A spoonful of sugar


Clever structuring sweetened Abbott’s acquisition of a division of Piramal. Yet, the success of the deal may prompt new FDI caps in the pharmaceutical sector

Raghavendra Verma reports from New Delhi

In May 2010, Abbott Laboratories, a US pharmaceutical company, revealed that it was buying the domestic formulations business of Mumbai-based Piramal Healthcare for US$3.72 billion. The purchase price was 31 times Piramal’s earnings and nine times its annual sales, meaning that Abbott was effectively paying more than twice what Daiichi Sankyo had paid in June 2008 for a controlling stake in Ranbaxy.

“It was a large valuation, but our investment was never intended to be on a short-term perspective,” Michael Warmuth, Abbott’s senior vice-president, told Mint after the deal closed on 8 September. “In fact, there was a scarcity for such assets in the emerging markets, including India. So the price was quite justified.”

Warmuth added that Abbott had evaluated three factors when considering Piramal as a target: the cultural fit between the two companies, Piramal’s portfolio of established brands and the quality of its management.

Unfounded rumours

In the weeks preceding the announcement of the deal, confidentiality was a major concern. Despite the fact that a very small team was privy to the negotiations, rumours surfaced that a multinational company was targeting Piramal. Oddly enough, Abbott’s name did not figure among the possible buyers, and just two days before the announcement, in a letter to the National Stock Exchange of India, Piramal was forced to deny that it was selling a controlling stake to Pfizer, another US multinational.

Innovative structure

When the deal was finally revealed, the buyer’s identity took many by surprise. But perhaps the bigger surprise was that the mega-deal that was to make Abbott the largest pharmaceutical company in India was neither a merger nor an equity-related acquisition.

Well aware of the problems created by minority shareholders in recent share transfer deals, such as those involving Ranbaxy and Sun Pharma, the two companies and their legal advisers had opted to play it safe. As a result, the transaction was structured as an asset sale.

Piramal was advised on the deal by UK-based Stephenson Harwood. Partner Andrew Edge led the firm’s team that worked on the tansaction. Indian law advice was provided by Crawford Bayley & Co.

Abbott received Indian law advice from Luthra & Luthra under the guidance of senior partner Mohit Saraf. Baker & McKenzie, led by Chicago-based partner Pablo Garcia-Morena, advised the US company on international matters.

Explaining the decision to structure the deal as an asset sale, Edge says: “If we had structured the transaction as a demerger, or otherwise transferred the target business into a company and then undertaken a share sale, we may have encountered problems with minority shareholders or different tax treatment.”

The deal still required the approval of shareholders, but as Edge explains, “once they had approved the disposal, a small number of dissenting minority shareholders would not have been in a position to create problems disproportionate to their shareholdings.”

Cherry picking assets

An added incentive for structuring the deal in this fashion was the flexibility that an asset sale affords. “When you purchase shares you get both assets and liabilities, but in this case you can cherry pick the assets you want,” says Nishchal Joshipura, the head of mergers and acquisitions at Nishith Desai Associates in Mumbai. Joshipura says this model is typically chosen when a large business group wants to combine the business it is acquiring with one of its existing entities.

And that is exactly what Abbott had chosen to do.

The assets that Abbott acquired – a manufacturing facility in Himachal Pradesh and 350 branded generic products, including antibiotics and respiratory, cardiovascular, pain and central nervous system drugs – were destined become part of the company’s new Established Products Division. This standalone business unit focuses on branded generics and aims to maximize opportunities in emerging markets.

Unfavourable tax treatment

From a taxation point of view, the asset sale model provides little benefit. On the contrary, Akil Hirani, the managing partner of Majmudar & Co, says that “an asset purchase deal can actually be more expensive”. The company is required to pay capital gains tax – which can range from 20% to 30% plus surcharge – on the transfer of assets, he adds. However, if the deal had been undertaken as a sale of shares, there would have been no long-term capital gains tax liability.

Similarly, the stamp duty is higher for an asset sale – 3% in Maharashtra, as compared to only 0.25% on the transfer value in a share sale.

The capital gains tax is the seller’s liability, while the stamp duty is borne by the purchaser.

In spite of these drawbacks, asset sales are not unusual. Hirani notes that when Reliance acquired various shale gas assets in 2010, it did so in this manner. Hitachi Metals’ acquisition in May 2003 of Honeywell’s amorphous metals division, Metglas, was also structured as an asset sale. In this case, the sale included all of Metglas’ personnel, plant, equipment and intellectual property rights.

