Mergers

Corporate Bridge E x c e l l i n g b e y o n d e x c e l l e n c e

Dr. Reddy’s Laboratories Acquires Cipla

A Merger Deal Overview

Corporate Bridge Research

Proposed Merger Analysis Consists of • M&A Deal Overview with

Comparisons of Financials and summary.

• Industry Analysis of the Domestic Indian Pharmaceutical Sector with drivers of growth.

• Share Price Comparisons of Dr. Reddy’s and Cipla with peer group industries.

• Share Price Performances of Cipla and Dr. Reddy’s with relevant price-volume charts.

• Deal structures including sources and uses of funds, proposed transaction debt obligations.

• Post merger analysis consisting of accretion/dilution analysis and synergies

• Valuation analysis and relevant synergies

• Credentials


Deal Overview

Purchase Price

Total Deal Size (INR MM) Rs. 3,01,883

Total Deal Size (USD Billion, At 1USD=50INR) 6.04 Implied Price Per share Rs. 375.98 Resulting Ownership of Cipla by Dr. Reddy's Laboratories 100% Transaction fees (INR MM) 1,555.0 Exchange ratio 0.23x Cap Rs. 445.83 Accounting Issues Form Purchase Accounting Consideration 50% Stock & 50% Cash Number of shares issued (MM) 90.93

Proposed Transaction Debt @19% Premium (INR MM) 1,52,504.3 Tax Considerations

Transfer Taxes (INR MM) 0.25% of shares transferred Rs. 377.35 Legal Aspects Share holder Approval

Share holders of Cipla and Dr. Reddy's

Laboratories will have to approve the deal Synergy Value FY12E Revenue Synergies - Cost Synergies 8,025.6 Other Income Synergies 395.6

Less Transaction expenses -1,555.0 Total Synergies 6866.2

Transaction Summary

• Purchase Method of Accounting is considered.

• Dr. Reddy’s will acquire a 100% stake in Cipla thereby Cipla will become a subsidiary of Dr. Reddy’s Laboratories Ltd.

• Cipla Brands will be preserved after the transaction and will continue

• The status of the Human Resource in Cipla is not documented

• Both companies will benefit from the merger, the combined entity will become the largest firm in the Indian Pharma sector.


Indian Domestic Pharma Sector

Industry Analysis

12.6

18.9

55

2009 2012 2020

Projected size of Indian

Pharma Market

USD billion

10 8

5 7

9

18

13

10

17 16.5 15.7

Mean 8

Mean 15

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Historical Growth of the Indian Pharma Market

Percent

8 0.1

3 0.3 0.2

1 12.6

Generics Patented Consumer

Healthcare

Biologics Vaccines Public

health

Total

Market

Size of Individual Segments

USD Billion, 2009

Source Corporate Bridge – India Pharma Domestic Sector review

• The Indian Domestic Sector is fragmented with many small and mid level firms with significant market shares.

• The years 2008 to 2011 has seen many mergers and acquisitions with relatively high valuations for the Indian firms

• Availability of cheap labor, favorable demographics of the Indian population and 100% FDI policy coupled with relatively less stringent government regulations make the sector attractive for investments in the form of M&A


Drivers of Growth

Industry Analysis

23.1%

46.9%

23.8%

68.4%

47.2%

11.8%

29.4%

0 2 4 6 8 10

Mental Health

diabetes

cancer

CardiovascularDiseases

COPD andAsthma

Injuries-deaths

No. ofHospitalizations

Hundreds

2015F

2005

Burden of Diseases in India, Non-Communicable diseases in Lakhs, % change 2005 to2015

61 48

39 31

39 52

61 69

1995 2005E 2015F 2025F

Necessities Discretionary

Share of average Household Income Spent %,In Thousands, INR

60 82 140 248

1,516

1,708

1,940

2,198

2005-06 2006-07 2007-08 2008-09

Expenditure Trends on Healthcare

in India

INR millions

Public Expenditure Private Expenditure

0.84% 0.84%

0.88%

0.93%

2005-06 2006-07 2007-08 2008-09

Government Expenditure on Healthcare

% GDP

Source Corporate Bridge – India Pharma Domestic Sector review

• Presence of strong growth drivers will sustain the Indian domestic Pharma sector with a CAGR of 15%

• In this scenario consolidation and use of economies of scale via mergers is a good strategy to gain strong fundamentals in the rather fragmented Indian Market

• India is also poised to be the R&D hub in the next few years with all major multinationals like Pfizer, Daichii Sankyo, Johnson & Johnson, Merck, Glaxosmithkline and Bayer each having back end manufacturing presence in India.


