Piramal Enterprises is a public company headquartered in Mumbai, India. The company was founded in 1988. Ajay Piramal is the chairman of the company. It is a diversified conglomerate having its presence in three sectors (1) Pharmaceuticals (2) Information Management (3) Financial Services. Given below are the charts showing its Income, EBITDA, Equity, and Debt for the last 5 years.
Looking at the charts I had the following questions
- Why did the income for the year 2011 went down by 47% compared to the year 2010.
- Why did the equity for the year 2011 went up by 700% compared to the year 2010.
In May 2010 Ajay Piramal sold Piramal Healthcare Solutions business for $3.8 billion to Abbott. At that time healthcare solutions was generating 50% of the company revenues. Around the same time he also sold Piramal Diagnostic Services Private Limited (PDSL) to Super Religare Labs for Rs 6 billion. This was the reason why revenues went down and equity shot up. Why did Piramal sell these businesses? Prof Sanjay Bakshi explained it here in an elegant way. I became a shareholder of Piramal Enterprises in 2012 and I was buying a dollar for 0.70 cents. A decent margin of safety.
Piramal Enterprises does business in three sectors (1) Pharmaceuticals (2) Information Management (3) Financial Services. Let us understand each one of them in detail.
Around 82% of the total drug sales happen in North America, Europe, and, Japan. Annual growth in these regions are slowing down. On top of that there are several other issues (1) Patents for a lot of blockbuster drugs are expiring (2) Low approval rates by FDA for new drugs (3) Increasing R & D costs (4) Healthcare providers are in favor of reducing costs by moving to generic drugs. Multinational Pharmaceutical companies are under tremendous pressure and they are looking at newer ways to drive growth and cut costs.
The only way out of this problem is to partner with pharma companies in India. There are several advantages in the partnership (1) Indian companies are among the world leaders in the production of generics and vaccines (2) Biggest pool of English speakers and a strong system of higher eduction, so there is a huge source of research talent (3) Lower costs (4) With 1.27 billion people and a rising disposable income global pharma industry cannot ignore Indian markets. The Indian pharmaceutical market is highly fragmented with more than 10,000 firms collectively control about 70% of the market. I strongly suggest reading this article to learn how the Indian Pharma industry works. Piramal focus on the following parts of the pharma market (1) Pharma Solutions (2) Critical Care (3) Over the counter (OTC) and Ophthalmology (4) Drug Discovery.
1.1 Pharma Solutions
Just like IT, major multinational pharma companies outsource their manufacturing work to India. Global Outsourcing market is estimated to be $36 billion, growing at 12%. Market share of India is extremely low at $2.1 billion and hence it is expected to grow at 17%. Outside of US, India has the highest number of manufacturing facilities approved by the FDA. One of the major benefits is the low cost of operations in India. In the recent years lots of research work also gets outsourced because of the availability of talent pool in India. To be successful in this business a company needs (1) Talented People (2) Facilities (3) Trust and track record. Piramal has all three and the company believes in partnering with MNCs rather than seeing them as competitors. This leads to reciprocation. Given below are the locations of its manufacturing facilities.
1.2 Critical Care
Anesthesia causes the patient to become unconscious and it is given before the surgery. The company has a strong presence in the inhalation anesthetic market. This is a global business that supplies anesthetic drugs to hospitals in 100+ countries. Halothane, Isoflurane, Enflurane, Sevoflurane, Desflurane, and Propofol are its anesthetic products. Sevoflurane a general anesthetic which has a market share of around 30% in the United States. In FY2013 this segment grew by 49.3% with a revenue of around $100 million. The addressable market size in 2016 is around $1.8 billion. Hence there is a lot of room for growth.
1.3 OTC and Ophthalmology
OTC drugs can be purchased without a prescription. This is a domestic business that caters to Indian consumers. The company has a strong product portfolio consisting of Lacto Calamine, Saridon, Polycrol, and i-pill. The complete list of its products can be found here. All these products have a strong brand name which is a powerful moat. It has a strong distribution network and supplies its products to 4 lakh chemists and 485 towns with 1 lakh+ population. It sells Ophthalmic (related to eye) products by partnering with Allergan India Limited a joint venture of 51:49.
1.4 Drug Discovery
Biopharmaceuticals are medical drugs produced using biotechnology. Drug discovery is a biopharmaceutical unit specializing in the discovery and development of novel small-molecule drugs. These molecules are then used to manufacture blockbuster drugs. This will be used to treat cancer, metabolic disorder, inflammatory and infectious diseases. There are 10 products that are under development. There are 2 other products. BST – CarGel an orthopedic product used for cartilage repair. It received the regulatory approval to launch in Europe. Florbetaben detects Alzheimer’s disease. NDA has been filed for this in US and Europe in March 2013. Drug discovery is a low probability and a high impact event. They are positive black swans. This unit is R & D heavy and it spent Rs 286.7 crores in FY2013 without any revenue. Let us hope fortune favors the brave.
Given below is the income split for all the pharmaceutical units
|(In crores)||FY2011||FY2012||FY2013||CAGR (2 years)|
|OTC and Ophthalmology||195.8||220||271.2||17.69%|
2. Information Management
Need to know about pharmaceuticals in China or how physicians prescribe certain drugs? Decision Research Group (DRG) has that information. Gartner offers objective insight on virtually any area of information technology. Similarly DRG provides insights about the global healthcare industry. In June 2012 Piramal acquired DRG, a US based based provider of high quality, web-enabled research, predictive analytics via proprietary databases and consulting services to the global healthcare industry. The acquisition cost was around Rs 3,400 crores and its income for FY2013 is Rs 650 crores. It is one of the fastest growing companies with a CAGR of 20% for the last five years. It has 48 of the top 50 global pharmaceutical companies as its customers. The Company has retained 96% of its customers as of Q1 FY2014. The global healthcare information industry is estimated to be around $5.7 billion and DRG can address around $2.4 billion. With FY2013 income of $160 million the company has a lot of room to grow. Why would pharmaceutical companies use DRG? Ajay Piramal tells
The global healthcare industry is facing several challenges including rising research costs, lower drug approval rates, mounting regulatory pressures and increasingly complex reimbursement models. The need for specialist information is critical and the demand is growing. DRG’s portfolio of products is widely regarded as the gold standard of information. We will leverage our longstanding reputation and relationships with global pharma companies, our knowledge of emerging markets as well as our track record of successful acquisitions as we continue to grow further DRG’s leadership position in the healthcare information and analytics industry.
