The inside story of a recovery

WHILE MUCH OF INDIA INC. spent 2012 dealing with the slowdown, Wockhardt, one of the country’s top 10 pharmaceutical and biotechnology companies, was trying to restrain its ebullience. For Wockhardt’s founder, 70-year-old Habil Khorakiwala, it was the turnaround year. After struggling for three years to repay huge debts and coming to terms with relinquishing control to banks, Wockhardt came back to black. It’s a fascinating story of how a poster child lost its sheen, restructured its finances, and then won it all back.

In February 2009, Khorakiwala was summoned to ICICI Bank’s headquarters in Mumbai to meet Sonjoy Chatterjee, head of corporate banking, and Zarin Daruwala, relationship manager for Wockhardt. Khorakiwala knew it would not be pleasant—Wockhardt was deep in debt and unable to repay—but it turned out worse than he had expected.

The bankers gave him two options: Pay up all dues, or sign on for a debt restructuring scheme, which effectively meant letting banks control all financials. It was a tough decision for Khorakiwala, who had founded the company in the early 1960s and led it to becoming a successful global entity. But money matters were going out of control; by March 2009, the company was unable to pay suppliers. Rating agency Crisil downgraded Wockhardt from AA+ (very low credit risk) to a “rating watch with negative implications”.

A worried board was in favour of corporate debt restructuring (CDR). Despite his doubts about how the company would manage, Khorakiwala accepted the decision. On March 31, at a board meeting, Khorakiwala resigned as managing director (he stayed on as chairman), making way for son Murtaza, who is now MD, overseeing operations, and daughter Zahabiya, who handles the health care business. And he signed the Debtor-Creditor Agreement, the first step in the process, on April 15, 2009.
Despite having signed away much of the control over the financials to the consortium of banks overseeing the CDR,

Khorakiwala fought for concessions that allowed business to carry on—something that’s seen as key to Wockhardt’s recovery. The CDR process has been compared with a hospital for companies going through severe financial problems. Some companies, like malingering patients, don’t leave for years; others get their financials in order soon and exit.

Other companies that have been through the process have come out strengthened; prominent among the successes is Jindal Vijayanagar Steel (now JSW Steel), which increased capacity 10 times since it came out of the CDR. Wockhardt’s distinction is that it exited the CDR process the quickest, and that everyday business was not affected through the three years or so that it was overseen by the banks.

To understand the CDR, and the push-and-pull between banks that want companies to curtail expenditure and promoters who want to grow the business, Wockhardt hired Hari Mundra as consultant. Mundra, an ex-Wockhardt hand, headed Essar Oil when the company went through something similar. He understood Khorakiwala and the CDR bankers’ mindset, and was soon handling banker meetings on his own. Meanwhile, Khorakiwala was going about personally meeting creditors, trying to repay debts not covered by the CDR scheme.

IT WAS A COMEDOWN for a man who had led what was, till 2008, a darling of banks; Wockhardt had never defaulted on loan repayments despite making large acquisitions abroad, and ramping up its R&D facilities. In fact, in 2003, the then chairman of ICICI Bank, K.V. Kamath, was willing to give Wockhardt a blanket $300 million (Rs 1,651.8 crore) bank guarantee to fund overseas buyouts. As the company got bigger and relied more on its overseas ventures to bring in revenue, it had to make provisions for a financial hedge to compensate for shifts in the value of the currencies it earned and spent. In other words, currency hedging.

Wockhardt began building an aggressive treasury desk, which included Kumar Ajwani, a trader who bought heavily into exotic treasury deals. Exotic deals, in general, are far more risky than the plain vanilla ones that conservative treasury desks opt for. These are generally not listed on an exchange; they are over-the-counter deals made and negotiated by brokers or traders.
It’s a truism that high returns come with higher risks. In the early years, Wockhardt’s treasury desk’s risky currency derivatives trades were successful; so much that in 2007, the board approved a special bonus to treasury executives for profits from derivative trades. Wockhardt made a profit of Rs 5 crore from hedging, in the first quarter of 2008. The market began seeing Wockhardt as a risky bet; a treasury executive who had worked with Barclays in India says, “Wockhardt’s treasury had the tag of a speculator with an appetite for exotic instruments.”

