TODAY, IT'S LIKE A BHOOT BANGLA —a haunted house, says my friend. We are sitting at a coffee shop in Gurgaon, overlooking an imposing grey mortar-and-glass building. A striking orange sign proclaims that this is Ranbaxy Laboratories, India’s first home-grown multinational generics pharmaceuticals company, which registered sales of Rs 10,614 crore in 2013-14. In its heyday, there were some 2,500 employees in this building, which my friend, an employee at Ranbaxy (and, therefore, unnamed), is now calling haunted.

He’s not alone. For a little over a year now, a sense of gloom has enveloped the place. The uncertainty began when Daiichi Sankyo—its former Japanese owner—made a surprise announcement on April 7, 2014, at 8.30 a.m. Tokyo time that it was selling Ranbaxy for $3.2 billion (Rs 20,214 crore) to Mumbai-based Sun Pharmaceutical in an all-share deal, plus $800 million of debt.

By paying Rs 457 per share—just 2.2 times its 12-month trailing sales—Sun coughed up far less than Daiichi Sankyo, which paid 5.5 times premium over sales in 2008 to acquire a 34.8% stake from Ranbaxy’s then owners Malvinder Singh and Shivinder Singh.
Termed as one of the largest and most hush-hush M&A deals in the industry in the recent past, the merger catapulted Sun Pharma to among the top five speciality-generics pharmaceuticals players in the world, with $5.1 billion in sales. In the domestic market, the deal increased Sun’s lead over its nearest rival—the merged entity has 8.9% of the market—far ahead of Abbott Pharmaceuticals, which has a 6.2% market share. Sales zoomed from Rs 16,200 crore in FY14 to Rs 27,600 crore in FY15, a 41.3% jump, largely because of the acquisition.

A Sun investor presentation made in June this year shows the other big difference the Ranbaxy acquisition has made: Before acquisition, revenue from global markets (outside of the U.S.) accounted for 12%; after acquisition, that number went to 8% from the Western European and other markets, plus 14% from emerging markets. In Eastern Europe, Sun has already started selling its products on Ranbaxy’s sales network.

You’d think Ranbaxy would automatically become the jewel in Sun’s crown, something that employees would have undoubtedly welcomed after years of being virtually neglected by Daiichi Sankyo, thanks to calamitous run-ins with the U.S. FDA. But Ranbaxy staffers across the board were in for a rude shock.

At a press conference a few days after the takeover announcement, new owner Dilip Shanghvi, managing director of the Rs 27,000 crore Sun Pharma, made it abundantly clear that there would be no place for several of Ranbaxy’s leaders and workers.

In a little over a year since the announcement, Ranbaxy’s top management, including Indrajit Banerjee, president and CFO; Yugal Sikri, country head (India); Maninder Singh, vice president, marketing; Govind Jaju, global head, sourcing; and Ratul Bahaduri, director, finance, have been given a golden handshake, with the choice of cashing their stock options. (Trade in Ranbaxy shares ended on April 6, 2015.)

The one Ranbaxy executive insulated from all this is former CEO and managing director Arun Sawhney. Sawhney had signed the consent decree between Ranbaxy and the U.S. FDA, when Ranbaxy ran afoul of the U.S. drug authority over poor quality standards at some of its India factories. (The consent decree is an agreement where an accused company agrees to pay a fine and carry out all the necessary changes its operations to end litigation, without any admission of guilt or liability.)

In 2012, when Sawhney signed this deal, Fortune India had explained a consent decree as “a Faustian deal that a company makes with the FDA, to allow the company to sell its drugs in the U.S.” At the time, we had also mentioned that the record of managing consent decrees isn’t cheery, with even biggies such as Wyeth and GlaxoSmithKline shutting plants under consent decrees. That has played out in a more drastic form in the case of Ranbaxy. The consent decree will be in force till 2017, and, as a signatory, Sawhney will have to remain with the company till then. Insiders say an “appropriate role” is being found for him.

MEANWHILE, ON THE advice of Israel Makov, Sun’s chief executive, Shanghvi hired McKinsey to merge functions in both companies; Makov had recommended a swift process of integration. As a first step after the merger, Sun is conducting a skill-gap analysis and plans to hire outsiders if new hands are needed; there’s no indication that Ranbaxy staffers will be given preference.

Senior Ranbaxy professionals were not involved in the merger exercise till early this year. Shanghvi has kept faith with his old team. Hence Abhay Gandhi, former CEO of Sun’s India business has been given charge of the Indian subcontinent; Aalok Shanghvi, Dilip’s son, earlier vice president of international markets, is now head of emerging markets; and Kal Sunderam, former CEO of North America and Taro will lead U.S. and Canada and keep his Taro job.

