A new sun rises on Shanghvi's profit strategy

MUMBAI: Dilip Shanghvi, the chairman and managing director of Sun Pharmaceuticals, has little in common with Yogi Berra. He probably doesn’t know enough about this famous American baseball star who played for New York Yankees alongside the legendary Joe DiMaggio, and was famous for his quirky quotes and punishing home runs.

But Mr Shanghvi would perhaps find himself nodding sympathetically at one of the quotes of this maverick Yankee—”This feels like deja vu all over again.” It aptly describes the position that Shanghvi and his Mumbai-based firm find themselves in.

Over the past few weeks, Sun Pharma has been struggling to gain control of Taro Pharmaceuticals, in a battle that is eerily reminiscent of a similar episode many years ago. In 1997, Shanghvi engineered the purchase of a stake in Detroit-based Caraco Pharma in one of India Inc’s major moves in the North American continent.

At a time when many Indian pharma companies had not even thought of America as a major market, Sun bought a partial stake in the company. But the story quickly turned sour. The US Food and Drug Administration withdrew registration for Caraco’s plant and the firm suffered big losses.

Sun, which agreed to supply products to Caraco in return for additional shares in the company, then had a run-in with some major shareholders and independent board members, who opposed the Indian company’s contract. What was once considered a pioneering move quickly descended into a battle of attrition. Sun was forced to pay a high price to gain full control.

The Taro move has not become as messy as that of Caraco. But it has one major common ingredient. Disgruntled but powerful minority shareholders willing to play the waiting game in order to secure their interests.

On Monday, the shareholders of Taro will vote on Sun’s acquisition proposal in Tel Aviv, the capital of Israel. A few hours after the start of Taro’s meet, the board of Sun Pharmaceuticals will meet in Mumbai to consider and discuss the first quarter results. Mr Shanghvi will chair the meet which will be attended by his trusted lieutenants, Sudhir Valia, Sailesh Prasad and independent non-executive directors Keki Mistry and Ashwin Dani.

Mr Shanghvi has already hatched a plan to thwart the ambitions of the minority shareholders. Sun is considering using the option to buy an additional 14% stake held by the promoters of Taro Pharma, in addition to the 18% stake it bought earlier in order to gain complete control.

Taro Pharma’s promoters, who own this 14% stake, have a contractual obligation to sell their shares to Sun Pharma if the latter wishes to exercise this option. Since promoters shares, referred as founders shares, carry a 33% voting right, this would immediately give Sun Pharma an effective 51% stake.

“We will improve the company’s cost structure, the productivity of its R&D, the efficiency of sourcing and manufacturing and the company’s product mix,” Mr Shanghvi told ET, confident of his deal going through. He has enough reasons to feel that way. Sun Pharma’s rapid growth and its success in the domestic and global markets is in many ways a reflection of his thinking approach and planning.

Cut back to 1982, Calcutta. As a young C&F agent for the pharma industry, Shanghvi was growing restless. Business was good, even in those days of licence raj and stifling price controls. But the young agent was bored. His job involved trading, buying drugs in bulk from the pharma companies and selling it to the pharma retailers. Cushy job but no major excitement.

“I wasn’t built to be a trader,” Mr Shanghvi says. He moved out to set up his own firm, Sun Pharmaceuticals. As a commerce graduate from a Calcutta college, his knowledge of the industry was limited but that did not stop him. He started reading, gathering information from every publication and book in the world. He read every research paper, news report about developments in the pharma industry. His wife, a pharmacist, was a great source of help.

In those days, the domestic pharma industry was a frightening place for a young entrepreneur. Fragmented, beset by low margins and stifled by severe price controls. Company executives spent more time in the corridors of power in Delhi, lobbying with bureaucrats than in trying to understand the market. Corruption was rampant and profits poor. Multinationals were in an even worse shape.

Dilip Shanghvi, who surveyed this scenario, quickly made up his mind about what he had to do. He decided that in order to survive and grow, he will have to focus his entire energies on making more money than others. Some promoters have a weakness for topline growth; others for market cap. They would spend their entire energies on boasting about their sprint in sales or their huge valuations. Mr Shanghvi had no such illusions. He realised that profit growth was the only way to succeed in this business.