Cipla

Cipla Key Financials

Income statement INR MM 2011 2012E 2013E

Net Sales 61,303.1 70,498.6 81,073.3

% Growth 15% 15%

Gross Profit 33,832.5 38,774.2 44,590.3

% Growth 15% 15%

EBITDA 14,268.3 18,329.6 21,079.1

% Growth 28% 15%

EBIT 11,747.6 15,580.1 17,743.0

% Growth 33% 14%

Pretax Income 11,645.7 15,054.8 17,145.8

% Growth 29% 14%

Net Income 8,993.5 11,291.1 14,493.6

% Growth 26% 28%

Balance Sheet INR MM 2011 2012E 2013E

Total Current Assets 46,599.3 53,390.4 61,294.0

Total Assets 86,302.4 99,593.1 1,14,773.5

Total Current Liabilities 11,790.9 14,160.8 16,284.9

Total Liabilities 19,641.0 23,246.6 25,539.4

Total Equity 66,661.3 76,346.4 89,234.0

A Brief Description of Cipla

The Chemical, Industrial & Pharmaceutical Laboratories , which came to be known as Cipla, was set up by Late Khwaja Abdul Hamied in 1935.The founder’s son now heads the company.

Cipla Manufactures approximately 5500 pharmaceutical products with over half exported in about 170 countries

Cipla has 8 manufacturing facilities in India, with the latest Indore SEZ plant starting commercial production in 2010

Cipla holds the highest market share in the Indian Domestic Pharma market with 5.72% share

36.8 33.3

29.8 63.1

Promoters Public Institutions Public Non-institutional

Share Holding Pattern Cipla, % of Shares

• Cipla Ltd is a limited Pharmaceutical company listed in India.

• It is a generic player with a strong exports base and a steady income growth over the past few years.

• It holds the largest market share in the fragmented Indian market with a 5.72% share.

Name Position

Y. Hamied Managing Director

M. Hamied Executive Director

S. Radhakrishnan Whole-time Director

Ranjan Pai

Non-Executive Directors

V. Kotwal

H. Manchanda

Pankaj Patel

M. Raghavan

Ramesh Shroff

Company Profile


Cipla Business Overview

Cipla Revenue Break Up

FY12

46.5% 43.0%

10.5%

53.5%

Domestic Exports - Formulations

Exports - APIs & others

Cipla International Business Break Up

FY12

24%

40%

13% 6%

17%

Americas Africa Australasia Middleeast

Europe Total

3,438

4,010

4,961 5,360

6,130

7,050

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

- 4

,00

0.0

8,0

00

.0

FY07 FY08 FY09 FY10 FY11 FY12E

Net Sales EBIT Net Sales Growth Rate

Cipla Historical Growth INR crores

Rs. 4

Rs. 6

Rs. 8

Rs. 10

Rs. 12

Rs. 14

Rs. 16

0%

5%

10%

15%

20%

25%

FY07 FY08 FY09 FY10 FY11 FY12E

RoAE % Net Profit Margin EPS

Cipla Stakeholder Returns

• Cipla has seen positive growth signs for the year 2012.

• It has been expected to grow at a steady rate of 15% in the near future, which is also the industry CAGR.

• Cipla’s export business is slated to grow on the back of a weaker rupee and strong production capacity addition from the Indore SEZ plant.