Perhaps Wockhardt’s treasury team drew some confidence from the fact that banks were selling some of these currency derivatives; Barclays and Citibank had been selling such instruments to textiles companies in South India. ICICI Bank and State Bank of India (SBI) followed suit and were selling derivatives contracts to Wockhardt. But here’s the thing: None of the other large domestic pharmaceuticals companies, such as Sun Pharma or Cipla, which get up to 60% of their revenue from exports, opted for this kind of hedging.

By late 2008, the risky bets were no longer paying off, and treasury operations were making the company bleed heavily. In addition, debts were mounting, as the company continued to buy foreign firms. For 2008, Wockhardt reported a debt of Rs 4,235 crore, as well as losses of Rs 4,000 crore from trading in derivatives. Lenders were worried.

That March, Wockhardt’s stock price hit a low of Rs 67.6. The pressure was mounting on Khorakiwala; executives from several banks, including Barclays and Citibank, were calling him directly to pay up huge losses in derivatives contracts. “It is ironical that the very banks that sell these exotic, risky derivatives, advise caution to companies when they lend to them,” says A.V. Rajwade, author and founder of risk management consultancy, A.V. Rajwade & Co. Wockhardt had hired the consulting firm to examine its foreign exchange contracts and suggest ways of repayment. This proved to be an important step in framing the terms of the scheme.

THE CDR SCHEME started off with a legal tangle: Put in place by the RBI and the Ministry of Finance, the scheme recognises only Indian companies and their loans. Wockhardt was reeling from debt with foreign lenders, but the CDR apparatus only recognised the liabilities of the India operations.

In a step that was to prove crucial, the Wockhardt board appointed investment banking firm Nomura in early 2009 as an external consultant to decode the derivatives trades and calculate the extent of damage. A Nomura executive, on the condition of anonymity, says when these derivatives were unravelled, several contracts were found to be one-sided. The banks that sold them were protected against any eventuality and the company that bought the contract had to bear damages. Nomura stated that because parts of Wockhardt’s derivatives contracts were untenable, so were the losses out of these. Nomura estimated that the total losses for Wockhardt would be just a fourth of the Rs 4,000-odd crore that banks were demanding.

The same currency fluctuations that created the need for hedging now came to Khorakiwala’s aid. Once a company signs up for a CDR scheme, the banks have 90 days to design a restructuring package. But daily currency fluctuations made it impossible to calculate the losses on open derivatives contracts, and the consortium was forced to accept Nomura’s estimate.

The final CDR scheme for Wockhardt covered the following: secured and unsecured long- and short-term borrowings of Rs 4,017 crore; $110 million of FCCBs; $250 million of foreign currency term loans taken by Swiss subsidiary Wockhardt (EU), but guaranteed by Wockhardt India; and crystallised foreign exchange losses of around Rs 650 crore (the crystallised or actual losses were about 25% of total—including notional—losses).

The benefits of the restructuring were seen almost at once. Soon after the CDR was approved, SBI and IDBI lent Wockhardt Rs 500 crore, which Khorakiwala said he needed to pay suppliers. He argued that if the money did not come through, his business would suffer and it would be tough to meet the CDR targets. There were several unpleasant actions to be taken, of course, but Khorakiwala says, “We did everything that was required to be a part of the CDR process.” The treasury desk was disbanded, and Ajwani quit, followed by CFO Rajiv Gandhi. There was an immediate freeze on hiring and travel, as well as on incidental expenses (including tea and snacks provided at meetings).

Through all this, Khorakiwala also had to attend regular CDR panel meetings, held every fortnight on the first floor of IDBI Towers in Cuffe Parade. Banks participating in CDR are notified about the companies to be reviewed, and the operating heads of these companies have to attend. But there is (and was) no time allocated to companies, so the brass of each company sits patiently in the first floor waiting room for their turn. A senior SBI manager once joked that the waiting room looked like a detention room for erring corporate honchos. But it was worth it, since Khorakiwala was able to wangle concessions; the one he’s most proud of is ensuring that through the restructuring process, R&D spends weren’t curtailed.

