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Raghvendra [email protected]

SUBSCRIBE

Issue OpensMay 27, 2008

Issue ClosesMay 30, 2008

Issue PriceRs 40

Bafna Pharmaceuticals

IPO Review

May 27, 2008 Pharmaceuticals

Fact sheet

Pre issue Post issue

Equity capital (Rs cr.) 9.58 15.98Promoters (%) 71.07 42.60

Others (%) 28.94 17.35

Public (%) - 40.05

Issue details Issue size (Rs crore) 25.6

No of shares on offer 64,00,000

Minimum lot size 150 shares

Market cap (post issue) (Rs cr) 63.92

Comparative return metricsStock return (%) 3 M 6M 12M

BDH Industries -15.71 -57.04 -24.36

Celestial Lab 31.41 5.34

Jenburkt Pharma -7.32 -14.97 -32

SyncomFormulation

-16.13 -52.83 -18.54

Bafna Pharmaceuticals is a Chennai-based company engaged inmanufacturing drug formulations. Currently, it sells its products to

domestic institutional clients and unregulated markets. It now plans to

foray into the domestic retail and regulated markets.

Foray into domestic retail and regulated marketsBafna is awaiting approval from the UK MHRA for its newly constructedplant near Chennai. The facility is already EU GMP compliant. With theapproval, the company plans to enter the regulated market of UK, whichoffers better growth and margin prospects. It also plans to enter the retailprescription market, which is margin accretive.

Entry into CRAMS to boost growth outlook

The company intends to enter the CRAMS segment, which would boost itsgrowth outlook. CRAMS offers a better growth outlook due to low-costadvantage in India.

Well diversified therapeutic exposureThe company is well diversified in terms of therapeutic segment exposurewith presence in anti-infective, cardio-vascular, analgesic and antipyretic,antihelmintics, appetite stimulants, cough & cold preparations,antiulcerants, anti diabetic and vitamins.

Concerns The company would be badly impacted if it does not receive approval

from the UK MHRA. Without the approval, it cannot sell its products inthe high-margin UK market and its revenue profile would remainunchanged. It is currently operating on a wafer thin operating marginof 5-8%.

Well established and bigger companies already have a presence in theregulated markets. For a new entrant like Bafna, it may be difficult togain a foothold.

The company intends to enter into the very competitive domestic retailprescription market. We believe this would result in an increase inmarketing expenses and put pressure on the EBIDTA margins.

ValuationsThe annualized EPS for FY08 (on a nine-month profit and post-IPO fullydiluted equity) of Rs 1.08 discounts the offer price of Rs 40 by 37.04x. The

annualized weighted average FY08 EPS (at full year equity of Rs 9.58) of Rs1.82 discounts the issue price by 22x. Though the pricing looks expensive,we believe the company’s foray into the lucrative regulated and domesticretail markets would boost revenue visibility. Meaningful revenue wouldaccrue only from FY10 onwards. Investors with a long-term perspectiveshould subscribe to the issue.

Exhibit 1: Key Financials (Rs crore) Year to March FY05 FY06 FY07 9MFY08

Net Sales 25.30 20.16 36.01 25.38

EBIDTA 2.05 1.83 2.07 2.06

Net Profit after exceptional income 0.89 0.85 0.97 1.29EPS (Rs)(Diluted on current equity) 3.89 2.19 2.51 1.35

Source: Company, ICICIdirect Research

Analyst’s Name

ICICIdirect | Equity Research

Regulated growth …

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Company Background

Bafna Pharmaceuticals was established in 1981 as a proprietaryconcern by Mr Bafna Mahaveer Chand. It started manufacturing

operations in October 1984. The manufacturing operations took offwith a tablets facility and subsequently capsule and oral syrup facilities were added.

So far, the focus of the company has been on institutional sales.Apart from the domestic markets, the company also has presence inthe unregulated international markets such as Ukraine, Sri Lanka,Ghana and Laos. The company has 57 products registered in SriLanka, 4 in Ukraine, 1 in Ghana and 3 in Lao.

The company has two manufacturing facilities near Chennai (one inMadhavaram and another in Grantlyon). The company is now

shifting its focus to the lucrative regulated markets and also theethical retail prescription based domestic markets. It hasconstructed a manufacturing facility in Grantlyon Village, nearChennai to expand its operations to regulated market like US andUK and also to manufacture its own products.

