Gland Pharma is an Indian Pharmaceutical company that has initiated IPO proceedings (IPO opens on the 9th of November 2020). It is one of the largest Pharma IPOs to hit the Indian market (However, most of the shares being offered are via the OFS route).
Gland Pharma is primarily a Generic Injectables company and its largest promoter is Chinese Pharmaceutical giant, Shanghai Fosun Pharma.
Today we will attempt to understand the company’s structure and business model, followed by an intrinsic and relative valuation.
What are injectables?
Injectables is a drug delivery system that today accounts for over 39% of the global pharmaceutical market. It has witnessed robust growth which is likely to continue owing to its advantages over other dosage systems such as (Oral Solids, Others – Topical, Nasal, Rectal, Oral Liquid, Ophthalmic, Lung administration). It has grown at a CAGR of 10.1% over the past 5 years.
- Near immediate onset of action
- Allows patients to maintain their medication regimen who otherwise might be uncapable of consuming drugs via other dosage forms
- Particularly useful for unconscious and comatose patients
- Enables the drug administrator to ensure drug delivery to the target area in a measured and controlled manner
- Several drugs have low efficacy when administered via other dosage forms (due to low water solubility and permeability). In these cases, injectables is the only way for efficient administration
What are APIs and Finished Formulations?
APIs stands for Active Pharmaceutical Ingredients which are the key chemicals that define the drug and bring about the intended pharmacological effect.
Finished Formulations refers to the process in which different chemicals, including the APIs, are mixed in specific ratios to produce the drug.
What types of Business Models exist in this industry?
(Please note that there are further sub segments of each business model given below. I intend to keep this a lighter read and hence the omission)
B2C – The company (Gland Pharma) manufactures, and markets finished dose formulations to the final customers. End-to-End model (Sourcing->R&D and IP->Manufacturing->Marketing)
B2B – The company (Gland Pharma) operates as a manufacturing partner specializing in manufacturing complex and diverse injectables and providing other value-added services to another pharmaceutical company which will market the product (IP generally belongs to the other Pharmaceutical Company). This model encompasses CMO & CDMO models (CMO – Contract Manufacturing Organization, CDMO – Contract Development and Manufacturing Organization)
Generally, the B2B model is better than the B2C model due to the following reasons:
- Long term contracts between Manufacturing Company & Pharmaceutical Company leads to steadier and predictable cash flows
- Operating Margins tend to be higher due to
- R&D and IP costs being borne by the other Pharmaceutical Company (Naturally, they also own the R&D and IP)
- Manufacturing Company can pass on raw material price fluctuations
- Lower R&D litigation risk
- The manufacturing company is sometimes granted the ‘manufacturing rights’ for the molecule thereby allowing them to supply it to multiple marketing partners and quickly establish market dominance in that molecule. Hence, this model is ideal for scaling
- Higher revenue growth
Now that we have laid down the basic ideas governing this business, let us talk about the company under consideration, Gland Pharma.
About Gland Pharma:
Areas of Operation:
7 manufacturing facilities in India (4 finished formulation facilities & 3 API facilities)
- Complex injectables Development, Manufacturing, and Marketing
- B2B – CMO/CDMO Services
Product Domain: 265 ANDAs – 204 Approved, 61 Pending Approval
- Sterile Injectables
- Complex Injectables
- NCE-1 – First opportunity for generic pharma companies to file ANDAs (Abbreviated New Drug Applications) for entry into branded markets
- First to File products – The first company to complete a substantial ANDA filing is granted an exclusivity time of 180 days (No other company can launch the same drug within this timeframe).
- 505(b)(2) filings – Tend to be novel new molecules instead of generics. These filings enable the company to acquire USFDA approval with reduced compliance needs
Drug Delivery Systems for their Products:
- Liquid vials (Product inside can be stored and reused, Multi-dose)
- Lyophilized vials (Freeze dried vials)
- Pre-filled syringes
- Ampoules (Small Glass vials containing a single dose)
- Bags & Drops
Use of IPO Proceeds as per the Company:
- To address working capital needs
- To incur additional Capital Expenditure across Plants – upgradation and expansion of capacity as well as corporate expenses
What is this IPO likely to enable?
