Why transformation is a buzzword at Piramal

Ajay Piramal is on a mission. The 65-year-old billionaire industrialist and chairman of Piramal Group, who recently wrapped up a mega acquisition of the beleaguered DHFL, is taking his flagship Piramal Enterprises Ltd (PEL) through a series of transformations to remould the multi-sector conglomerate into focussed, listed entities in financial services and pharmaceuticals sectors. The long, laborious journey from a real estate wholesale lending entity to a well-diversified non-banking finance company has already begun in earnest.

The group is not new to such makeovers. “In the last 32 years, PEL has undergone several successful transformations. The first transformation was in 1988 when we exited the textile business and entered the pharmaceutical business through a series of M&As, organic growth, JVs, and alliances. We created one of the largest pharma companies in India. The second transformation took place in 2010 when we sold our domestic formulations business to Abbott Laboratories for $3.8 billion, a multiple of 9 times sales and 30 times Ebitda, the highest value for any generic pharma deal globally till now. We rebuilt a pharma business model and scaled it all the way back to get a valuation of $3 billion with Carlyle [The Carlyle Group] this fiscal,” Piramal said during an analyst call on February 11.

In 2021, he is positioning the group for the next transformation, “the boldest one yet” by his own submission.

According to Piramal, the group is now executing two major transformations. Firstly, it is transforming the financial services business through multiple initiatives, including the acquisition of DHFL. And secondly, it is transforming the pharma business into a large differentiated listed pharma company post the Carlyle deal. The U.S.-based private equity giant bought 20% in Piramal Pharma Ltd, a subsidiary of PEL, in October, 2020.

Clearly, the revival in the real estate has helped him immensely. PEL, which was rattled by rumours of payment defaults by some of the top developers such as Lodha Group and Omkar Group, has invoked a one-time restructuring (OTR) of ₹1,741 crore, accounting for 3.8% of the loan book in the third quarter. Interestingly, only one of the four accounts that are part of the OTR is by a real estate company, the others being from the infra, hospitality, and auto components sectors, which were hit by the pandemic. PEL is recasting the loans provided to Lodha Group, one of its top 10 companies. “By March, we expect the Lodha exposure to be around ₹2,500 crore, which will be split into two. One will be to Lodha, exposure to which will be around ₹1,000 crore or lower. And the balance will be an SPV exclusively charged to us which is fully ready inventory. It will help us monetise quicker and stay away from the insolvency and bankruptcy risks,” said Khushru Jijina, managing director, Piramal Capital & Housing Finance Limited (PCHFL), in the analyst meet.

Jijina said the Lodha exposure has already come down from ₹3,300-odd crore to ₹2,671 crore in the third quarter.

With regard to the Omkar Group, another major exposure by PEL, Piramal Realty, a group company, has started developing the Mahalakshmi project while L&T is undertaking the other big project in Bhoiwada. “We have kept both Lodha and Omkar off from the IBC risk,” said Jijina.

He said the concentration of top 10 exposure has seen a drop sequentially, from ₹14,700 crore to ₹13,400 crore in the third quarter, while the wholesale book is down by ₹4,000-odd crore.

“There were concerns earlier about our infrastructure portfolio. It was down to ₹2,375 crore by December and is further down by another ₹100 crore in January. At one point, our infra book was as high as ₹4,500 crore. In real estate, not just our top exposure, all our exposure is coming down. We are bringing them below 7%. And a majority of them are between 3%-5%,” said Jijina.

Piramal said the real estate sector has shown a healthy revival over the last few months and residential real estate sales have in fact surpassed the pre-Covid-19 levels in most of the large markets. “During the third quarter, sales of our developer clients increased 92% over the previous year. The collections from homebuyers were 49% higher than the previous year same period and construction activity at 100% of the projects,” said Piramal.

In financial services, the group is undergoing five significant transformations. Firstly, it is working towards transforming the existing business model—of a largely wholesale lending business, mostly focussed on real estate—to a well-diversified financial services business. “We want to create a lending portfolio where retail will be 50% of our lending book in the near term. We want to grow retail through an organic build-up as well as the DHFL acquisition,” says Piramal.

In the organic build-up, the company has launched a multi-product retail lending platform in 2020 and has already commenced disbursements in the third quarter. It has launched six new products during the third quarter and will be launching new products every month going forward. It has built a fintech-led digital platform which will be modular in structure, having the ability to add multiple products.

PEL has also exited ‘affluent housing’ (in terms of new business) as it moved towards ‘affordable’ and ‘mass affluent’ housing under the new strategy.

Piramal said the quarter-on-quarter increase in gross non-performing assets (GNPA) is largely due to the slippage of one account from stage 2 to stage 3 and the lower base effect because of the reduction in the loan book size. “There is no change in the net NPA ratio which is 1.8% as of December 2020.”

He said PEL continues to maintain conservative provisioning of ₹2,935 crore, which is 6.3% of the overall loan book. This is more than adequate to meet any future contingencies that may arise due to the impact of Covid-19.

In financial services, the group is undergoing five significant transformations. Firstly, it is working towards transforming the existing business model—of a largely wholesale lending business, mostly focussed on real estate—to a well-diversified financial services business. “We want to create a lending portfolio where retail will be 50% of our lending book in the near term. We want to grow retail through an organic build-up as well as the DHFL acquisition,” says Piramal.