Objects of the issue

• To undertake a brand buildingexercise in the domestic and

international markets

• To part finance the cost of obtainingUK MHRA approval for Grantlyon unit

• To set up a R&D unit at Grantlyon

• To meet its working capitalrequirements

• To partly repay a loan taken from SBI,Chennai

• To meet the public issue expensesand to achieve listing on stockexchanges

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INVESTMENT RATIONALE

Industry structure and outlook During FY1998-2005, the global pharmaceutical industry logged an 11% CAGR.The regulated markets, which make up 88% of the global market, grew at a

robust rate. Banking on its low-cost advantages, the Indian pharma space hassuccessfully projected itself as a preferred outsourcing partner to the big MNCpharma majors. The domestic pharma industry registered a 19% CAGR overFY98-06. Formulations account for 55% in revenue terms of the Indian pharmasector. We believe the growth story will continue as India maintains its costadvantage and abundant skilled staff. India also has among the largest numberof US FDA-approved plants. This would help it capitalize on the large genericsopportunity emerging in the regulated markets in the next few years. Webelieve the persistent advancement in the manufacturing facilities by Indianplayers to enter the regulated markets would further drive the exports.

R&D: The key to success in pharma business

Having recognized the importance of research and development (R&D) for theregulated markets, Bafna plans to focus more on R&D going forward. Out ofthe Rs 25.6 crore it plans to raise from the issue, the company plans to investRs 3 crore on R&D. For the regulated markets, it would manufacture genericdrugs, wherein it would use the reverse engineering for the product, but thetechnology that the company would apply should be non-infringing. R&D teamwould become handy in finding new non-infringing processes for the reverseengineered products. After India became a product patent compliant nation onJan 1, 2005, R&D is becoming a key success ingredient in pharma sector.Moreover, in order to succeed in the formulations export to regulated marketsof US or Europe, which offers higher margins, a company needs to havestrong R&D team developing new processes for existing molecule. Bafna plansenter the contract manufacturing business post the MHRA approval.

Proficient to produce multiple products The company manufactures formulations under various therapeutic segmentssuch as anti-infective, cholesterol lowering agents, analgesic and antipyretic,antihelmintics, appetite stimulants, cough & cold preparations, antiulcerantsanti diabetic and vitamins. The company’s manufacturing facilities are multi-adaptable i.e. the facilities can produce multiple products using a combinationof process. The therapy distribution enables the company to capture thegrowth in any therapeutic segment and ward-off the risk emerging from slowdown in a particular therapy area.

Diversifying into new markets

Bafna plans to enter regulated markets post to this IPO. The foray into newmarkets would enable the company scale a new growth trajectory and also de-risk its existing business. The company intends to diversify into a growingmarket of formulations used in lifestyle disorder segments like diabetic,cardiovascular and also enter growing anti-infective market by launching theproducts and promoting them ethically through brand building exercise inIndia as well as in the international market.

Increased contract manufacturing activities India started recognizing the product patent in 2005, which boosted theconfidence of global pharma companies with strong IP (intellectual property)based products portfolio to outsource manufacturing to India. This opened up

a new line of business for the Indian pharma industry – Contract Research andManufacturing Services (CRAMS). CRAMS has its roots in the outsourcing &off-shoring strategy that is successfully being employed by the developed

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countries. Many large multinational pharmaceutical companies with largediscovery pipeline and proprietary products are expected to be affected bydeclining research productivity and the number of drugs going off-patent. Inorder to maintain their margins and protect their growth momentum, thesecompanies are emphasizing on reducing manufacturing cost. With theobjective of maintaining their margins, these pharma MNCs are likely to keep

the outsourcing thriving in the foreseeable future. Since Bafna has already setup its new factory as per EUGMP guidelines and MHRA officials have made thevisit, we believe the company would bank on the recent outsourcing trend butthe essential ingredient would be MHRA approval of the plant.

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KEY CONCERNS

Pending approvalsOfficials from the UK MHRA visited its plant near Chennai in early 2008 and thecompany expects approval in few months. However, if the approval does not

come in, the revenue profile would remain the same. Currently, the company’soperating margins are wafer thin at 5-8%.

Late entry into the regulated markets Bafna has been late in entering the regulated markets. These markets arehighly regulated and competition is very high.

Very high input cost The operating cost of the company is very high. Revenues may be high in theregulated markets, but expenses are also high. The company is entering intonew markets (domestic retail prescription market and regulated markets),accordingly there will be heavy expenditure to establish its presence in these

markets. The company is expected to breakeven in 18-24 months.

Pressure on EBIDTA marginsThe company intends to enter the retail prescription market, which is highlycompetitive with very large number of players. We believe the rise inmarketing expenses in coming few quarters will put pressure on the EBIDTAmargins.

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FINANCIALS

Bafna Pharma is entering into the lucrative businesses of regulated marketsand retail segments which may generate handsome revenue and marginscould expand substantially. But all depends upon the approval from UK MHRA.

The company is also foraying into the domestic retail segment, which is alucrative segment and offers good margins. But we believe that the companywould take around 15-18 months to break even as the domestic market ishighly competitive with so many players.

The company reported a 19.29% CAGR in top-line over FY05-07. But there wasa de-growth in bottom-line during the same period from Rs 0.48 crore to a lossof Rs 0.33 crore. For the nine-month period ended Dec 31, 2007, the companyreported a net profit of Rs 2.21 crore on sales of Rs 25.38 crore.