- Increase technological capabilities
- Increase presence in India and target emerging market countries and APAC, bolster and increase efficiency, and improve margins across the business
- Potential Acquisitions of API companies operating in niche segments which complement Gland Pharma’s existing capabilities
- Help the Chinese promoter pare their stake in the company amidst these testing times. This would help Gland Pharma shed its ‘China’ image (to a certain extent) and probably gain better acceptance due to a more diverse shareholding
Strengths of Gland Pharma:
- Vertical Integration- 3 API facilities that manufacture critical APIs for 24 of their key products thereby insulating them from supply constraints from China (China caters to roughly 70% of India’s API demand). Ensures greater control over quality standards and manufacturing processes, strengthens product development (in-house R&D), and improves supply chain efficiencies
- 22 Production lines granting flexibility to accommodate different product requirements at quick notice
- Well diversified products spread across different facilities thereby reducing regulatory risks
- Presence in B2B and B2C
- B2B (includes CMO, caters to over 60 countries) – 96% revenue contribution – The company retains the manufacturing rights
- B2C (primarily for the Indian market) – 4% revenue contribution – The company controls the entire chain from manufacturing to marketing of their branded products. They have a dedicated salesforce of over 200 and cater to around 2000 direct customers (Nursing Homes, Hospitals, Government Facilities)
- Internal R&D supported by strong regulatory capabilities – The company has not received a single FDA warning for the past 5 years and derives between 8% – 21% revenues from new products annually
- Experienced Promoter – Shanghai Fosun Pharma, a global pharma major, is the key promoter of the company. This allows the company,
- to take advantage of Fosun’s market experience in China
- to leverage Fosun’s clout: to file for product filings in China, increase bargaining power for raw materials, increase market penetration owing to extensive distribution networks
Risks pertaining to Gland Pharma:
- High Customer Concentration – Top 5 customers have contributed an average of 48% of revenues annually (However, this happens to be a feature of the B2B model, but still poses a risk)
- Regulatory risks arising from USFDA and other regulatory bodies
- Pricing power variance across geographies
- Chinese Promoter (However, the IPO and the OFS will bring down Shanghai Fosun’s shareholding)
- Negative sentiment regarding Chinese ventures in India due to border tensions
Revenue breakdown by Geography:
The injectables market held roughly 40.3% share (by value) of the global formulation market in 2020. I expect the injectables market to capture a market share of 45.47% (by value) by 2030.
Today, over 70% of the injectables market is controlled by the top half of all injectable pharma companies. There has been a trend of consolidation in this market with the larger companies getting bigger and the smaller companies either getting acquired or being pushed out.
This market tends to have fewer competing companies due to the following reasons:
- Market consolidation leading to economies of scale and moderate levels of customer captivity
- Complex Nature
- High Initial Capital Investment to get the plant operational (contingent on getting regulatory approval)
- Extremely stringent compliance and regulations due to the sterile nature of the product
- Complex supply chain requirements post manufacturing
- Packaging – Must be inert
- Storage – Cold Storage logistics / Regulated Temperatures
- Transport Logistics
- High Personnel Training Costs
- Increase in the prevalence of chronic diseases (diabetes etc.) and cancer
- A broader shift towards injectables by Pharmaceutical companies
- A large gamut of drugs is expected to be off patent soon. This will lead to a surge in injectables usage as generic players enter
- Over 40% of drug shortages come from injectables (a lot of these shortages come due to failing compliance/regulations tests). Hence, there is a dire need to plug this shortage. Thus, companies that have strict quality control from start to finish could benefit tremendously
Gland Pharma is a highly profitable near debt-free company backed by a strong experienced promoter. I do not see them succumbing to their competitors.
Historically the company has witnessed Sales Growth of over 25% annually. Going forward, considering the growth drivers, I expect the company to continue being in high growth for the next few years. Gradually, growth rates will start reducing and will eventually reach steady state.
We have capitalized R&D expenses for the company. The operating income and invested capital have been adjusted accordingly.
Margins have been maintained above 30% over the last few years. Going forward, I believe that margins will erode gradually towards 18% (80th Percentile of Pharmaceutical Companies).
We will use the marginal tax rate of 25.17% in our valuation.
The company currently has a Sales to Capital ratio of 0.79.
I expect the company to continue to reinvest heavily as this industry is characterized by high upfront capex costs. Eventually, the company will be able to live off its investments and will attain a Sales to Capital ratio of 1.21 (75th Percentile of Pharmaceutical Companies).
The cost of capital in the Terminal Year is 8.84%. Due to the characteristics of this industry, I believe that the company will earn a ROC of 10.84% in the stable period (3.45% growth)
Accordingly, the appropriate Reinvestment Rate is 31.83%.
The intrinsic value of Gland Pharma (as per the DCF model) is 782.09 INR.
The IPO price band is between 1490-1500 INR. Hence, the IPO seems to be overvalued by 91.79%.
To justify a price of INR 1500, the Cost of Capital needs to be 7.34% and the margins need to be 30% – 32% in the Terminal Year (Stable Growth Phase).
I feel that such a scenario is plausible, but the probability of it happening is quite low.
I ran regressions across the Pharmaceutical industry for EV/EBIDTA and PE ratios while adjusting for differences. This industry has witnessed a sharp run up in prices (of over 60%) in the past 9 months. Hence, the entire sector trades at elevated EV/EBIDTA and PE ratios.
|Gland Pharma Multiple||Corresponding Value per Share|
Gland Pharma warrants multiples on the higher end due to better growth prospects as well as low risk of regulatory issues.
The IPO price band of INR 1490-1500 is quite expensive and hence I would not subscribe to this issue based on my intrinsic valuation.
On the relative valuation front, Pharmaceutical companies have been the fancy of investors over the past few months and we may see the same momentum carry forward in the IPO.
Thus, based on my relative valuation, I would wait to see the response that the IPO receives and then take a decision.
Regardless of what happens with the IPO, Gland Pharma is a strong company fundamentally and would be a good candidate to invest in at the right valuations!
Post Listing Update:
Despite a poor response to the IPO, the stock opened at INR 1844 before closing at INR 2089.05 on the first day of listing. Today (as of 12/12/2020), the stock trades at INR 2241.6
Hence, it is quite clear that the stock is being ‘priced’ as is evident from our relative valuation numbers!