Daiichi overhauls Ranbaxy

GOING PURELY BY APPEARANCES, nothing has changed at Ranbaxy Laboratories. The headquarters are the same: plot 32, sector 90, Institutional Area, Gurgaon; the building looks the same, grey mortar and glass; even the signage, that imposing symbol of corporate pride, stays unchanged—Ranbaxy, in striking orange.

But appearances can be deceptive. For inside, Daiichi Sankyo, the Japanese company that owns 63.92% of Ranbaxy, is permanently altering the fabric of the organisation.

On November 15, 2010, in a first, executive chairman Tsutomu Une spoke in a conference call to Ranbaxy employees around the world, some 13,000 in all. The call, which began at 5 p.m. IST, went on for half an hour. Through most of it, Une was critical of how Ranbaxy functioned. He called the organisation top-heavy with excessive overheads, and critiqued the lopsided nature of its profits, pointing out that most of the revenue came from Valacyclovir (a generic version of a herpes drug, whose exclusivity has now come to an end), Oxcarbazepine suspension (a drug to treat epilepsy), and Sumatriptan, a treatment for migraine, both of which enjoy a 180-day exclusivity in the U.S.

Those present say Une was especially critical of how Ranbaxy’s different divisions were unwilling to share information with each other, which made it difficult for the organisation to act as one. “It [the speech] set off warning signals among the brass at Ranbaxy. Obviously, some changes
are afoot,” says a senior Ranbaxy official, on the condition of anonymity. Despite repeated attempts, Ranbaxy officials weren’t available for comment.

A week later, two Daiichi executives from Japan were inducted into Ranbaxy’s annual budget meetings, held between November 22 and December 1, 2010. They sat through the presentations and discussions along with the Ranbaxy budget team. This was another first: a pointer that Ranbaxy’s budget too is up for scrutiny by its Japanese owners. “Now every penny will have to be accounted for,” says the official.

Senior Ranbaxy employees might have seen these changes coming. By the time of Une’s call, the exits had already started. On August 12, 2010, CEO and managing director, Atul Sobti, quit. His departure was significant: After all, he had been appointed by Daiichi barely 17 months earlier to lead the company. At a press conference soon after he left Ranbaxy, Sobti said: “There are certain differences in the overall working of Ranbaxy as a company, in its running, and how to go forward and integrate it. Sometimes it’s better to quit when there is no resolution.” He was replaced by Arun Sawhney, who was appointed as managing director (though not CEO).

Three more senior executives quit soon after. They were T.G. Chandrashekhar, vice president, global quality and analytical research; Abha Pant, executive director for
regulatory affairs; and Anil Khandelwal, head of M&A. When news of their departure leaked, the management denied it. However, sources say all three have stopped attending office for over two months.

Chandrashekhar headed a team of more than 320 scientists for analytical research and 1,500 executives who were part of the global quality management team. Pant was responsible for regulatory compliance—providing data on stability of drugs. Each of them had spent upwards of 20 years in Ranbaxy. Their exit, say some insiders, could mean that extensions of tenure granted to senior officials, part of the Ranbaxy culture, may be a thing of the past now.

Ranbaxy employees, both past and present, say that the new owners are now recasting the company in line with the Rs 19,804 crore Daiichi’s global strategy and processes. Insiders talk about the culture becoming more “process led”, how there are many more meetings to resolve a single issue, and that many of the go-aheads now come from Japan directly. Equally telling is the steady increase in the number of Japanese managers—not just at the top level but also in the middle ranks—clearly seeking full operational control of the organisation.

For starters, sources point out that a Daiichi appointee will join Ranbaxy this month, just below Omesh Sethi, the president and chief financial officer (CFO). Top Ranbaxy finance honchos such as Ranjit Kohli, head, global accounting; Sanjeev Mahna, head of business finance; and Maninder Singh, head, trade finance, treasury and insurance, have been asked to report to the Japanese executive, who in turn will report to Sethi. It is just a matter of time before other such important middle-level positions are filled by Daiichi appointees so that the directives from overseas are better implemented, says a senior official at Ranbaxy.

What was once a family-run outfit that was widely seen as India’s first pharmaceutical multinational firm is now transforming itself into the local subsidiary of the world’s 15th and Japan’s second largest drug company. “For some time, we struggled with the way Ranbaxy was changing. But now we have accepted the inevitable,” admits a senior company manager.

A senior Delhi-based executive, who has no direct connection with Ranbaxy but has years of experience with Japanese joint ventures, says: “The Japanese don’t exactly come roaring in. They do things quietly, but with meticulous precision.” Much of the change has to do with business logic—how Daiichi, an innovator pharma company, plans on using Ranbaxy (a generics company) to expand. Innovator companies discover new medicines (and therefore, cures) and sell them, while generics companies usually manufacture off-patent drugs originally made by innovators and sell them. In recent years, innovators have begun acquiring generics players, best exemplified by Novartis’ takeover of Sandoz.