Key challenges

The Abbott-Piramal deal was completed in little more than six months, and Edge, whose involvement began in February 2010, considers this to have been an accelerated timetable for an operation of such magnitude. The issues involved were not necessarily more complex than those on other transactions, but owing to the size of the deal, there were more issues to contend with. “One always thinks twice when the sums involved are so large,” says Edge.

Some of the challenges arose because the transaction was structured as an asset sale. “A large number of contracts had to be novated to the purchasers and individual offers of employment had to be made to every single one of the [5,000] transferring [employees],” says Edge. He adds that it was a “huge undertaking”, but one that was managed efficiently by Piramal’s in-house legal team with assistance from the lawyers at Crawford Bayley.

The company also had to ensure that all of its employees were provided with the benefits to which they were entitled under the Industrial Disputes Act, 1947. “Provident fund, gratuity and superannuation had to be transferred to the fund of Abbott or to the regional provident fund commissioner,” says Madhu Nair, the group president of legal affairs at Piramal.

In addition, Piramal’s lawyers had to arrange the release of security in relation to mortgages and charges created on immovable assets that were transferred to Abbott. According to Nair, they were able to finish this task promptly because of the good relationships the company enjoys with its lenders. Furthermore, “as the other assets which remained with Piramal were enough to cover those loans, it was not a concern for the banks to release those charges,” he said.

Deferred payment

Many of the financial aspects of the deal were particularly interesting. According to the agreement signed on 21 May 2010, only US$2.12 billion was to be paid on the completion of the sale in September 2010. The remaining US$1.6 billion will be paid to Piramal in four annual instalments of US$400 million, starting in 2011. Deferred payment is not unusual in such deals, but Edge notes that the four annual payments to be made by Abbott are not dependent on future profits as the deal did not have an earn-out element.

For Piramal, the deal represents a windfall. “The financial fire power [from the cash received] provides it with vast opportunities, particularly with the debt markets still not as fluid as they were three years ago,” says Edge.

Since the completion of the deal, the Indian company has not been shy about flaunting its new-found wealth. In June, it announced that it would pay a one-time bonus of up to six months’ salary to its employees, including those who moved to Abbott. Then, on 22 October it announced a US$550 million buyback of 20% of its shares at US$13.5 each, a 19% premium over the average share price of the previous three months. The buyback, which some estimate to be the largest buyback in the history of corporate India, will be conducted on a proportionate basis through tender offers and is expected to be completed by February 2011.

In addition, Piramal has said it will contribute US$45 million to charitable funds and other causes.

Restrictive covenants

As part of the deal, Piramal agreed not to engage in the generic drug business in India and emerging markets for the next eight years. According to Edge, “Piramal is allowed to diversify its activities but, consistent with every other business sale, the vendor has entered into restrictive covenants agreeing not to compete for a finite period with the business it has sold.”

Piramal is currently active in glass, real estate and financial services. In 2009-10 it recorded 23% growth with sales of over US$1 billion. According to Ajay Piramal, the company’s chairman, Piramal will be exploring opportunities to make new investments in the near future.

Fears of protectionism

Abbott, too, is bullish about its future. It expects the Indian pharmaceutical market to grow at around 20% a year, and total sales in the sector to hit US$2.5 billion by 2020. But while Nitin Agarwal, a Mumbai-based pharmaceutical sector analyst, describes the acquisition as Abbott’s way of becoming “a larger player in the domestic market,” not everybody is celebrating.

Alarm bells are ringing in the offices of many small pharmaceutical manufacturers, which foresee troubled times ahead. They fear that the rising number and increasing scale of multinational corporations in India’s pharmaceutical sector will drive smaller players out of business.

The Small and Medium Enterprise Pharma Industries Confederation (SPIC), along with other drug industry associations, has already expressed these fears to the government. “With big Indian companies being bought out by MNCs, the market share of six MNCs alone has risen to a whopping 25%,” said the SPIC in a letter to the government. “The amount spent on acquisitions … cannot be recovered in less than 25 years unless prices of medicines are increased.”

Recent media reports indicate that the government is taking these concerns seriously. Officials from the Ministry of Commerce and Industry and the Ministry of Health have reportedly held several rounds of talks on reducing the foreign direct investment cap in the pharmaceuticals sector from 100%, as it is now, to 49%. The discussions are being held at the behest of the Ministry of Finance.

Edge describes the Abbott-Piramal transaction as “an outstanding example of the attractiveness of entrepreneurial Indian businesses to major multinational companies”. But whether more mega-deals can be expected in India’s pharmaceuticals sector will depend to a large extent on the outcome of the government’s deliberations.