the developed markets, the major markets now are the emerging
countries. However the earnings of the citizens in these nations are not high enough to buy the
costly patented drugs, so generic low-price drugs form a majority part of the drug markets in
these countries. These Pharmerging nations were forecasted to account for the biggest share of
pharmaceutical industry growth over 2008-13 periods, it was supposed to be a $160-190bn
market by 2013. However majority of multi-national pharmaceutical companies were
underpenetrated in these markets.
With this changing market dynamics Daiichi made the decision to acquire a generic drug
manufacturer from second largest populated country, India. This will help them establish
presence in a new area (Generics) in the pharmaceutical value chain.

India: an emerging hub for Global Pharma

India in 2008 had gained a respected place in the in the space of Contract Manufacturing, Drug
Development and Drug Discovery and Research. This had become possible due to a strong
stream of talent flow, compliance with quality and regulatory standards, distinct cost advantages
both in manufacturing and drug development. India also had a large naive patient pool with some
of the fastest patient recruitment rates and an innovation and original research engine. India's
strength in this space was reflected by its research collaborations with global Pharmaceutical
Companies.
For Daiichi its R&D expenses and COGS stood at around 45% of the Sales, shifting the R&D
and manufacturing to India made sense to operate in the highly competitive environment and
address continuous pressures from government to reduce drug prices.

Access to new markets

Daiichi believed that realizing sustained business growth would need the expansion of its
prescription drug business in advanced country markets along with tapping growth opportunities
in developing countries.
Ranbaxy had a strong presence in markets such as Africa, where Daiichi had never ventured. By
using Ranbaxy's network, Daiichi Sankyo could more than double its global reach from 21
countries currently to 56. As growth would slow in the developed markets, Ranbaxy will give
Daiichi a strong position to expand their businesses in emerging markets including India, China,
Russia and Brazil. Emerging Markets was a strong geographic component of Ranbaxy's
revenues. India was undoubtedly the biggest market that Daiichi would get access to now, the
Indian market was supposed to triple by 2015 from its 2005 size. Ranbaxy with its strong
distribution reach and excellent brand recognition was well positioned across the Indian metro
and extra urban areas.

Collaborations and Subsidiaries

In order to optimize value at various points across the pharmaceutical value curve, Innovator
Pharmaceutical and Generic Companies were moving from a competing business model to a
collaborative one. On this front too Ranbaxy had strong collaborative projects with companies
such as GlaxoSmithKline. Some of them were in Oncology space, Oncology being an area of
focus both for Ranbaxy and Daiichi would greatly bolster its presence in this space.
Ranbaxy itself had made many acquisitions in previous 2 years, BeTabs Pharmaceuticals South
Africa being the recent one. These acquisitions made Ranbaxy's position stronger in the
Pharmaceutical space.

Japan Markets
Due to government measures to curb healthcare expenditure, in spite of growing prevalence of
lifestyle diseases and aging population the Japan market was growing only quantitatively but not
value wise. This government control on pricing is rare in many Asian countries and USA,
making Japan an unattractive market.
However in-line with encouraging the use of generic drugs, many Japanese hospitals were
applying the diagnosis procedure combination (DPC) reimbursement system. The Japanese
government was also making efforts to restrain drug-related expenditures through systemic
reforms as well as other factors such as drug price revision under the National Health Insurance
(NHI) scheme. So generic drugs was surely a promising business opportunity in the Japanese
markets, in fact in FY 2008 Ranbaxy registered a sales growth of 38% in Japan (Sales of $20
million). However Daiichi later formed a new company in Japan for handling its generic space in
Japan, the strategic intent of this step is a bit doubtful to me.
OTC and Biogenerics
Given the focus on OTC drugs by both the companies, opportunities existed to expand OTC
product offerings of both Ranbaxy and Daiichi across world markets.
Biogenerics was also a common interest area for both the companies, Daiichi had just acquired
U3 pharma AG and Ranbaxy had acquired Zenotech in the Biogenerics space. Both of them
could use each other's expertise in clinical trial design, relationship with regulators and
marketing power in the US and the EU

