Has Aurobindo Formulated The Right Prescription?

STRATEGY
Has Aurobindo Formulated The Right Prescription?

Cash-rich CEO R. Reddy may be, but creating brand equity in competitive formulation-segments now will be tough.

By M.P. Vinod Kumar

Ramaprasad Reddy, CEO, Aurobindo Pharma: "I am confident that formulations will drive our future" It must be the 13-year itch. What else would you expect from the sole glass-and-granite pharma company in a lane chock-a-block with software firms in dull concrete buildings? The world over, pharma companies that want to move up the value chain begin by producing bulk drugs, and quickly progress to formulations before eventually trying their hands at molecular research. Not, though, the Hyderabad-based Aurobindo Pharma.

For the first 13 years of its existence, the Rs 550-crore company steadfastly stuck to producing semi-synthetic penicillins. And thrived. In the last 5 years, Aurobindo Pharma's turnover has grown by an average of 71 per cent per annum, and its post-tax profits by 79 per cent. What's more, it has become the biggest local player in that market, with a 35 per cent share. So, Aurobindo Pharma has decided that bulk drugs will stay its focus forever, right? Wrong.

After all these years, CEO Ramaprasad Reddy, 42, is, suddenly, having second thoughts. His new brainwave: take a short-cut instead of the highway that the majors have so far trodden. So, he is now jumping into formulations in a big way, planning an investment of Rs 60 crore in the next 2 years. Says the cash-rich Reddy: ''We have a few exciting plans up our sleeves. If they click, we will soon be in a different league altogether.''

As a first step, in November, 1998, Aurobindo Pharma commissioned a 240 tonnes per annum (tpa) unit to make oral cephalosporins, and set up a line in March, 1999, to make sterile cephalosporins too. By December, 1999, Reddy plans to set up 2 more units (investment: Rs 25 crore) to manufacture cephalosporin formulations as well as other antibiotics for the anti-inflammatory and anti-ulcerants segments. Explains Ajaya Kumar, 53, Director, Aurobindo Pharma: ''We intend to increase both the depth and the breadth of our range.'' Adds Reddy: ''I am confident that formulations will drive our future.''

In theory, a logical transition. In Aurobindo Pharma's case, a trifle belated. For, the formulations business is bursting apart: every global manufacturer worth its molecule is preparing to target the post-2005 Indian market. That's when the GOI will introduce a product patents regime as per its commitments to the World Trade Organisation. Given this scenario, it is hardly surprising that eyebrows are receding into hairlines.

Asks Sailesh Raj Bhan, 31, a pharma sector analyst at the Mumbai-based Shah & Sequeira (S&S): ''Isn't Aurobindo Pharma's renewed thrust on formulations coming a bit late in the day?'' He's right; the majors made their moves 5 years ago. To put things in perspective, however, Reddy too has been eyeing the market for a while. He first flirted with antibiotics in a small way in 1994, when he raised Rs 18 crore through a bought-out deal with 3 companies in the Videocon Group.

That was the year he acquired Chaitanya Organics to manufacture ciprofloxacin. Explains Reddy: ''We wanted to use semi-synthetic penicillin as a launch-pad to enter other (antibiotics and formulations) markets even at that stage.'' His gameplan didn't work because a shakeout in the bulk drugs business in 1996 presented Reddy with an opportunity to consolidate himself. ''We went and grabbed an extra share of the penicillin market instead,'' he points out. As a result, the push into formulations-which, in 1998-99, constituted just 8 per cent of Aurobindo Pharmas' turnover-was relegated to the sidelines.

No longer. Although the company's net margins have grown from 5.51 per cent in 1996-97 to 8.75 per cent in 1998-99, the bulk drugs market is, increasingly, becoming a low-margins, high-volumes game. When the market grows, that isn't a problem. But when it slows, players like Aurobindo Pharma must rethink their paradigms. According to the Mumbai-based Probity Research, the growth-rate of the domestic bulk semi-synthetic penicillin market will range between 5 and 10 per cent in the next 3 years versus the 3-year average of 67 per cent. Reddy, obviously, has no choice but to formulate a fresh formulations strategy.

