BofA-ML upgrades Sun Pharma as it plans to acquire Ranbaxy Laboratories

Written by fe Bureau | Mumbai | Updated: Apr 7 2014, 22:19pm hrs
Bofa MLThe FY15 price-to-earnings multiple is estimated at 24-times. Reuters
Bank of America Merrill Lynch (Bofa-ML) upgraded Sun Pharmaceutical Industries from neutral to buy after the drugmaker announced that it will acquire Gurgaon-based troubled pharmaceutical peer, Ranbaxy Laboratories, for about $3.2 billion in an all-stock deal to combine and consolidate market share.

The Sun Pharmaceuticals Industries scrip gained more than 4% intraday on the BSE on Monday. The scrip ended 2.68% higher at Rs 587.25 on the BSE.

Analysts believe earnings per share (EPS) post the acquisition could rise as much as 12%. Sun Pharma is to buy Ranbaxy in an all share swap (16.2% dilution for Sun Pharma), valuing Ranbaxy at 2.2xLTM sales. While the deal will be earnings dilutive in the near-term (-4% in FY16), we see significant synergies over the next 3-4 years which we believe will lead to 10-12% incremental EPS in year 3 from the acquisition, BofA ML analyst Manoj Garg said in a report on Monday.

The FY15 price-to-earnings multiple is estimated at 24-times. Per management, acquisition will be cash EPS accretive in the first year. While our base case forecast today is unchanged, given Sun Pharmas previous track record in M&A, we would expect the market to factor in some of this upside prior to the deal closure. We have moved up our PE multiple to 24-times to reflect the higher growth visibility which was a key reason for our earlier downgrade, Garg added in the report.

The report further added that even though Ranbaxy has been facing regulatory issues, Sun Pharma has a history of turning around distressed assets. Sun Pharma has a successful track record of turning around distressed assets with recent cases such as Taro and URL. While we acknowledge that Ranbaxy will likely have its own challenges, we highlight that Ranbaxys 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 Ranbaxys profitability, where Sun Pharma can bring its operational strength, Garg said.

The regulatory issues have hurt Ranbaxys margins. We highlight that with all four US FDA approved plants under import alerts, Ranbaxy is at the peak of regulatory issues which has resulted sub-optimal margins of 8% in CY13. We highlight that Ranbaxy spends approximately 4% of its sales on consent decree. While it is difficult to ascertain the regulatory timeline, we believe that there is significant scope for operational improvement and hence earnings upside, the report said.