RANBAXY'S VALUATION
We used simple DCF valuation methodology to valuate Ranbaxy stock in June 2008, with
following assumptions:
Sales will grow at 12% for 10 years (McKinsey projections for Indian Pharmaceutical industry)
and then slowed down to 8% for 5 years. In order to account for the losses caused due to FDA
action against Ranbaxy we have lowered the growth rates for 2008 and 2009 to 10% because
Ranbaxy had made alternative arrangements through its US its subsidiary Ohm Labs in the US.
NOPAT Margin maintained at 14% for 10 years and then lowered to 10%.
The company is making continuous efforts to decrease the working capital so we assume they
would decrease it till 25%.
The Net Long Term Assets to Sales ratio would fall down to 45%.
DCF Valuation: 254.6
FTF Value: 106
Investment in Associates: 5.03
Total: 365.63
With these assumptions we came to a value of INR 254.6 (details in ANNEXURE J, K);
however this value does not incorporate the value the strong FTF pipeline that Ranbaxy had.
This FTF pipeline is valued at around INR106/share (details in ANNEXURE E). Going further
we also need to adjust the value for investment in associates (refer ANNEXURE F) for market
value wherever information is available. The effective price as per our calculation for Ranbaxy
in June 2008 should be INR 365.63.
This shows how much premium Daiichi paid above the intrinsic value of Ranbaxy, with an
acquisition price of INR 737, they paid almost a premium of 100% over the intrinsic value. I
think this was a huge premium for a friendly takeover, suggesting that Daiichi would take long
time to enjoy the real benefits of this acquisition.

SHAREHOLDER'S REACTION
The market reaction to this announcement was positive only during the open offer period, post
that both the stocks plunged to almost 50% of their pre-transaction values. In Feb 2009 in
response to FDA's action against Ranbaxy share price of Ranbaxy was almost 1/3 of what
Daiichi Sankyo had paid. Later the Ranbaxy stock moved up considerably but Daiichi was still
trading a low levels. To reflect the fact that the market price for the shares of consolidated
subsidiary Ranbaxy was way lower than the acquisition price, Daiichi recorded ¥351.3 billion
one-time write-down of goodwill associated with the investment in Ranbaxy. This led to a
considerable net loss for Daiichi in fiscal 2008. The write down itself signifies that the
shareholders money, the retained earnings were wiped out in this acquisition and hence the
southwards movement of stock price was as expected. The market expectations from Daiichi
were low due to this write-down.

WHAT MIGHT HAVE GONE WRONG?