Company Profile


Dr. Reddy’s Laboratories Company Profile

Dr. Reddy's Laboratories

Income statement 2011 2012E 2013E

Net Sales 72,368.0 93,973.9 1,08,045.0

% Growth 30% 15%

Gross Profit 49,419.0 62,022.8 71,309.7

% Growth 26% 15%

EBITDA 15,950.0 20,538.0 24,029.5

% Growth 29% 17%

EBIT 12,500.0 15,682.5 17,407.6

% Growth 25% 11%

Pretax Income 12,359.0 15,358.5 17,117.7

% Growth 24% 11%

Net Income 10,520.0 12,357.2 13,764.3

% Growth 17% 11% Balance Sheet 2011 2012E 2013E

Total Current Assets 47,517.0 51,877.8 57,705.5

Total Assets 88,650.0 99,202.4 1,11,128.3

Total Current Liabilities 23,628.0 28,124.8 32,718.5

Total Liabilities 48,332.0 48,087.8 47,940.5

Total Equity 71,960.0 76,212.6 80,659.0

A Brief Description of Dr. Reddy’s Laboratories

Dr. Reddy’s Laboratories was started in 1984 by Dr. K Anji Reddy.

Dr. Reddy’s currently has 18 manufacturing facilities with 15 in India, 2 in USA and 1 in Mexico

Dr. Reddy’s ranks second by market share in the Indian Domestic market after Cipla

Dr. Reddy’s is an integrated Pharma company dealing on three segments viz. Pharmaceutical APIs, Global generics and Proprietary Products

Currently employs 15000 people across 25 nations including USA and Russia.

25.61

40.85

16.73

16.81

57.58

Promoters Public Institutions

Public Non-institutional Shares held by Custodians

Share Holding Pattern Dr. Reddy’s, % of Shares

Company Profile

• Dr. Reddy’s is an Indian Pharma manufacturer.

• It is one of the few Indian companies listed in the New York stock exchange.

• Along with Ranbaxy it is a key player in the Global Generic business

• Dr. Reddy’s has had a history of inorganic growth via acquisitions and mergers from it’s inception.

• Dr. Reddy’s Laboratories has been one of the very few firms that has forayed into the high margin patent products, it has a dedicated segment called proprietary products


Dr. Reddy’s Business Profile

17.8%

31.0% 14.9%

21.7%

14.5%

India

North America

Russia and otherCIS countries

Europe

Others

Dr. Reddy's Sales by Geographies FY12 INR MM

Dr. Reddy's Sales by segments FY12

29%

69%

1% 2%

PharmaceuticalServices and

ActiveIngredients

Global Generics ProprietaryProducts

Others Total

6,435

4,914

6,790 6,852 7,237

9,335

-30%

0%

30%

60%

05

00

01

00

00

2007 2008 2009 2010 2011 2012ENet Sales Net Income

Net sales Growth

Dr. Reddy’s Historical Growth INR Lakhs

Rs. 0

Rs. 30

Rs. 60

Rs. 90

0%

5%

10%

15%

20%

25%

2007 2008 2009 2010 2011 2012E

RoACE (%) % PAT Margin EPS (Rs)

Cipla Stakeholder Returns

Company Profile • Dr. Reddy’s Laboratories has

strong growth prospects going into FY12 and has been projected to grow at a CAGR of 16%.

• Although it’s North American and European sales have been volatile, the company has projected strong fundamental growth in various markets like Russia and Asia.

• The proposed merger will make the combined entity one of the big players in Global generics


Share Prices have been steady

Share Price Performances

60

70

80

90

100

110

120

130

140

150

01-Apr-11 01-Aug-11 01-Dec-11 01-Apr-12

Share Price Comparisons Base 100, April 2011 to May 2012

BSE30 Sensex Cipla Dr. Reddy's SUN Pharma Lupin

Cipla announces Q4FY12 results which were lower than analyst expectations

Analyst Reviews CIPLA

1-5 Linear Scale Current

(1) BUY 13

(2) OUTPERFORM 13

(3) HOLD 11

(4) UNDERPERFORM 2

(5) SELL 1

No Opinion 0

Mean Rating 2.12

Source Reuters.com/IndiaMarkets

Analyst Consensus Dr. Reddy's

1-5 Linear Scale Current

(1) BUY 19

(2) OUTPERFORM 11

(3) HOLD 8

(4) UNDERPERFORM 2

(5) SELL 2

No Opinion 0

Mean Rating 1.98

Dr. Reddy’s announces the Launch of Darbepoitein alfa under brand name Cresp

Cipla slashes Anti-cancer drug Nevexar prices by 75%, analysts predict outcome akin to Anti-HIV drug price slashes in 2001

