Controlling the front-end

Updated: Nov 26 2012, 10:34am hrs
Cipla announced that it has offered to buy the controlling 51% stake in Cipla Medpro at 8.55 rand per share which is at 11% premium over Cipla Medpros closing price the previous Friday. The offer is priced at $220 million which values Cipla Medpro at 1.7x (times) sales, 8x Ebitda (earnings before interest, taxes, depreciation and amortisation) and 10x trailing 12-month EPS (earnings per share). The deal will be funded entirely through internal accruals. As of Sep-12, Cipla has cash and equivalents of R15 bn ($290m).

For first six months Cipla Medpro has reported sales of $122m with Ebit of $25m (Ebit margin of 20%, Ebitda 25%). The company had reported top line growth of 28% for H1CY12. Near-term performance has been hit by dollar strengthening against rand and negligible price increases in generic products. Cipla Medpro has net debt position of $26m as per June 2012 financials.

Following resignation of Cipla Medpro CEO Jerome Smith, Cipla Medpro was a seemingly attractive target for companies like Adcock Ingram, which had expressed its intention to acquire in 2009. We believe Ciplas offer to acquire controlling share over its marketing partner is in lieu of preserving its supply arrangement and gain control over front-end operations in African market. Africa currently contributes c40% of Ciplas exports.

Adjusting for cash outflow and minority share, consolidation of Cipla Medpro would be EPS accretive from first year to the tune of R0.2-0.3 per share. We remain Overweigh on Cipla as we remain positive about stable domestic formulation sales and sales ramp-up from increasing utilisation of its Indore SEZ facility. We value Cipla at 20x (unchanged) Mar-14 EPS of R22 to arrive at TP (target price) of R440.

Key catalyst is increasing contribution from Indore SEZ and potential scale up of Dymista in FY14 which is currently in launch preparation phase.

Risks include a slowdown in key geographies, like India and big export markets like the US and European Union and slow pick up in Dymista.

Cipla MedproCipla India arrangement: Cipla Medpro relies heavily on product supply arrangement with Cipla India. The agreement covers a period of 20 years and was signed in September 2005. Cipla India sends dossiers through Medpro which then files for registering the products with the MCC (The Medicines Control Council). Once the products are registered, Cipla India provides the products to CMSA (Cipla Medpro South Africa) in dollar denominated prices to register market and sell in South Africa. This exposes Cipla Medpro to exchange rate fluctuations and would hurt Cipla Medpro if the dollar strengthens against rand.