“This transaction is all about Sun acquiring Ranbaxy and not, I repeat not, a merger between the two organisations,” says Sanjiv Kaul, managing director of private equity investment firm ChrysCapital, and a Ranbaxy old-timer who spent two decades in the company. “There

will be no courtesies or velvet glove extended by Sun to Ranbaxy.” In effect, it’s going to be only the Sun way from now on.

It starts with salaries. Ranbaxy employees have always earned way above market rates, and definitely more than Sun employees. That has come to an end. The daily allowance of Ranbaxy managers (second- and third-level) has been slashed. Almost all employees have had their travel perks curtailed. Senior management will no longer automatically be entitled to business class seats. (This last is something of a Sun quirk; Shanghvi is known to eschew spending on travel, and in the early days of Sun, almost always travelled by train to save costs.)

Costs are being slashed elsewhere too. Ranbaxy outsourced at least half a billion dollars’ worth of products, building relationships with new suppliers who brought in better technology and reduced margins. These suppliers had set up factories at the behest of Ranbaxy management. Since Daiichi didn’t want to rock the boat and get bad press in India, it did not attempt to rationalise the supply chain. But Sun has no such compulsions. A supplier who had put up a plant in 2010 to supply chemicals to Ranbaxy, says that over the last year, orders have dried up.

The one bright spot: Ranbaxy’s sales staff have been treated on a par with their Sun counterparts, even up to getting an annual increment last month. This has pleasantly surprised a number of sales reps. A former Ranbaxy employee, who left soon after the takeover, says Sun “has not shown any aggression in pruning the sales force or shown any overt toughness, at least at the sales levels”.

This, despite the fact that in terms of productivity, the Ranbaxy sales force brings in less per medical representative. The average Ranbaxy rep brings in Rs 3 lakh worth of business a month, compared to a Sun Pharma rep who brings in an average of Rs 8 lakh a month. But then, say Sun managers on condition of anonymity (Sun refused official comment for this story), this is because the two companies deal in vastly different kinds of drugs, and it’s not fair to compare. What matters is that the feet on the street have not been curtailed.

IS THIS THE END of the road for Ranbaxy? Few will spell it out, but former Ranbaxy hands say Sun has drawn up a blueprint that delienates its future. It includes a three-pronged strategy that includes integration of supply chain and field force for enhanced efficiency and productivity; resolution of regulatory issues; and higher growth through synergy in domestic and emerging markets within the next three to four years. Low-margin products and less profitable markets, such as France, may be dumped.

As far as Ranbaxy’s factories and R&D units are concerned, Sun is not taking any drastic steps. Ramesh Adige, former executive director at Ranbaxy, explains: “Ranbaxy’s R&D is being studied carefully to identify exceptional products in development like first-to-file molecules. If nothing important is found, my view is that the [R&D] unit in Gurgaon may have no role in the merged entity.”

Ranbaxy’s global factories and distribution chains also merit place in the new order. For instance, Ranbaxy was once the second-biggest pharma company in South Africa. And it has a factory in Cluj in Romania (Terapia Ranbaxy, now Terapia), which gave it access to the European markets. Sun is barely present in the European and African markets.

Then there are the products. Ranbaxy has been sitting on at least three blockbuster drugs with 180-day marketing exclusivity, which it had failed to launch because of regulatory issues. Now that Sun has taken over, it plans to launch these drugs soon—the generic version of Astra Zeneca’s Nexium for treatment of acid reflux, blood pressure drug Diovan, and the generic version of Roche’s antiviral Valcyte. Pharma analysts say these drugs could easily have brought in a few million dollars, but for the regulatory strife.

More important to Sun is the healthy portfolio of over-the-counter (OTC) products that Ranbaxy brings, which includes stars such as Volini and Revital. Ranbaxy’s OTC business was worth Rs 1,373 crore, and Sun is planning to expand this. Equally, Sun wants to take this business to Ranbaxy’s traditional strongholds—Eastern Europe, West Asia, and Africa.

Sun is also looking at developing products for regulated markets with a view to creating a private label business. This segment has always been Ranbaxy’s stronghold even in the U.S., where it had established strong relationships with drugstore chains. Sun has been virtually non-existent in this space so far.

Sun’s OTC experience comes from another acquired company, Taro Pharma, which it bought in 2010. Unlike in generics, where price competitiveness pushes down prices, OTC products are proprietary and, therefore, allow for price increases. This made Taro a fast-growing and highly profitable company in the U.S. Sun hopes the same formula will work with Ranbaxy’s dermatology business, which is the biggest chunk of its U.S. OTC sales. Sun is also building a practice in ophthalmology, and Shanghvi says the company has created a sales and marketing group to drive it.