Takeda Pharmaceuticals in preliminary talks with Cipla and Lupin for a possible buy out


Share Price Comparisons

Share Price Comparisons for the last 5 fiscals

-

50.0

100.0

150.0

200.0

250.0

300.0

02-Apr-07 02-Jan-08 02-Oct-08 02-Jul-09 02-Apr-10 02-Jan-11 02-Oct-11

Share Price Comparisons: Cipla & Dr. Reddy's Base 100, April-2007 to May-2012

Cipla Dr. Reddy's mean BSE30 Sensex

Dr. Reddy’s announces strategic partnership with Merck to develop new anti-cancer drugs

Cipla Ltd receives demand notices from the Government for Rs. 424.64 crores for overcharging drugs

Dr. Reddy’s announces Q1FY10 Results PAT growth of 120%, Revenue Growth 21%

Dr. Reddy’s expands portfolio in Russia and CIS countries by in-licensing deals

Rupee Appreciation hurts exports of Indian Pharma companies

Low export demands results in lower than expected income growth

Cipla announces Q4FY10 results exports growth at only 5%

• Dr. Reddy’s has seen more volatility in revenues because of its high proportion of exports of which Europe and North America form a significant share

• Cipla has been insulated since its exports are only 50% of its production but has witnessed lower growth in exports.

• The Pharma industry hurt by the strong rupee of 2007 has posted big gains after 2010.

• On the back of a weaker rupee and gradual demand recovery in the US after Sub-Prime crisis the Pharma sector will post strong growth

Source BSE Website


Price Volume Charts

-

4,000.0

8,000.0

12,000.0

16,000.0

-

100.0

200.0

300.0

400.0

01-Apr-11 01-Aug-11 01-Dec-11 01-Apr-12

Cipla

volumetraded

WAP

-

4,000.0

8,000.0

12,000.0

16,000.0

-

500.0

1,000.0

1,500.0

2,000.0

01-Apr-11 01-Aug-11 01-Dec-11 01-Apr-12

Dr. Reddy’s

Volumetraded

WAP

• Cipla has been more actively traded than Dr. Reddy’s at the BSE since the high price range of Dr. Reddy’s makes it inaccessible for potential investors

• Comparatively both companies have maintained a stable price range over the period analyzed

Share Price Comparisons

Source BSE Website


Dr. Reddy’s vs Cipla Financial Snapshot

Financials in INR millions 2011 2012E 2013E 2014E 2015E

Sales 1,33,671.4 1,63,205.2 1,86,229.4 2,13,276.9 2,45,183.8

Dr. Reddy's Laboratories 72,368.0 93,973.9 1,08,045.0 1,24,108.4 1,43,040.3

Cipla 61,303.4 69,231.2 78,184.4 89,168.5 1,02,143.5

EBITDA 30,218.6 37,358.7 42,585.2 48,750.1 56,023.6

Dr. Reddy's Laboratories 15,950.0 19,358.6 22,257.3 25,566.3 29,466.3

Cipla 14,268.6 18,000.1 20,327.9 23,183.8 26,557.3

EBIT 24,227.1 30,978.4 34,590.0 38,950.9 44,203.9


Cipla 11,727.1 15,295.9 17,182.4 19,537.7 22,339.3

PBT 23,984.2 30,250.0 34,014.4 38,568.2 44,045.5


Cipla 11,625.2 14,891.5 16,896.7 19,383.4 22,311.4

Net Income 19,493.0 23,520.4 26,430.8 29,949.7 34,187.9


Cipla 8,973.0 11,163.3 12,666.5 14,530.9 16,726.3

Relative Multiples 2011 2012E 2013E 2014E 2015E

Ebitda Multiples

Dr. Reddy's Laboratories 16.62x 13.69x 11.91x 10.37x 8.99x

Cipla 17.53x 13.90x 12.31x 10.79x 9.42x

P/E multiples

Dr. Reddy's Laboratories 14.44x 11.97x 10.65x 9.40x 8.23x

Cipla 28.27x 22.72x 20.03x 17.46x 15.17x

• Contribution from Cipla will grow but is forecasted to be lower than Dr. Reddy’ EBITDA margins by 2012.