Agrees Ravi Sankar, 31, Manager, Investment Information & Credit Rating Agency (IICRA): ''Aurobindo Pharma has to move into related therapeutic segments if it wants to maintain its growth-rates.'' One option would have been to increase exports-in 1998-99, they accounted for 39 per cent of the company's turnover-but the global market isn't hot. As estimates by DSM Group-the world leader in semi-synthetic penicillin-indicate, the antibiotics segment (global pharma share: 11 per cent) will only grow by 5 per cent every year. What's worse, competition will only become stiffer in future.

Moreover, Aurobindo Pharma does not have a grand design to become a global bulk drugs player. Admits Reddy: ''Our projections do not justify the massive investments that are required to become a global player.'' So, he has decided to write out a new local prescription for himself. ''We have decided to go in for a private placement to fund our future plans,'' reveals A.J. Kamath, 41, Director (Finance), Aurobindo Pharma. Not surprisingly, investment bankers from Mumbai have been flocking to the its Ameerpet headquarters in recent weeks.

Actually, money isn't the issue for Aurobindo Pharma. With reserves of Rs 106.28 crore as of March 31, 1999, a debt-equity ratio of 0.89:1, and an equity-base of just Rs 9.45 crore, Reddy can easily raise money through internal accruals, fresh equity, or even loans. Borrowings will be a distant third option although Aurobindo Pharma's loans have zoomed from Rs 32.09 crore in 1995-96 to Rs 110.96 crore in 1998-99, which has, obviously, increased its interest burden from Rs 4.12 crore to Rs 17.10 crore in the same period of time.

Nor will money guarantee Reddy success. Formulations are quite different from bulk drugs; it's high-margin brands, not volumes, that generate money in that market. Aurobindo Pharma has hardly any, and the ones it does have meagre marketshares. One example: Aurobindo Pharma's Zmox (ampicillin; marketshare: does not figure in the ORG Market Survey) lags behind Cipla's Novamox (6.50 per cent) and Rexcel Pharma's Mox (6.50 per cent). So, Reddy wants to acquire brands. Agrees S&S' Bhan: ''Instead of growing its own brands now, Aurobindo Pharma should focus on acquiring them.''

According to Reddy, such brands will make inroads domestically while the 4 subsidiaries he is setting up in Brazil, Hong Kong, Thailand, and the US will boost Aurobindo Pharma's exports of bulk drugs. In addition, the company will invest Rs 15 crore to secure regulatory approvals for the developed markets, and develop new drug-delivery systems. Still, he is starting from scratch. Says V.C.S. Reddy, 35, the General Manager (Marketing) of the Rs 58.32-crore Neuland Laboratories, a bulk drugs-manufacturer that has consciously steered clear of formulations: ''That market is a different game altogether. The learning curve is quite steep, especially for a bulk drugs producer, who has to build the infrastructure and acquire marketing skills to succeed there.''

Reddy realises that. Which is why he is trying to consolidate his core business too. On the cards is a backward integration into the manufacture of Penicillin-G, a raw material for making semi-synthetic penicillin. While he admits that he has received several feelers from potential takeover targets in that sector, a deal has not worked out because, according to Reddy, ''the price was too high.'' If Aurobindo Pharma does manage to buy a Penicillin-G unit, Reddy will be able to consolidate his stranglehold over the penicillins segment.

For, the company-which has a capacity of 1,800 tpa to produce the entire range of semi-synthetic penicillins, including ampicillin, amoxycillin, cloxacillin, and dicloxacillin-will derive additional cost-advantages in the process. Agrees IICRA's Sankar: ''Aurobindo Pharma is cost-competitive because of its lower capital costs and in-house manufacture of drug intermediates such as dane salts and isoxazoles.'' Even the stockmarket recognises its strengths, with the scrip zooming from Rs 190-the price at which the stock was offloaded by the Videocon Group in January, 1995-to Rs 489 on May 31, 1999.

While Aurobindo Pharma's decision to revive its formulations thrust may work, it will, however, be tricky. Apart from investments in brand-building, the company will require marketing acumen too. And Reddy's ability to graduate from a low-cost producer to a suave marketer is unproven, especially in the crowded formulations market. In the ultimate analysis, Aurobindo Pharma may end up realising that bulk drugs may, after all, have been the right formulation for its survival in the next century.

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