When Indian pharmaceutical companies started hiving off their research entities into separate companies to essentially de-risk their core business of producing generic drugs and give a renewed push to basic research, the infusion of investment was slow. It has started picking up now and top drug makers are in talks with few overseas funds for investment in their proposed R&D facilities.

It?s small wonder then that Sun Pharma, Dr Reddy?s, Ranbaxy Laboratories, Wockhardt and Nicholas Piramal are quite upbeat about their strategy of hiving off their research units. The move is expected to reduce cost pressures on their generic business and increase valuation of their entities in the market.

If the country?s top 10 pharmaceutical firms hive off their R&D divisions, the collective market capitalisation of new research entities is expected to touch $120 billion in less than a decade. At present, a total of $20-billion has been invested in R&D in these firms. On the whole, the industry size is about $150 billion.

Demerging is particularly important in India because R&D spending is generally viewed as an investment, which hits a company?s bottomline, says Swati Piramal, director, strategic alliance and communications at Nicholas Piramal (India) Ltd. It has its own reasons.

Though the R&D expenditure is usually high with companies spending on an average between 5% and 10% of their revenues on it, it?s a risky proposition and does not always guarantee favourable results.

The fact that new drug research

activity is not seen as part of the core operations of pharmaceutical companies in India is another hitch. It means that drug research doesn?t get desirable resources and attention. Hived off research units promise to attract more investments because in that case the research business is judged on its potential to create innovative products and the expected worth of those products. Initially, the companies that have announced the setting up of standalone R&D units might have to invest on their own, though.

Emphasising that demerging R&D units helps companies reduce their cost burden on other group businesses and improve valuation, an industry analyst says that the major attraction for investors is an R&D unit?s drug portfolio. It helps particularly if a molecule is in advanced stages of clinical trials. In that case it can be a win-win situation for both investors and pharmaceutical companies.

While investors find it easier to bet on advanced stage trials, pharmaceutical companies find the support helpful because of high costs involved at that stage. ?The costs involved in the development of molecule escalate as the candidate matures. Advanced stage clinical trials require more funds and therefore companies are on the look out for funds at that stage. In a few cases companies have out-licensed their molecules to large pharma companies,? says Utkarsh Palnitkar, head of health sciences at Ernst and Young India.

There are other reasons, too. Says Apurva Shah, group managing director of Veeda, a clinical research organisation, ?Hiving off R&D units into separate companies is also being done because it is being recognised that research is a business in itself and should be treated so. It?s not a bottomless pit. One has to invest in R&D and only then you can expect results that are measurable in financial terms.?

The process would also enable the companies to know the actual cost of R&D. In fact, they can get work done from other pharmaceutical companies as well as on contract basis. Besides, hiving off the R&D unit into a separate company means that the researchers involved are under pressure to start performing and show results without the benefit of hiding behind the bigger balance sheets of the parent company, adds Shah.

Ranbaxy laboratories Ltd, India?s top most drug maker by sales, is already in an advanced stage of finalising the structure of its new R&D company, Ranbaxy Life Sciences Research Ltd. The new entity is expected to be listed in the second half of 2008 and would have the same promoter family?s share as they have in Ranbaxy Laboratories.

The restructuring impact will be effective from January 1, 2008. The entire New Chemical Entity (NCE) pipeline along with all relevant intellectual property is to be transferred to the new entity. It?s expected to enable greater commitment with dedicated resources for undertaking research.

While Ranbaxy?s first molecule is undergoing phase IIb trials (anti-malarial RBx 11160), the second molecule has completed phase I trials (RBx 9841 for urology). The likely target date for launching the new anti-malarial drug is 2011. It may well become the first new chemical entity developed in the country.

Commenting on the partnerships and funds available for the new entity, Ranbaxy?s chief executive officer and managing director, Malvinder Mohan Singh, says, ?We will explore the possibilities for more alliances, co-development, out-licensing and bringing in more partners. The new structure will ultimately unlock value at different layers of the value chain, resulting in faster growth of the NCE business, thereby generating greater wealth for shareholders.? Singh adds, ?I would eventually want Indian pharmaceutical industry to earn its rightful place in the global pharmaceutical research space.?

Wockhardt has also managed to get board approval for hiving off its R&D unit. Says chairman Habil Khorakiwala, ?Companies here are working on various drug molecules that can have a fairly significant market share. So, the money is readily available for such projects.? Indian pharmaceutical sector because of its capabilities, for sure, should prove to be a better investment opportunity for overseas investors, he adds.

The company?s board of directors recently gave an in-principle nod to raise equity and equity-linked securities to the tune of $200 million to expand the domestic and international opera- tions.Dr Reddy?s Laboratories Ltd is also not behind its counterparts. Several private equity players have approached the company with investment intentions. With the kind of skills and difference in the cost of production of drugs available here, it works as a pull for investors to invest here than in developed nations, says Satish Reddy, managing director and chief operating officer, Dr Reddy?s Laboratories. ?Indian pharmaceutical companies have a sizeable presence in the global drug market and there seems to be no dearth of investments coming in both, from within and outside the country for the sector,? he adds.

Dr Reddy?s has announced the formation of its integrated drug development company, Perlecan Pharma Private Ltd, with equity capital commitment of $52.5 million from venture capital investors, Citigroup Venture Capital International Growth Partnership Mauritius Ltd and ICICI Venture Funds Management Company. Perlecan Pharma is engaged in the clinical development and out-licensing of NCE assets. An independent board and an executive management team manage the company.

Sun Pharma demerged its innovative research unit into a new company, Sun Pharma Advanced Research

Centre (Sparc), early last year. It got subsequently listed on the exchanges. Sparc has four technology platforms covering technologies that could be applied across therapy areas. It has an anti-allergic lead,

Sun 1334 H, which has completed phase II human trials.

Three more compounds are in the pre-clinical stage. These include Sun 461, a soft corticosteroid for asthma and chronic obstructive pulmonary disease; Sun-44, a prodrug for gabapentin; and Sun-09, a prodrug of a muscle relaxant. Most of these molecules are in their early stages of development.

Says Dilip Shanghvi, chairman and managing director, Sun Pharma, ?The generic and the innovation business has been separated with the aim of running these two businesses independently, with improved focus on each. We can feel this change is already happening.?

Total overseas investment in Sparc, which has a market cap of over Rs 1,890 crore, stands at less than 1% and is held by both financial institutions (0.12%) and foreign corporate bodies (0.75%).

Uday Baldota, vice-president, investor relations, Sun Pharma expects to spend $65-70 million over the next few years on the new chemical entity and novel drug delivery system projects, which are currently in its pipeline. Sparc has access to these funds as part of the demerger from Sun Pharma. Sparc is not looking for outside funding right now.

However, foreign investors hold around 12% of Sparc through the secondary market route. Sparc would seek out-licensing opportunities for the intellectual property that is currently being created once it is closer to the market, typically in phase III, Baldota adds.

It seems to be only the beginning. What could be the end of research activities in Indian pharmaceutical companies can well give birth to a new drug research industry in the country. The momentum is expected to pick up as more and more drug makers demerge their research entities to de-risk their pharmaceutical businesses and seek strategic investors on board to support the long-gestation drug research initiatives.

And the moment the country produces a single new chemical entity and reinforces its position in the global drug market, overseas investors are expected to flock to the Indian market to put their money in pharmaceutical R&D. The wait is worth it.