But some of it may also have to do with Daiichi’s need to regain its honour in the Ranbaxy acquisition, which was followed by a series of problems.

THERE ARE BITS of the old Ranbaxy that are useful to Daiichi. Think of Ranbaxy as having three key parts—an R&D unit, factories, many of them U.S. Food and Drugs Administration (FDA) approved, and sales operations in India and abroad.

Within R&D lies the New Drug Discovery Research (NDDR) unit. Around a decade back, Ranbaxy believed that NDDR would some day produce a new drug out of India. That never happened. But NDDR’s record hasn’t been a write-off either. It is currently in the process of independently developing the anti-malarial combination drug Arteolane+Piperaquine Phosphate in India and Thailand, which is in phase III trials. If all goes well, this will be commercialised.

In July 2009, Daiichi bought Ranbaxy’s NDDR unit for $176 million (Rs 794.64 crore). The unit was first spun off from Ranbaxy to form a new entity called Daiichi Sankyo India Pharma and then made a part of the Daiichi Sankyo Life Sciences Research Centre in India, a wholly owned Daiichi subsidiary. The objective: tighten control over the R&D activities going on in this laboratory and also use it to develop new molecules for Daiichi Sankyo. (The money raised from the sale has come to Ranbaxy. If dividends are paid out, 63.92% could go to Daiichi Sankyo, which could be either repatriated or ploughed back.)

Insiders see this as a hollowing out of sorts for Ranbaxy, because the drug discovery unit, which employs around 170 scientists, will cease to be part of the Indian company. (The markets had started picking up the signals early on. Sapna Jhavar, who tracks the stock for broker Sharekhan Securities, saw it in the company’s falling spends in R&D—from 7% of turnover in 2005 to 5.5% in 2009.)

Next, Ranbaxy could also be looking at paring down its portfolio of branded and ordinary generics in India. Among its branded generics are Cephalexin, Ciprofloxacin, Amoxicillin, Atorvastatin, Simvastatin, and Co-Amoxiclav. A senior executive within Ranbaxy says that though 40% of Ranbaxy’s turnover still comes from India, the net margins of this business are between 10% to 15%, figures that don’t excite Daiichi very much. “A strip of Atorvastatin that costs Rs 70 in India could be sold for a significant multiple of that in the U.S.,” says an employee. Indeed there is a strong buzz that the India portfolio could hence be sold, either along with distribution rights and the sales force or separately. The number of subsidiaries is also being pruned. In 2009, Ranbaxy had 45 subsidiaries. Two of these, in Vietnam and China, have already been closed after they were found to have made losses of around Rs 52.67 million and Rs 247.49 million respectively in 2009.

What this means is that Ranbaxy will now begin to resemble a gigantic manufacturing outpost for Daiichi. Of course, it was Ranbaxy’s factories that attracted Daiichi in the first place. But, it was also here that Daiichi received its biggest blow.

ON JUNE 11, 2008, amid popping flashbulbs, the heads of Ranbaxy and Daiichi painted a picture of a glorious shared future at a press conference to announce the deal at Delhi’s Taj Mahal hotel. Daiichi CEO Takashi Shoda described it as a “perfect strategic fit that would deliver a considerable opportunity for the future growth of the new Daiichi Sankyo group”. Malvinder Singh, then Ranbaxy’s boss, and grandson of its founder, was equally eulogistic. The deal, he said, would put Ranbaxy on a “higher trajectory of sustainable growth in the medium and long term in the developed and emerging markets”.

On the Nikkei, notwithstanding the eyebrow-raising money that Daiichi paid for Ranbaxy, its stock closed at ¥2,975 (Rs 1,576.75), 5% higher than its previous close. This was after all the coming together of a well respected innovator company and an equally reputed generics company with unparalleled global reach. Shoda felt vindicated: buying Ranbaxy had been his idea all along. Between October 15 and November 7, 2008, the Japanese firm picked up a 22.01% stake through an open offer, 11% through preferential shares, and 30.91% of the promoter’s stake in two tranches, paying Rs 19,804 crore for the 63.92% stake.

Meanwhile back home, Ranbaxy’s stock stayed mostly flat on the Bombay Stock Exchange to close at Rs 560.80, while the sellout generated controversy. Many saw Singh as a canny businessman with almost no interest in pharmaceuticals who cashed out. (The family was richer by Rs 10,000 crore for selling its entire 30.91% stake.) Others lamented that he had betrayed Ranbaxy’s (and more acutely his late father’s) grand mission of creating India’s greatest pharma MNC. Ranbaxy, however, maintained that an alliance was inevitable if the company were to survive the long term—and here was one on its own terms.