In the organic build-up, the company has launched a multi-product retail lending platform in 2020 and has already commenced disbursements in the third quarter. It has launched six new products during the third quarter and will be launching new products every month going forward. It has built a fintech-led digital platform which will be modular in structure, having the ability to add multiple products.

“More importantly, we have gradually pivoted the retail lending business to a mass affluent and affordable housing [one] with no fresh disbursements in the affluent housing finance business. This will help us improve our profitability in our retail segment in future,” said Piramal, adding that the DHFL acquisition will give them a significant push to achieving the diversification of their book sooner, thanks to DHFL’s branch network and customer reach. “We are looking at consciously reducing the wholesale book or keeping it at the same level.”

The second transformation is to move from concentrated exposure to granular exposure in the existing lending book. The company’s top 10 exposure has reduced by 27% from ₹18,400 crore in March 2019 to ₹13,400 crore in December 2020.

The third transformation is to move from a high leverage ratio to high capital adequacy ratio. Capital inflows of ₹18,000 crore since April 2019 through various capital market transactions have significantly strengthened its balance sheet. The net debt-to-equity is below 0.9% versus 2x in September 2018. Of course, the company has done significant debt leveraging with the net reduction of ₹24,000 crore from ₹55,000 crore in March 2019 to ₹31,000 crore now. The financial services business is more than adequately capitalised, said Piramal.

“Our capital adequacy ratio is 31% as of December 2020 vis-à-vis 22% in December 2018. Our net debt for the financial services sector business is 1.9 times, a multiple lowest across sizeable NBFCs and home finance companies in India. Given this strong capital adequacy ratio, we believe there is significant opportunity to improve the utlisation of the equity capital available to the business and we do not expect our financial sector business would be in need of any additional equity capital,” said Piramal.

The next transformation is moving from short-term liabilities to stable long-term borrowings. Apart from reducing the overall leverage, the company has significantly shifted the mix towards long-term debt. In the last nine months, it managed to raise ₹12,800 crore of long-term debt despite the pandemic. Piramal said the company’s commercial paper (CP) exposure remains low at ₹1,000 crore, a reduction of 94% since September 2018.

The fifth transformation is to move from regulatory provisioning to a conservative provision coverage ratio. “We now maintain conservative provision of ₹2,935 crore, which is equivalent of 6.3% of the overall loan book vis-à-vis 1.8% a year ago. Our total provision as a percentage of gross NPA is at 132% versus 100% a year ago. Our provision against stage-1 and stage-2 loans has increased to ₹2,000 crore in December 2020 from ₹700 crore in December 2019. As a result, non-NPA assets have provisioning of 4.5% as of December 2020, with total provisions as a percentage of the loan book standing at 6.3%.”

Post the sale of the domestic formulations business to Abbott, PEL has rationalised the pharma portfolio and focussed on three core pharma verticals with a long runway to grow: contract manufacturing, critical care, and the India consumer products. Pharma revenues have grown 3.5 times at a CAGR of 15% from ₹1,537 crore in 2010-11 to ₹5,400 crore in 2019-20.

During the quarter, Piramal Pharma Solutions, a contract development and manufacturing organisation (CDMO), and Piramal Consumer Products have shown strong performance, growing at 16% and 14%, respectively. The complex hospital generic business was impacted by the volatility in the demand of products used in surgeries globally and the company expects it to be normalised in the next quarter. Operating margins were marginally impacted in the quarter by the volatility in the complex hospital generics business.

To accelerate the organic and inorganic growth in the coming years, PEL has subsidiarised its pharma businesses and raised fresh capital from Carlyle. The Carlyle deal of fresh equity investment of $560 million in the pharma business for 20% stake has established an enterprise valuation of nearly $3 billion. “During the quarter, we have received ₹3,523 crore on closure of the 20% strategic growth investment by Carlyle Group,” said Piramal.

In the third quarter, PEL has gone for both organic and inorganic expansions. In the CDMO space, it continued to see a healthy order book despite the Covid-19 challenges. In order to meet this demand, the company is investing organically and inorganically in the CDMO business. It has invested $32 million in its Riverview Michigan facility for solid oral dosage in Pennsylvania for additional capacity in potent and non-potent API development and manufacturing. In June, it entered into an agreement with G&W Laboratories Inc. to acquire its solid oral dosage drug product manufacturing facility located in Sellersville, Pennsylvania, in an all-cash deal for a total consideration of $17.5 million. In the complex hospital generics space, it took over former partner Navin Fluorine’s 49% stake in Convergence Chemicals for ₹65 crore.

In the consumer products business, it launched 15 new products during the fiscal. With the expiry of the non-compete clause with Abbott, Piramal sees it as an opportunity to get back into the segment.

Kunal Shah of ICICI Securities said in an analyst note that PEL is actively pursuing consolidation—its loan portfolio is down 10% quarter-on-quarter and 20% since 2018-19—and the consolidation cycle seems to be nearing its end.

The DHFL deal is valued at ₹34,200 crore, comprising an upfront cash component of ₹14,700 crore (including cash on DHFL’s balance sheet) and a deferred component (NCDs of 10 years to existing DHFL lenders) of ₹19,550 crore. “The existing gross block of DHFL’s wholesale lending portfolio will be significantly marked down prior to acquisition and, on the truncated value, PEL expects some upside through recoveries,” said Shah.