Sombre still? Well Prasad can smile now

It is neither the strongest nor the most intelligent of the species that survives, but the one most responsive to change." When Gunapati Venkateswara Prasad, Executive Vice Chairman and CEO of Dr Reddy's Labs, told this to shareholders at the company's annual general meeting in Hyderabad last July, many thought he was trying to make a bad situation look good. After all, the 22-year-old company had reported an unprecedented 77 per cent drop in net profits to Rs 65.46 crore and a smaller, but worrying nevertheless, 6 per cent fall in revenues.

Less than a year on, the 45-year-old Prasad feels vindicated. Consolidated total income for the first three quarters of 2005-06 is up about 20 per cent and net profits have more than trebled to Rs 185.25 crore (results for the full year are due end of May). And the stock, which went into a near free fall from Rs 1,399 in January 2004 to Rs 835.55 at the time of the agm, is back up at Rs 1,461.85. "We went through some difficulties, (but) built our muscles and are healthier today," he says, sitting in his corner room office at the headquarters on Hyderabad's Ameerpet road.

Just what sort of muscles did Dr Reddy's build past year? To put it simply, it cut some flab weighing down the bottom line. In two novel deals (See Turnaround Moves), it took a lot of the risks out of generic drug launches (called andas for abbreviated new drug applications) and new drug development (nces, or new chemical entities). Prasad credits his President and CFO V.S. Vasudevan, for the innovative deals. When the search for potential partners in the US did not yield any results, "Vasu, who understood what the company's need was, structured a deal and we quickly closed it," says Prasad. Thanks to the deals, R&D costs in the first nine months of 2005-06 dropped to 9 per cent of sales compared to 12 per cent (and 14 per cent for full year) the same period the previous year.

The speed with which the company moved to address its cost issues was certainly one thing that impressed investors (that's one reason why its bigger rival Ranbaxy hasn't witnessed a similar bounce back in stock price; See Delayed Rebound). But they were more thrilled by the fact that it had found a way to cut costs without shortchanging growth. For, Dr Reddy's challenge really was to, on the one hand, cut R&D costs but, on the other, do more R&D to fuel growth. Says an analyst who has tracked the company for sometime now: "It is a good hedging mechanism to ensure a steady business."

Dr Reddy's Lab: Financial investors share the risk

Business Looks Up

R&D cost cuts aren't the only reason why Dr Reddy's has bounced back. International markets, other than the US, have performed better than expected. Revenues in Russia increased 13 per cent and in Europe, by 16 per cent. Even in India, Dr Reddy's sales of branded formulations grew 21 per cent, increasing the country's contribution to sales from 35 per cent to 37 per cent.

Prasad, however, says that the most important step the company took was to acquire two businesses abroad. In November last year, it bought Roche's bulk drug facility in Mexico for $59 million (Rs 265.5 crore), thereby acquiring a platform to build its custom pharmaceutical services (cps) business, which involves offering a range of services to innovator companies. "It's also the first time," points out Prasad, "that the company will have a really large manufacturing presence outside India." To be sure, Dr Reddy's has two other facilities-in China and the UK-but they are small compared to the Mexico unit, which gave the world the first synthetic steroids. "With this we have, in a sense, acquired a part of pharmaceutical history," says Chairman and founder, K. Anji Reddy.

The second acquisition, of German generic drug firm betapharm, is even more important for the company, and not just because the deal size of m480 million (Rs 2,640 crore) was bigger than Dr Reddy's revenues when announced in mid-February this year. Betapharm is the fourth largest generics company in Germany and the fastest growing of the top 10. Germany is not just Europe's largest market for generic drugs, but also the second largest in the world (after the us). "From the point of geographical and customer reach, we fit into Dr Reddy's like a piece in a jigsaw puzzle," says Dr Wolfgang Niedermaier, the 54-year-old CEO of betapharm.

Most analysts agree that the M164-million (Rs 902 crore) betapharm, courted by Ranbaxy too, is crucial to Dr Reddy's future, but some others are sceptical of the price paid. Not only has the all-cash deal depleted the company's cash reserves but added $300 million (Rs 1,350 crore) in debt. (The company won't reveal betapharm's profit figures, but Niedermaier says it is "quite profitable...and among the top earners" in Germany.) Prasad isn't too worried, though. "We are not much concerned about the debt as long as the performance is healthy," he says.