DRG is a terrific business with (1) negligible capital expenditure (2) predictable cash flows (3) High profit margins (4) Information is a non rival good and with time its value will only grow there by creating a high switching costs (moat) for the customers.
3. Financial Services
Why did Piramal enter into the financial services industry? I found the answer in 2011 annual report
India has had strong GDP growth in past decade and is likely to continue with 8-9% GDP growth rate for the next decade. Given sound economic fundamentals, rising disposable income, financial sector liberalization and growth of consumer oriented, credit oriented culture; the financial services sector is poised for strong growth in India. To participate in this growth story, PHL has decided to foray in financial services sector.
In order to have a strong presence in the financial sector the company did the following.
- It purchased a real estate private equity fund. Indiareit Fund Advisors Pvt. Ltd. and Indiareit Investment Management Company was acquired for Rs 230 crores in 2011. As of Sep 2013 it has around Rs 5,000 crores under management.
- Set up an non-banking-financial-company (NBFC) for lending to real estate, education related infrastructure, hospital projects and medical equipment. As of Sep 30th 2013, NBFC has lent Rs 2,650 Cr.
- Structured investments are umbrella which focuses on funding of infrastructure projects over $100 million. Recently it completed two structured investments. Invested Rs 425 crores in Navayuga Road Projects and Rs 500 crores in Green Infra Limited.
- On May 2013, it acquired a 10% stake in Shriram Transport Finance Co Ltd (STFC), the country’s largest player in commercial vehicle finance, for Rs 1,652 crore. STFC is featured as a high quality business in Prof Sanjay Bakshi writings.
In his usual style Ajay Piramal entered into the financial sector through acquisitions and partnerships. Loans should be given to people with good credit. If not this sector will give rise to negative black swans. Since a lot of these investments were made in 2013 we need to wait for some time to see how it performs.
Given below are the Income and EBITDA margins for the last 5 years.
Every business has some risks which we as an investor should be aware of. Pharma solutions business model is based on contracts with customers. Significant business is contracted with a few major customers. Any setback for the customers will affect revenues. Drug discovery has an extreme low probability of success. Hence a lot of R & D expenses might not yield any ROI for a very long period. In FY2013 the company spent Rs 286.7 crores in R & D compared to Rs 233.1 crores. In NBFC the borrowers might default on their payments which could adversely affect the companies profitability. In the book The Black Swan – Taleb writes
If you are in banking and lending, surprise outcomes are likely to be negative for you. You lend, and in the best of circumstances you get your loan back – but you may lose all of your money if the borrower defaults. In the event that the borrower enjoys great financial success, he is not likely to offer you an additional dividend.
In FY2013, EBITDA – 611.0 crores; Depreciation – 209.6 crores; Interest Expense – 575.0 crores. Hence the company had a loss. Same trend is continuing in FY2014. The huge interest expense is the reason behind this. Take a look at the annotated balance sheet given below. The company has a huge debt of Rs 9,277 crores. Should I worry about this?
Piramal invested Rs 5,864.37 crores in Vodafone India Limited during 2011 – 2012. The objective behind this investment was to deploy surplus funds available from sale of the healthcare solutions business to Abbott. He will be selling this back to Vodafone for Rs 8,900 crores. In 2 years the CAGR comes to 23.19%. This is a much better outcome than originally assumed return of around 17%. This alone should take care of the debt. You can read about it here.
The key person in the management team is the CEO. If you buy an excellent business run by an able and honest CEO then the stock should take care of itself. Ajay Piramal is another outsider CEO. He is the only reason why I am a shareholder of this company. The following actions speak for his ability and honesty (1) From 1998 to 2011 his company has compounded the money for his shareholders at 28% compared to Sensex which compounded only at 17% (2) A contrarian value investor who buys low and sells high – Sold healthcare solutions business to Abbott at 9 times FY10 sales. The highest he has ever paid for buying a pharmaceutical company was 3 times sales for iPill, which bought from Cipla in March 2010. Acquired DRG by paying 5.23 times sales. This was relatively cheap for a terrific business. (3) Used some of the proceeds from the sale to Abbott and bought back 20% of total shares outstanding at Rs 600. A great way to return money to shareholders when it was selling for less than the book value. In 2011 increased the dividend per share from Rs 5.40 to Rs 17.5 once again rewarding the long time shareholders. In a recent post about corporate governance in family owned business Prof Sanjay Bakshi classified Piramal as Owner-Operator 2.
Owner-Operator 2 (OO2): An owner-operator who is passionate about running the business proﬁtably but is also attracted to creating wealth for himself. He will receive higher compensation than OO1s but is not a crooked person.
Adjusting the difference for the Vodafone sale and accounting for 20% capital gains tax the company has book value of Rs 13197.504 crores as of Oct 2013. With 17.5 crores shares outstanding the book value comes to Rs 754 per share. As of this writing its stock is valued at Rs 555.30. In other words you can buy $1 for 0.74 cents. Take a look at the book value of other pharma companies. I believe Piramal is undervalued. What do you think?