• P/E multiples suggest Cipla to be slightly overvalued over Dr. Reddy’s

• Dr. Reddy’s growth will be derived mainly from India and North America

• Cipla will hold it’s position as the largest Indian Pharma company by market share in the near future

Financials


Pro forma Income Statement

Income Statement INR MM 2012 2013 2014 2015

Net Sales 1,63,205 1,86,229 2,13,277 2,45,184

Sales Synergies - - - -

% Change 22% 14% 15% 15% Cost of Sales (excluding D&A) 64,421 73,431 84,060 96,601 COGS Synergies (2,245.0) (4,405.9) (5,043.6) (5,796.1) Gross Profit 1,01,029 1,17,204 1,34,260 1,54,379 % Change 24% 16% 15% 15% SG&A Expense 69,338 79,226 90,781 1,04,410 SG&A Synergies (2,416) (4,754) (5,447) (6,265) Other Expense/ (Income) (7,913) (9,013) (10,314) (11,850) Income Synergies (230) (451) (516) (593) EBITDA 42,250 52,195 59,756 68,677 % Change 40% 24% 14% 15% Depreciation 5,670 7,028 8,537 10,219 Amortization 710 967 1,262 1,601 new Amortization 3,838 3,838 3,838 3,838 % sales 2.8% 2.6% 2.4% 2.2% EBIT 32,031 40,362 46,119 53,019 % Change 32% 26% 14% 15% Interest Expense 852 635 418 209 New Interest expense on debt 7,529 12,963 12,963 12,963 Interest Income (124) (60) (36) (50) Pretax Income 23,774 26,823 32,773 39,897 Income Taxes 4,279 4,828 5,899 7,182 Net Income 19,494 21,995 26,874 32,716 % Change 13% 22% 22%

Financial Snap Shot

Sources of Funds INR MM

Excess Cash -

Acquisition Debt Financing

1,52,504.3

Target Debt Assumed

4,191.6

Stock Issued 1,50,949.2

Total 3,07,645.0

Uses INR MM

Transaction Expenses 1,555.0

Purchase of Equity 3,01,898.4

Target Debt Assumed 4,191.6

Total 3,07,645.0

Purchase Price Allocation INR MM

Write Up of Assets -

Addition to Intangibles 25%

Amortization over years 7.0

To Good will 75%

Financing fees 1%

Advisor fees 30.0


The Overall deal will create synergies

Valuations Summary INR Billions

DCF Analysis

350.7 348.2 343.6

389.6

410.7 419.9

Offer Price 376.0

DCF Analysis Comparables Relativevaluations

Valuations Summary INR

Pricing Analysis

Merger rationale

Dr. Reddy's and Cipla

• Use of Cipla's 8 FDA approved manufacturing facilities for increased exports to North America and Europe

• Cipla can benefit from the strong marketing and distribution bases of Dr. Reddy's abroad

• Will be the single largest pharma manufacturer in India by market share which will be ~ 10%

• Combined manufacturing facilities will provide economies of scale improving operating margins

• Due to the size of the firm, it will be easier to secure funds for R&D development in India

Synergy Assumption

Revenue Increase NA

COGS 6%

SG&A Expenses 6%

Other Income 5%

DCF Assumptions

Indian Risk free rate 8.5%

Market Risk Premium 7%

Growth Rate 8%

Beta (Cipla) 0.33

Beta (Dr. Reddy’s) 0.6

Beta (Combined) 0.93

Tax Rate (Dr. Reddy’s) 18%

Debt Interest rate 8.5%

Merger Synergy Analysis

• The valuation gives a positive value for the synergy.

• For an overall synergy of INR 59.7 Billion, the consideration paid at 19% market premium would be INR 48.2 Billion.