Unlike Ranbaxy, analysts say, there's more clarity about Dr Reddy's big-ticket opportunities. It has 49 andas pending approval, of which 10 have tentative approvals. In all, 28 are para iv filings, or patent challenges, where profit margins could be higher. That apart, Dr Reddy's has signed a deal with Merck to manufacture and distribute two of the latter's drugs, Zocor (a cholesterol-lowering drug) and Proscar (for treating prostrate cancer), once they go off patent in the us in June this year. There's some more good news the market is expecting. Sanofi-Aventis may pay Dr Reddy's a significant amount to keep it from launching a generic copy of its blood-thinner drug, Plavix. Mid-April, the company received the Food and Drug Administration (FDA) nod for generic Allegra, prescribed in the treatment of nasal allergy. Rivals Teva and Barr Pharmaceuticals already have a generic Allegra (patent holder is Aventis) out in the US markets, but others like Ranbaxy and Sandoz are awaiting approvals. So, Dr Reddy's may be able to make a tidy sum on the generic Allegra before the market gets too crowded.

Power duo: MD & COO Satish Reddy's (left) focus is on cutting costs and improving efficiencies, while CFO V.S. Vasudevan is the dealmaker

More Flab To Shed

By Prasad's own admission, there's a lot more of cost-cutting to be done and efficiency to be improved. "I think we are only 30 per cent there. Seventy per cent of the journey is yet to be completed," he says. What's ahead? He plans to revamp the company's it backbone and re-implement its ERP system, and focus on ways to improve product development. Within the next year, the plan is to slash product development time by at least 30 per cent and costs in each of the businesses by 5-10 per cent. In terms of generic launches, too, Prasad wants to move away from a "machine gun kind of approach" to a targeted, high-value strategy, but not restricted to copies of blockbuster drugs.

Other than this, Dr Reddy's is looking at creating research and manufacturing capacities. Prasad wouldn't reveal the proposed investment in these facilities, but says that it will be in "hundreds of crores" and spent over the next 18 months. The facilities planned include a bulk drug factory, one for custom pharmaceutical services, a product development centre, and a laboratory. To fund the plans, the company will be raising money. Once again, Prasad won't tell the planned source, but it is obvious that debt is not an option.

RANBAXY: DELAYED REBOUND

It's his turn now: CEO Singh is making bets for the long term, but investors aren't impressed No other pharmaceutical company in India has made its aggression so apparent by acquiring four global businesses in just 10 days. So why has Ranbaxy's stock performance been lacklustre over the last two years? Unfortunately for Malvinder Singh, the 33-year-old CEO and Managing Director of India's biggest drug company, Dalal Street analysts are so focussed on quarterly earnings that they are unwilling to reward him for his long-term bets. Ergo, on the day (March 29, 2006), Singh announced his biggest deal so far by acquiring Terapia of the US for $324 million (Rs 1,458 crore), the Ranbaxy stock rose just 3.21 per cent. In contrast, announcement of the betapharm purchase boosted Dr Reddy's stock by almost 10 per cent. Ask analysts why and they'll tell you that a) except Terapia, Ranbaxy's acquisitions (Senetek in the US; Allen SpA, unbranded generics business of GlaxoSmithKline; and Ethimed of Belgium) are relatively small, and b) the bigger reason is a lack of new product launches. "Since October last year, there has been no news of an ANDA approval from Ranbaxy, besides which they still have to pass through the pain of incurring legal and R&D costs, for which Dr Reddy's seems to have found an answer," says an analyst. That said, Ranbaxy is a solid long-term bet. It has a far bigger presence (compared to Dr Reddy's) in the international markets, and unlike its competitor from Hyderabad, doesn't have to share the upside from new generic launches with partners. If you are looking for some good news in the short-term, here's one: Ranbaxy may soon get exclusive marketing rights in the US for an 80 mg version of generic Pravachol, a cholesterol-lowering drug. The market opportunity: $250 million, or Rs 1,125 crore.

When the company announces end of May its full-year results for 2005-06, the top line is expected to be at $500 million (Rs 2,250 crore). So the question is, when will Dr Reddy's hit the billion-dollar mark? "We are not so much driven by numeric goals," replies Prasad, explaining that the goal in the medium term is to be a dominant global generics company and an innovation-led company in the long haul.

Shareholders who heard his address last July already know what Prasad's growth mantra is going to be. After all, in the cut-throat world of pharmaceuticals, innovation must go beyond the labs.