Ranbaxy would retain its identity, business model, and people, while Daiichi would act as an enlightened though somewhat distant shareholder. Singh would run the business as managing director and CEO till 2013, with his salary bumped up from Rs 20 crore to Rs 25 crore annually. For a year, Daiichi didn’t even have a nominee on Ranbaxy’s board, despite its position as the single largest shareholder. That Daiichi would one day actually run Ranbaxy was unthinkable. But, six months after the press conference, Shoda was apologising to Daiichi’s shareholders for the Ranbaxy acquisition. With all the symbolism that accompanies such penitence in Japanese corporate life, Shoda’s honour (and Daiichi’s) was in peril. Daiichi’s carefully planned buyout had exploded. In an interview to Fortune India while he was still CEO, Sobti had described Daiichi’s predicament: “Within months of acquiring a company for $4.6 billion and telling the world that it has taken a very pioneering decision, the whole thing comes apart.”

Daiichi’s world turned upside down on September 16, 2008, the day the FDA issued a second lot of warning letters to Ranbaxy (now owned by Daiichi but run by Singh), and also an import alert for 30 generic drugs that were being made at factories in Paonta Sahib, Batamandi (both in Himachal Pradesh) and Dewas (Madhya Pradesh). Of Ranbaxy’s seven factories in India, these three were FDA approved. Worse was the notice Janet Woodcock, director of FDA’s Center for Drug Evaluation and Research, put up on its website: “With this action we are sending a clear signal that drug products intended for use by American consumers must meet our standards of safety and quality.” Ranbaxy’s vaunted U.S. strategy was in tatters.

Ranbaxy’s correspondence with the U.S. authorities had begun in 2006. That year the FDA issued the first warning letter for the Paonta Sahib plant, alleging deviation from the U.S. Current Good Manufacturing Practice (CGMP) regulations following an inspection.

But things would get even messier. On June 24, 2008, two U.S. Congressmen, John Dingell, chairman of the Committee on Energy and Commerce, and Bart Stupak, chairman of the sub-committee on Oversight and Investigations, launched an investigation into whether the “FDA had allowed drugs made by Ranbaxy to be sold in the U.S., despite knowing it had approved them based on fraudulent information and that these were made in violation of good manufacturing practices”. The Congressmen wrote to then FDA commissioner Andrew Von Eschenbach seeking information of each drug that FDA had approved. On July 3, 2008, the U.S. Department of Justice moved the Maryland district court seeking a motion to access privileged records of Ranbaxy’s internal audits.

Daiichi’s due diligence had surely thrown up the headwinds blowing in from the U.S., but it had misjudged their intensity. Sobti argued that this was the first major acquisition that Daiichi had done and that too in the generics space. So it may not have fully gauged the import of what was building up. Also, Daiichi was in a hurry. When discussions between both sides were on, there were rumours that biggies such as Pfizer and GlaxoSmithKline were also eyeing Ranbaxy. So Daiichi sealed the deal quickly.

By February 2009, the FDA blowback became bigger. It stopped reviewing medicines manufactured at Paonta Sahib. Ranbaxy’s stock was now in free fall. Between June 11, 2008, (the day of the grand press conference) and February 28, 2009, the value of Daiichi’s holding in Ranbaxy had dropped by nearly Rs 10,700 crore.

The import ban crippled sales in the U.S., Ranbaxy’s most important and profitable market which accounted for 27% of sales; a few wrong bets on currency knocked off another $122 million; and all this occurred in the midst of one of the worst slowdowns in history. These body blows forced Daiichi to book “extraordinary losses due to a one-time write-down of goodwill worth $3.59 billion on Ranbaxy,’’ as it wrote in its statement to the stock exchanges. If the Japanese were looking for a moment to take charge, this was it. At a press conference in Tokyo in March 2009 to announce Daiichi’s results, Shoda laid it out: “The key to turning around Ranbaxy’s earnings is to resolve the problem with the FDA. Ranbaxy is now an important part of Daiichi Sankyo, so the parent firm aims to resolve the problem by getting actively involved in Ranbaxy’s management.”

In a boardroom reshuffle on May 24, 2009, Singh was edged out. In a press statement he said it was “difficult to separate from Ranbaxy. But it was the right time to do so”. In a meeting with Fortune India, he refused to answer questions on those days, saying they were “history”. Two other directors, Sunil Godhwani (then MD, Religare, a financial services company started by Singh) and Balinder Singh Dhillon (a well known Delhi lawyer and a friend of the Singh family) then moved out.