• Synergy assumptions are expected to change and we have considered full synergy contribution from FY12.

• A price cap for the DCF valuation is at 20% from par value at INR 389.6

487.6

344.9 892.2 59.7 48.2

Value of Dr.Reddy's

Value of Cipla Value ofCombined

Firm

Synergy Premium Paid


The Acquisition will be Accretive

Accretion/Dilution to Dr. Reddy's Laboratories

FY12

Market Premium

Equity Financing

2% 0% 10% 20% 30% 40% 50%

0% 6.8% 6.8% 6.8% 6.8% 6.8% 6.8%

25% 7.5% 5.6% 3.7% 2.0% 0.2% -1.5%

50% 8.0% 4.8% 1.8% -1.1% -3.8% -6.4%

75% 8.4% 4.2% 0.4% -3.2% -6.6% -9.7%

100% 8.7% 3.8% -0.7% -4.8% -8.5% -12.0%

73.72 75.01 75.90 76.55 77.05

68.74 65.75 63.77 62.35

-

50.00

0% 25% 50% 75% 100%

Equity Financing

0% Market Premium 50% Market Premium EPS Analysis of combined firm INR

FY12

Market Premium

#REF! 0% 10% 20% 30% 40% 50%

Equity Financing

0%

73.72

73.72 73.72

73.72

73.72

73.72

25%

75.01

73.66 72.37

71.11

69.91

68.74

50%

75.90

73.63 71.49

69.47

67.56

65.75

75%

76.55

73.60 70.87

68.33

65.97

63.77

100%

77.05

73.58 70.41

67.50

64.82

62.35

6.8% 7.5% 8.0% 8.4% 8.7%

-1.5%

-6.4%

-9.7%

-12.0%

3.7% 1.8%

0.4%

-0.7%

0% 25% 50% 75% 100%

Mar

ket

Pre

miu

m

Equity Financing

0% market premium 50% market premium 20% market premium

Accretion/Dilution Analysis


Break Even Synergies

Break even Synergies for EPS neutral transaction INR MM

2012E 4,411.0

2013E 8,732.8

2014E 7,297.8

2015E 5,671.1

Synergy Analysis

P/E Analysis of Dr. Reddy's Laboratories after merger

FY12 in INR

Market Premium

Equity Financing

23.154 0% 10% 20% 30% 40% 50%

0% 22.52x 22.52x 22.52x 22.52x 22.52x 22.52x

25% 22.13x 22.53x 22.94x 23.34x 23.75x 24.15x

50% 21.87x 22.55x 23.22x 23.90x 24.57x 25.25x

75% 21.68x 22.55x 23.42x 24.29x 25.16x 26.03x

100% 21.54x 22.56x 23.58x 24.59x 25.61x 26.63x

Synergies from

• 8 FDA approved manufacturing facilities of Cipla combined with 18 of Dr. Reddy’s

• Lowering of material costs and overall manufacturing costs since these make up a considerable percentage of COGS

• Better position on Patent and intellectual rights protection of the product portfolio

• Market penetration with Cipla’s range of Anti-retrovirals and Anti cancer drugs

• Strong R&D prospects of the combined entity

Top Brands

Dr. Reddy’s Cipla

Omez Asthal

Stamlo Seroflo

Ketorol Viraday

Reditux Ciplox

Nise Norflox

Exifine Novamox

Cetrine

Triomune

• Without the consideration of synergies the transaction becomes dilutive and the break even synergies have been computed

• Cipla and Dr. Reddy’s do not possess significantly overlapping product portfolios

• The Combined entity will benefit from a relatively broad range portfolio


Corporate Bridge Research Consultants

Credentials

Corporate Bridge Academy B WING, 104, MANGALAYA, OFF MAROL MAROSHI ROAD, BEHIND SANGEET PLAZA, ANDHERI EAST, MUMBAI - 400 059 (MH)

Merger Analysis Completed on 8th June 2012 Analyst:- Amit Nayak IMT, Ghaziabad Under the able guidance of Project Guide: Dheeraj Vaidya Director, Corporate Bridge Research Consultants

Mergers

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