But achieving high profit is also not easy, especially in a market where government control is all pervasive. The only way to do this is through niche marketing. Sun Pharma set out to identify categories, segments where competition is limited, where brand or product loyalty is high and where margins are higher. Mr Shanghvi personally sifted through the list before selecting gynaecology, cardiovascular and psychiatry. Today, Sun Pharma is not just a successful pharma company but also the one with the highest margins.

At 37% of net sales, Dr. Reddy’s Lab’s operating margin in 2006-07 comes closest to Sun’s 44%. Cipla is at about third of that, and Ranbaxy’s is even lower. Ranbaxy, Cipla and Dr Reddy’s are often mentioned in the same breath as pioneers of India’s pharma revolution and while they deserve the accolades, Sun Pharma’s performance has been equally praiseworthy.

For the four years ended March 2007, Sun grew its sales by a compounded annual growth rate (CAGR) of 16.23%, higher than Ranbaxy. Cipla and Dr Reddy’s growth rates were marginally higher. Sun’s net profit has grown by 22.14% compared with a rise of 21.63% for Cipla and a drop of 9.13% for Ranbaxy. Sun’s market cap has vaulted more than eight times during this period, making it the country’s most valuable pharma company.

“He is shrewd, smart and loves the business with a passion,” says Jacob Mathew, head of MAPE Advisory Group, a boutique investment banking firm and brokerage firm.

In acquisitions, a very similar philosophy has been played out. Ranbaxy, Dr Reddy’s are often perceived to be aggressive in buyouts. Sun has also been active though it has managed to maintain a low profile. In the past 10 years, it has bought out several domestic and overseas companies. But the purchases have also been carefully calibrated and designed to secure the maximum possible at the lowest possible price.

“We wait for the right buy at the right price,” says Mr Shanghvi, who has likened his strategy to his colleagues to that of a `bottom-hunting fish’. For instance, the Taro Pharma acquisition is only about 1.5 times sales compared with the Betapharm purchase where Dr Reddy paid three times sales and the Terapia buyout where Ranbaxy paid more than four times sales. “We go in for complex products which are difficult to make and where competition is limited,” Mr Shanghvi says.

Sun’s purchase of a Hungarian plant from Valient is illustrates this strategy as it is one of the few in the world to make controlled substances. Able Labs, whose assets were bought by Sun some years ago, makes drugs to treat urinary tract infections and narcotic-based painkillers.

“Sun Pharma is the Rolls Royce of Indian pharma industry. Mr Shanghvi is absolutely focused on profit and growth. He knows his onions and the clarity of mind is amazing. He is not the guy who will waste his time with small things,” says Rajeev Gupta, managing director, Carlyle, the US buyout specialist.

Mr Shanghvi has been variously described as focused, sharp and a no-nonsense kind of a guy. In meetings, he fixed his listeners with a steady, intent gaze. His answers, delivered softly, reveal the working of his mind, while his questions are probing and pointed. The listeners, industrialists to bankers to bureaucrats, usually come away impressed.

His approach and style of functioning has also been criticised. For instance, it is said that he is a control freak, involves himself in everything whether it is product selection or marketing. A leading south-based drug maker described Mr Shanghvi as a banyan tree. Nothing grows under him, he is believed to have said.

To some extent, the criticism is true. Decisions in Sun Pharma are taken by Mr Shanghvi and a team of two senior directors, brother-in-law, Sudhir V Valia, and Sailesh T Desai. Other independent directors are also involved but the core decision making is done by this trio. “I cannot decide on things if I don’t understand how it works,” he defends himself.

Mr Shanghvi is not known to be a social animal. “I don’t known if people like me are ever satisfied,” he says with the air of a man who lives and breathes his work every day. He has seldom been spotted in parties preferring to spend his time at work or meeting people related to his job. Though intensely low profile, he can some times display sound public relations skills such as asking industry veteran Dr Anji Reddy to give some advice to his young son.

Despite his hectic schedule, there is one routine he does not miss. Getting out on Sunday mornings for a bite of tasty masala dosa in one of the south Indian restaurants in Dadar-Matunga area of Mumbai. This is perhaps one low-priced acquisition that will not get Mr Shanghvi into any trouble.