There were other problems. Around the time Khorakiwala signed up for the CDR scheme, banks including Singapore-based DBS (not part of the 17-strong consortium involved in the CDR process) filed petitions to wind up Wockhardt’s operations to pay for their losses from derivatives trades. Countering this, the CDR consortium, headed by ICICI Bank, appointed Cyril Shroff of leading law firm Amarchand Mangaldas to argue against the petitions. Shroff successfully argued that the business was fundamentally strong, and closing it would put over 6,000 employees out of work.

Meanwhile, Khorakiwala met some of these banks, and personally negotiated settlements and reopened contracts. Some banks were reluctant to accept a low compensation and continued to file wind-up petitions; as late as March 2011, a petition was filed on behalf of Lehman Brothers to recover derivatives losses; the case was settled out of court. (The bankrupt Lehman Brothers is still an operating company, which works to raise money to repay its creditors.)

Other cases were not so easy to resolve. When CDR is underway, secured loans get priority for repayment; unsecured debt, which includes bonds, comes way down the list and bondholders are among the last to be paid and get the least payment. In 2008, Wockhardt had issued FCCBs (which can be redeemed at a specific time at a predetermined price) to foreign private equity and hedge funds. In October 2009, Wockhardt defaulted on $110 million worth of FCCBs. Under the CDR scheme, the banks proposed paying back bondholders a mere 25% of their dues, on the assumption that unsecured lenders must be prepared for greater risk.

Private equity firm QVT, which held Wockhardt’s FCCBs, argued that it should be repaid in full if there was

money to repay other lenders, or the bonds should be converted into equity as mandated under the FCCB rules. Khorakiwala refused, saying that Wockhardt’s valuation did not represent its actual potential. He asked QVT to extend the tenure of the bonds, something SBI had already done. QVT refused and filed a winding-up petition.

The PE firm also reacted strongly to Wockhardt’s plan to sell its nutrition business to Abbott Laboratories: The plan was eventually scuttled, and the nutrition business was sold only in 2011. After hectic negotiations, Wockhardt was close to settling the QVT case out of court. However, around then, the trustees of the overseas arm of Mumbai-based Sun Pharma, which had bought Wockhardt’s FCCBs, filed a winding-up petition.

Sun was joined by QVT and some other bondholders. The court ruled in favour of the bondholders and directed Wockhardt to repay them in full, giving the company a few years to repay. An SBI official says, “We were a bit angry as unsecured lenders were getting paid before secured lenders.”

THE BANKS DID get their money back, despite the FCCB setback. As part of the CDR, Wockhardt had to recompense the banks for the low interest charged during the restructuring. The recompense fee of Rs 220 crore has been paid in full. This is generally among the last few obligations before a company exits the CDR process.

Through the three years of dealing with bondholders and winding-up petitions, Khorakiwala focussed on the core business of generics, active pharmaceutical ingredients, biotech products, and vaccines. By getting the banks to agree to maintain R&D costs, he ensured that the company did not lose out on product development. For the second quarter ended September 2012,

Wockhardt reported Ebitda (earnings before interest, tax, depreciation, and amortisation) of Rs 517 crore compared with Rs 280 crore in the same period last year, a growth of 85%. Net profits for the same period increased 375% to Rs 447 crore. Says Nimish Mehta, analyst at a Baroda-based pharmaceutical research firm: “Wockhardt’s U.S. success is based on a few complex research products, which implies that Khorakiwala’s focus on research is paying off.”

In August 2011, Khorakiwala announced the sale of Wockhardt’s nutrition business to Danone at Rs 1,326 crore, more than twice what Abbott had offered. The launch of its generic drug Toprol raked in profits of over $200 million. And by pruning the workforce at its French subsidiary, Khorakiwala has ensured that Wockhardt’s European operations don’t weigh down profits.

The market has welcomed Wockhardt’s turnaround; from its low of Rs 67 in 2009, the stock is now trading at close to Rs 1,600. All signs point to Wockhardt shaking itself free of the CDR scheme in 2013. Today, Khorakiwala sees the good in the bad times. “In the tough years, we focussed on improving productivity by doing more for less, and that has shaped our thinking in new ways.” Debt turned out to be a strong medicine, after all.