Strides’ API business (15.2% of FY17 sales) would demerge into a separate listed entity, Solara Active Pharma Sciences Ltd (Solara), which will also have human API business of Sequent Scientific.
The stock price of Strides Shasun Ltd (Strides) has started trading ex-API business as the record date for demerger was April 9, 2018. The company had earlier announced demerger of third party API business into a separate listed entity (Solara) along with the human API business of Sequent Scientific. Solara will list separately. We believe this demerger would improve overall profitability metrics of Strides and help in growing the formulation business faster with dedicated focus. API business contributed 15% of total revenue for Strides in FY17 and we believe EBITDA contribution was 11%. Strides shareholders would have 60% stake in Solara and remaining 40% would be with Sequent shareholders. We value the stake of Strides shareholders in Solara at Rs 72/share based on EV/EBITDA of 8xFY20E Solara EBITDA. Since the stock has started trading ex-API business and the shareholders would now receive equity shares of Solara, we reduce our target price by Rs 72 to Rs 990/share (earlier Rs 1,062) and reiterate Buy on the stock.
API business demerger is value accretive step
Strides’ API business (15.2% of FY17 sales) would demerge into a separate listed entity, Solara Active Pharma Sciences Ltd (Solara), which will also have human API business of Sequent Scientific. However, Strides would continue to keep captive API manufacturing for vertical integration. This move should improve overall profitability metrics and help in growing the formulation business faster with dedicated focus. The API portfolio of Strides includes several high value products such as generic Sevelamer (Renvela) and is one of the top five companies for supplying Ibuprofen API in US.
Value stake in Solara at Rs 72/share
As per the pre-determined swap ratio for valuation of this demerger, Strides shareholders would receive 1 equity share of Rs 10 each in Solara for every 6 equity shares of Rs 10 each held by the shareholders in Strides. In the new entity, Strides shareholders would have 60% equity stake. We value the stake of Strides’ shareholders in Solara at Rs 72/share based on 8xFY20E EV/EBITDA assuming 12% revenue CAGR over FY18-20 in Solara and 15% EBITDA margin.
We are positive on Strides’ long-term outlook considering ramp-up of US business backed by strong execution, sturdy positioning in less competitive Australian generics market, potential for operating leverage, and attractive valuations. We expect EPS to grow at 67.2% CAGR over FY18-20 driven by 11.2% revenue CAGR and 510bps EBITDA margin expansion.
Valuation and risks
We reiterate Buy with revised target price of Rs 990/share based on 17x FY20E earnings. The reduction in TP is due to removal of Rs 72/share value in API business for which shares of Solara would be allotted. Key downside risks are: regulatory hurdles, currency fluctuations and delay in margin expansion in Australia.