Ravi Talwar, senior vice president, ICICI Securities, who advised Ranbaxy on the merger, says: “Not only are the two companies’ portfolios complementary, with Sun strong in the chronic segment and Ranbaxy in the acute segment, there are geographical synergies as well, with Ranbaxy having a larger emerging market presence and Sun a dominant presence in the U.S.” The synergies alone, driven by procurement and supply chain efficiencies, are likely to add another $300 million to the merged entity.

Talking of the gains at the first analysts’ call after the acquisition, Shanghvi said: “A large part of the money will come from common procurement, increase in revenue from higher productivity, and in the longer term, from the ability to develop more complex products globally.”

Pharma insiders however say there will be no windfall, since Ranbaxy’s factories are still under the FDA scanner. But analysts claim there’s hope; all Sun has to do is shift production to one of its 20 FDA-approved factories.

With 45 state-of-the-art factories across the world, Sun may not be tempted to make all the India units of Ranbaxy FDA-compliant. In fact, say insiders, it is likely to shut the unprofitable ones and shift production to other FDA-approved factories.

IT ALL SOUNDS PRETTY sorted from Sun’s point of view. But the merger comes with its own set of problems. Perhaps the biggest challenge for Sun will be to resolve the troubles with the FDA that grounded Ranbaxy in the U.S.—the world’s most lucrative generics market. This meant Ranbaxy could not supply drugs to the U.S. from its four India factories—Dewas (Madhya Pradesh), Poanta Sahib and Batamandi (in Himachal Pradesh), and Toansa (Punjab). Sorting out this tangle—some of it dating back to September 2008—could be quite a task, as Daiichi Sankyo learnt. It spent seven years and millions of dollars upgrading these factories, but the FDA was not impressed. “Once you have lost credibility with the regulator, it takes time to regain it,” says Adige.

Kaul of ChrysCapital believes that while Daiichi Sankyo acquired Ranbaxy as a strategic asset for global footprints in the pure generics and branded generics space, it appeared quite clueless in extracting synergies or leverage from this platform since it seemingly didn’t have an integration strategy in place. Ranjit Shahani, managing director of pharma major Novartis, points out that Daiichi Sankyo did not seem fully aware about the regulatory non-compliance issues of Ranbaxy, which kept cropping up and surprising it. Daiichi, he says, always seemed to be firefighting.

Instead of wasting time, money, and energy in fixing the Ranbaxy factories, explains Adige, Daiichi Sankyo should have concentrated on using the facilities in India for markets in India, Europe, Japan, and the rest of the world because they have regulatory clearance in all these countries. “For the U.S. market, it would have been prudent to use Ranbaxy’s facilities in New Jersey (Ohm Labs), and set up an additional plant there for drug formulations even if it meant lower margins,” he adds.

Kaul offers a note of hope in all this: “At least the merger will provide some direction and leadership, which were lacking for some time now.”

The real question, says Adige, is not whether Sun Pharma can rescue Ranbaxy but whether its new owner, the second-richest man in India, can create value in the merged entity. Shanghvi and Makov have shown that they can pull off magic with mergers.

Makov had been hired by Shanghvi a couple of years ago from Israeli rival Teva, the world’s No. 1 generics company, where he was known as a mergers-and-acquisitions wizard. That experience is coming in handy: Since Makov came in, Sun has focussed more on acquisitions and tie-ups—seven since 2012, including Ranbaxy. According to an industry executive, who has access to Sun’s senior management, the company is said to be building another war chest to continue picking up attractive assets.

This is apart from the cash balance of $1.5 billion that Sun is sitting on, to say nothing of the awe-inspiring debt-to-equity ratio of 0.13. Clearly, Sun will find it easy to take on debt to fund any large-scale acquisition.

That the company is placing a premium on this route to growth is underlined by the appointment of Arvind Kumar, a former M&A executive at companies such as Reliance Industries and JSW Steel, to head its acquisitions team.

Shahani of Novartis agrees that Sun has more inorganic headroom, but he looks at a slightly different scenario than most analysts. He reckons that the reason Shanghvi hired Makov from Teva, and the reason he has been so aggressively snapping up competitors, including Ranbaxy, is because there’s a hugely audacious gamble in the offing. “Sun will buy Teva”—which is almost double the size of Sun and Ranbaxy put together—”in the next few years,” says Shahani. “You heard it from me first.”

In this version of the future, Ranbaxy’s destiny is to support Sun’s bravado. Will it have a role in the bold new world? The answer to that may be a bitter pill for one of Indian pharma’s most storied names.

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