In September 2008 the FDA sent Ranbaxy warning letters regarding current good manufacturing
practice violations at two of its plants Paonta Sahib and Dewas and forced restrictions on the
import of drugs manufactured at these plants. This banned the entry of almost 30 Ranbaxy
products in the USA. In February 2009, FDA also invoked its Application Integrity Policy (AIP)
against the Paonta Sahib facility. The FDA enquiry had started long back in 2006 itself.
According to the FDA report, Ranbaxy's quality control scientists took shortcuts on the stability
tests for at least two major drugs. They conducted these tests on the same day or within a few
days of each other, not over nine months as claimed by the company. The FDA also claimed that
Ranbaxy had submitted manipulated data as a part of its application to market new generic drugs
in the US, as well as kept hundreds of improperly stored samples in its factories in Paonta Sahib
and Dewas.
This was partly to blame to the organizational structure of the company as well. Traditionally the
analytical research and quality assurance (QA) departments always had firewalls between them;
the QA department job was to keep a watch on the activities of the research unit. However in the
recent past, Ranbaxy brought both departments together, encouraging the problems to stay
confined within the walls of the company. Daiichi should have assessed the standard
pharmaceutical organizational structure and also tried to estimate the full extent of the legal risk
arising out of the US FDA letters. They should have asked for information on plant inspections
done in 2006 and details of submissions made by Ranbaxy in defense. However the fact that a
Japanese company like Daiichi decided to tackle the issue when presented with the problem
rather than spending time evaluating the risk, was really impressive.
Ranbaxy was said to have poor human resource practices, which led to high employee turnover.
In research and development alone, four departmental heads had resigned in quick succession in
the period just before acquisition. This phenomenon of resource attrition at Ranbaxy continued
even after the acquisition. Mr Malvinder Singh the CEO and promoter of the company left the
company in May 2009. In the original agreement he was to stay with Ranbaxy for 5 years after
the acquisition. By leaving 4 years before the contractual date not only did he have to pay a hefty
severance package but also raised doubt among foreign companies, looking for Indian partners.
For a foreign company like Daiichi it was natural to rely on promoters and their team to continue
running the company for a while. Daiichi paid INR 737 for a company with an intrinsic value of
just INR 365. This valuation glitch clearly demonstrates Daiichi's lack of understanding of
generic business. I believe inadequate due diligence was done considering the size, scale and
scope of the deal, reflecting Daiichi's inability in understanding of India and the generic world. I
also feel Daiichi was not able to properly access the possible impact of the ongoing FDA
enquiry. Ranbaxy was also to blame for not being transparent about the actual status of the FDA
enquiry. One more prominent thing that Daiichi probably missed on was the continuously
increasing debt levels of Ranbaxy.
The year of 2007 witnessed great currency volatility in response of unforeseen global financial
crisis. Through 2007 until early 2008, INR steadily appreciated against the US Dollar. From
around levels of INR 44, it strengthened to about INR 39 with the market forecasting further
appreciation. In order to de-risk export revenues Ranbaxy took derivative positions to protect
against exchange volatility. However INR movement sharply reversed to the US Dollar in June
2008 sliding past the INR 50 mark in H2 of that year. Owing to these losses making derivative
positions Ranbaxy recorded foreign exchange losses of INR. 10,856.24 million in 2008. Daiichi
with its global expertise should have reviewed Ranbaxy's overseas investments, including
derivative instruments with open positions.
There must have surely been cultural differences and management style differences between the
two companies and they did not get enough time to handle these issues. In an interview Atul
Sobti, CEO Ranbaxy said "The Japanese are very process-oriented. They have a tremendous
respect for teamwork. On compliances and quality, there can be no compromises. And those are
the areas that we need to work on. Culturally, those are also not our (country's) biggest strengths.
We will be sharply focusing on these issues." Daiichi also realized the need of global
management structure and hence building a global management structure with clear roles and
responsibilities for all locations and functions was one of the strategic agendas for them.
I am also skeptical about the synergies achieved in the patented drugs space, because even after
the acquisition R&D expenses for Daiichi had grown from 18.6% to 21.9% of sales. Should the
synergies have been achieved, with the directing of R&D and manufacturing to India, COGS and
R&D expenses for Daiichi should have decreased or at-least remained stagnant.

CONCLUSION:
Initially the Ranbaxy deal seemed a win-win, allowing both companies to use each other's
networks and technological power. The deal seemed very lucrative for Daiichi Sankyo due to the
access to best FTF pipeline, access to the generics product line, access to new markets and an
opportunity to diversify away from Japan into the emerging markets. However looking at the
post acquisition financial statements of these companies we realize that this deal was a failure
and Daiichi is trying its best to make the acquisition work in its favour.
In the immediate year after the acquisition Ranbaxy reported a loss of INR 9,512.05 million and
Daiichi in spite of diversifying its geographic footprint booked a loss of ¥215,499 million and
they also made a onetime goodwill write-down of ¥351.3 billion for investment in Ranbaxy.
These losses were mainly rooted in Ranbaxy's poor performance owing to the FDA ban and bad
decision in hedging currency risks.
The pre-acquisition due diligence should have understood that Emerging markets are lucrative
but corporate governance and integrity are surely not to be assumed in these markets. Valuations
in these markets are way higher than their real potential and valuation in strongly regulated
industries like pharmaceutical is strongly linked to regulations in the major markets. For the
export oriented companies developed markets with stricter regulations are the main revenues
streams due to higher margins; however the regulations in these markets are stricter unlike
merging nations. Ranbaxy also had ease in clearing the Indian drug regulations but failed to clear
the US FDA regulations and hence its US subsidiary Ohm Labs had to pitch in. Other factors
such as top-management retention rates, organizational structure, internal firewalls and proper
use of financial instruments to hedge risks should have been analyzed before the deal.