In their place came three Daiichi nominees, all Japanese: Une as chairman with Akihiro Watanabe and Shoda as non-executive directors. They then appointed Sobti, an existing Ranbaxy hand, as CEO and elevated him to the board. Of Ranbaxy’s seven board members, three were now from Daiichi and one a Daiichi appointee. Two of them, Shoda and Une, were also on the main Daiichi board. For Sobti this was an awkward moment: At the first meeting held between Ranbaxy and Daiichi in December 2007, he had represented Ranbaxy.

Appointing Une as chairman, with Shoda as his board colleague, was a significant move. The two go back to the days of the Daiichi Sankyo merger in 2005—Shoda was from Sankyo and Une from Daiichi. And they had worked closely together to make the merger work.

With the board now firmly under Daiichi, senior management changes began. Dale Adkisson, the former senior director, quality assurance, Daiichi Sankyo U.S., and earlier with Novartis and Bristol-Myers Squibb, was brought in to head global quality control systems. (Job description: cleaning up the FDA mess). Then came Hiroyuki Okuzawa and Eiichiro Sato, both old Daiichi hands, to figure out and rethink Ranbaxy’s global strategy. Even the auditors changed. Grant Thornton was replaced by BSR & Co., the local chartered accounting arm of KPMG, which audits Daiichi globally.

By May 2010, Shoda had been pushed up to the chairman’s office and Joji Nakayama was named president and CEO of Daiichi Sankyo.

AT THE HEART OF Daiichi’s Ranbaxy strategy lies what it calls the Hybrid Business Model. It means selling Daiichi’s innovator drugs and vaccines and Ranbaxy’s generics and over-the-counter drugs jointly around the world, with many of these being manufactured in India. Okuzawa has been put in charge of the steering committee that oversees this.

Japan is a good place to begin. Its rapidly ageing population has led to rising health care costs and there is a strong push to genericise. HDFC Bank analyst Ranjit Kapadia estimates that generics could account for up to 30% ($20 billion) of drugs prescribed in Japan by 2012, up from 17% today. Already, a new company called Daiichi Sankyo Espha has been formed to market Ranbaxy generics in Japan. The new company’s sales target is ¥50 billion by 2015.

It’s not just about Japan. Daiichi also wants Ranbaxy to bring its U.S. revenues to $3.5 billion (it was at $397 million in 2009) by 2012. So what is Daiichi doing about sorting out the FDA issue? It can’t shut down the factories or build new ones, because both are expensive propositions. The concerted effort to sort the mess out actually began in September 2008, when former New York City mayor Rudy Giuliani’s firm Giuliani Partners was pressed into service to straighten matters out. (The relationship has since been terminated.) Shoda, who has also met FDA officials, has publicly claimed that all FDA issues will be resolved by 2012. The company is trying everything it can: venture capitalists, consultants, third party assessments, and repeated visits by a joint task force of the Ranbaxy management and industry experts to the FDA.

Meanwhile, the Dewas plant has been completely renovated and is awaiting a visit from the FDA, though the future of Batamandi and Paonta Sahib continues to be uncertain. Daiichi has also figured out other ways to sidestep the FDA tangle. Concerned that U.S. sales had fallen by 41% in the second quarter of 2009, it has begun falling back on its U.S. factories. While there may be no cost advantage, Ranbaxy will continue its market presence. For example, two first-to-files (Valtrex and Oxycodone), each with a 180-day monopoly to sell, are being manufactured at the Ohm Laboratories in New Jersey.

The buzz inside Ranbaxy’s Gurgaon headquarters is that Daiichi may opt for an out-of-court settlement and pay a hefty fine (hundreds of millions of dollars) though this could not be independently confirmed.

Daiichi seems to be coming to terms with other contentious issues too. Within seven days of announcing its takeover of Ranbaxy, Daiichi announced that it had settled its patent litigations worldwide with Pfizer involving Lipitor, the world’s most prescribed cholesterol-lowering medicine. It will be able to sell generic versions of Lipitor in the U.S. and seven other countries from November 30, 2011, and not from March 2010, when the main patent expires. Ranbaxy and Pfizer have been fighting a protracted, expensive and multi-country battle since 2003, which has been bleeding the former dry.

While the stock may be up (finally)—it has risen by 24.4% in the last six months—Shoda still needs to prove beyond doubt that his bet on Ranbaxy was right. In one of his interviews, Sobti, a veteran of the Japanese way of working—before Ranbaxy he spent seven years with Hero Honda—had mentioned that Indians would have admitted to their mistakes but never apologised. “It is their way of life,” he said.

And it is for this reason alone that Shoda needs to make Ranbaxy Daiichi’s.