Following the announcement of Sun Pharmaceuticals Industries (Sun) acquiring Ranbaxy, we upgrade Sun Pharma to ‘buy’ (earlier ‘neutral’) with a revised price objective of R680 (24x FY16e), a 20% premium to peers and in-line with historical multiple.
Sun Pharma is to buy Ranbaxy for $4 billion in an all-share swap (16.2% dilution for Sun), valuing Ranbaxy at 2.2 times in last 12-month sales. While the deal will be earnings dilutive in the near term (-4% in FY16), we see significant synergies over next 3-4 years, which we believe will lead to 10-12% incremental EPS in three years from the acquisition. As per management, the acquisition will be cash EPS accretive in the first year. While our base case forecast is unchanged, given Sun's previous track record in M&A, we would expect the market to factor in some of this upside prior to the deal closure.
Sun has a successful track record of turning around distressed assets with recent cases such as Taro and URL. While we acknowledge Ranbaxy will likely have its own challenges, we highlight that Ranbaxy’s gross margins (63-64%) are largely in-line with other Indian peers (indicates that geography mix or product-mix is not an issue). Regulatory overhangs and high fixed costs have depressed Ranbaxy's profitability, where Sun Pharma can bring its operational strength.
We remain positive on Sun because of its best-inclass franchise, stable and differentiated business model (rich US pipeline) and strong profitability, and return ratios.