Corporate Front: Strategy, Can HMR Nurse Itself Back To Health?

Post the Roussel-merger and a drop in exports, only if the pharma company can access its German parent's labs to grow its domestic sales.

Corporate Front
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From Russia, with losses. On November 7, 1998, Debabrata Bhadury, the Managing Director of the Rs 382-crore Hoechst Marion Roussel (HMR) suddenly winged his way to Frankfurt, the headquarters of its 49 per cent parent, the dm 14-billion German major Hoechst Marion Roussel AG (Hoechst). The 57-year-old Bhadury knew the first item on the agenda: HMR's poor Second Quarter (Q-2) results for 1998-99, which have stripped the halo of invulnerability around transnational pharma companies in India.

Thanks to a slowdown in exports--and dormant domestic sales--HMR declared an 85 per cent drop in net profits over Q-2, 1997-98, from Rs 10.55 crore to Rs 1.55 crore. In fact, a 126-per cent jump in Other Income allowed HMR to avoid red on its balance-sheet. Says Bhadury: "We expect the situation to improve towards the end of the year, but the fact is, it will hit us this year."

The primary culprit: HMR's heavy reliance on the moribund economies of Russia and the Commonwealth of Independent States (CIS). In fiscal 1998, these destinations accounted for 90 per cent of its exports, and 30 per cent of turnover. But in August, 1998, HMR's exports virtually came to a halt. Thus, the company's operating margins crashed to 2 per cent, down from 15 per cent in Q-2, 1997-98.

Traditionally, the brand-conscious Russian market has put a high worth on HMR's Baralgan and Avil, which are household names. No longer, it appears, as other pharmaceutical companies with an exposure to Russia--like the Rs 335.19-crore Dr Reddy's Laboratories (DRL)--will testify. Says a DRL spokesperson: "A conscious decision has been taken to restrict our exposure to these markets." But HMR is taking no such step: it feels that the Russian market is too lucrative to be given up. However, Bhadury adds: "There are no short-term solutions to the exports problem."

So, HMR must beef up its sales in the domestic market--and that is not going to be easy. The Indian market is playing truant with a company that is re-inventing itself. With a traditional focus on the generics market in the antibiotics, analgesics, tuberculstatics, and cardiovascular therapeutic segments, HMR's sales grew by a negligible 8.70 per cent in 1996-97. The next year, sales growth fell by 3.50 per cent, largely because of the ban on Baralgan: all analgesic anti-spasmodic combinations were banned by the Drug Controller General of India in December, 1997. In fact, over the last 3 years, HMR's sales have grown only at a Compounded Annual Growth Rate of 5 per cent. And with the collapse of the exports markets, 1998-99 could be worse.

Warns Visalakshi Chandramouli, 29, Analyst, Prime Broking: "It will be difficult to make up the loss of the lucrative Russian market elsewhere." Globally, Hoechst is focusing on the life-sciences business, and planning to exit from the industrial chemicals sector. In fact, in Hoechst's 1997 balance-sheet, Chairman Jurgen Dormann emphasises a further shift towards R&D: "Generic drugs, over-the-counter drugs, and the production of standard active ingredients for third parties do not fit in with Hoechst's strategy."

This change in strategy is giving HMR increasing access to its parent's patented product-line. Thus, in the last 12 months, HMR launched 5 critical therapeutic products: Tycoplain (antibiotic), Dermatop (dermatology), Cetapin (anti-diabetic), Frisium (anti-epilepsy), and Allegra (anti-histamine). The company also plans to launch Cefprio (antibiotic) this year. Says Bhadury: "We are becoming aggressive with product launches. It's our bid to move up the value-chain."

In particular, HMR is making a big push into the Rs 293-crore anti-tuberculosis drugs market, where it has a 2 per cent marketshare with 2 products: Rifater and Rifadin. The anti-tuberculosis market is growing at 10-12 per cent a year even as the increasing evidence of a linkage between tuberculosis and aids is likely to push up growth. Moreover, HMR's parent has filed applications to the German drug authority for the approval of its new anti-tuberculosis drug, Rifapentene, which is reported to be effective for a longer duration than the current crop of anti-tuberculosis drugs, like R-Ccin and Combutol. Says Chandramouli: "If HMR launches this drug, it can literally sweep the anti-tuberculosis market."

Here, its pricing strategy will be crucial. Traditionally, HMR has priced new products at a nominal premium to the next-best substitute, making it less lucrative for Indian companies to enter the market. While this strategy works for the Indian market, the benefit to HMR's bottomline may be negated by a conditional clause for access to its parent's product-line. Hoechst insists that HMR purchases the bulk drug, or the medicinally-effective chemicals, from it, which puts HMR at a disadvantage vis-à-vis companies that manufacture the bulk drugs at a lower cost domestically. Says Bhadury: "For all the new drugs, the bulk has to be sourced from the parent."

The parent, however, justifies the practice as a natural corollary to delivering its best products to the Indian subsidiary. Nonetheless, the net result: even for the period where a product does not have a direct competitor, HMR cannot ride on higher sales to shore up its bottomline as the transfer price for the purchases from Hoechst remains a drag. Thus, HMR's operating profits margins in Q-1, 1998-99--when 4 new drugs were launched in the Indian market in the past 12 months--actually fell by 1.80 per cent.

The merger of Roussel into HMR is likely to add to the latter's bag of troubles, at least in the short term. Although the merger has been approved, effective April 1, 1997, HMR just presented its consolidated accounts, for 1997-98. Sure, except for a few overlapping antibiotics and analgesics, the 2 companies complement each other's products (covering about 10 therapeutic segments). And Roussel does have some stars in its medicine box, including Combiflam (1997 marketshare: 36 per cent) and Soframycin (30.80 per cent). But the overwhelming counterweight to this is the fact that 90 per cent of Roussel's 20-product portfolio--including Combiflam and Soframycin--are under price-control.

And that is likely to remain an uncomfortable reality for HMR which, in fact, phased out some of its older products (accounting for Rs 10 crore in sales) last year. Promises Bhadury: "The high quantum of drugs under price-control will be dealt with over a period of time." Moreover, given Roussel's poor profitability, the integration is unlikely to be painless: its operating profit margins of 6 per cent compared unfavourably with HMR's 14.50 per cent.

Not surprisingly, in 1997-98, HMR's Return On Capital Employed has fallen to 20 per cent, against 34.67 per cent the previous year. Now, BT learns that HMR is negotiating to sell the Roussel plant to the Chennai-based Orchid Pharmaceuticals for Rs 15 crore. Finally, overheads would get reduced once the merged entity completes the shift of its production facilities to Goa in 2000. But before HMR can reap the benefits of an enviable access to its parent's global product-lines, its house must be put in order. And the answers are not in cyrillic.