The revenue of the company de-grew year-on-year in FY06, but it grew by76.88% in next year (i.e. 2007). The sudden rise was due to increase in sales

from the EoU (export-oriented unit) at Madhavaram. The nine months revenue for the year ending 2008 is roughly maintained at the same level as of theprevious year.

For the full year FY07, the company reported a profit before tax of Rs 1.19crore against Rs. 1.06 crore in FY06. Though the company improved itsperformance, it was not been able to improve its profit margins. The profitsmargins have bounced back to 10.83% in the nine months for year ending2008.

VALUATIONS

The annualized EPS for FY08 (on the basis of nine-month profit and post-IPO fully diluted equity) of Rs 1.08 discounts the offer price of Rs 40 by 37.04xwhile the annualized weighted average FY08 EPS (at full year equity of Rs 9.58)of Rs 1.82 discounts the issue price by 22x. The pricing looks to be on higherside factoring the current financials. The company is foraying into the lucrativeregulated markets and domestic retail segment. We believe the meaningfulrevenue would come from FY10E onwards. Investors with a long-termperspective should subscribe to the issue.

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FINANCIAL SUMMARY

Profit & Loss A/c (Rs crore)

Year to March FY05 FY06 FY07 9MFY08

Net Sales 25.30 20.36 36.01 25.38

Total expenditure 24.57 19.54 36.55 22.63

EBIDTA 0.73 0.82 -0.54 2.75

Other Income 0.91 1.18 1.24 0.20

Interest 0.49 0.50 0.51 0.45

Depreciation 0.17 0.27 0.37 0.26

Profit Before Tax 0.98 1.24 -0.18 2.25

Tax 0.50 0.14 0.15 0.04

Net Profit before Adjustments 0.48 1.10 -0.33 2.21

Adjustments 0.40 -0.25 1.30 -0.91

Net profit as adjusted 0.89 0.85 0.97 1.29

OPM (%) 2.88 4.03 -1.51 10.83

NPM (%) 3.50 4.16 2.69 5.09

Outstanding Shares (Cr) 0.23 0.39 0.39 0.96

EPS (Rs)(Diluted on current equity)

3.89 2.19 2.51 1.35

Balance Sheet (Rs crore)

Year to March FY05 FY06 FY07 9MFY08

Sources of funds

Equity Share Capital 2.28 3.87 3.87 9.58

Advance against share capital 0.30 0.28 2.77 0.00

Reserves & Surplus 1.68 1.54 2.50 2.37

Secured Loans 6.72 11.46 15.85 22.78

Unsecured Loans 0.06 0.00 1.26 1.31

Current liability 5.17 4.05 27.50 23.61

Provisions 0.51 0.16 0.13 0.13

Deferred Tax Liability 0.14 0.11 0.13 0.12

Total Liabilities 16.85 21.46 54.01 59.90

Application of Funds

Net Block 2.16 3.59 2.49 2.35

Capital work in progress 1.47 4.45 23.02 26.52

Investments 0.00 0.00 0.00 0.00

Cash and bank balances 1.16 1.08 1.77 1.36

Inventories 5.85 4.97 6.56 6.76Sundry debtors 4.27 4.96 18.41 20.61

Loans and advances 1.92 2.35 1.72 2.27

Miscellaneous Exp not w/off 0.02 0.06 0.05 0.03

Total Assets 16.85 21.46 54.01 59.90

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ICICIdirect endeavors to provide objective opinions and recommendations. ICICIdirect assigns ratings to its

stocks according to their notional target price vs. current market price and then categorises them asOutperformer, Performer, Hold, and Underperformer. The performance horizon is 2 years unless specified andthe notional target price is defined as the analysts' valuation for a stock.

RATING RATIONALE

Outperformer: 20% or more;Performer: Between 10% and 20%;Hold: +10% return;Underperformer: -10% or more.

Disclaimer

The report and information contained herein is strictly confidential and meant solely for the selected recipient and may not be alteredin any way, transmitted to, copied or distributed, in part or in whole, to any other person or to the media or reproduced in any form,without prior written consent of ICICI Securities Ltd (I-Sec). The author of the report does not hold any investment in any of thecompanies mentioned in this report. I-Sec may be holding a small number of shares/position in the above-referred companies as ondate of release of this report. This report is based on information obtained from public sources and sources believed to be reliable, butno independent verification has been made nor is its accuracy or completeness guaranteed. This report and information herein issolely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell orsubscribe for securities or other financial instruments. Nothing in this report constitutes investment, legal, accounting and tax adviceor a representation that any investment or strategy is suitable or appropriate to your specific circumstances. The securities discussedand opinions expressed in this report may not be suitable for all investors, who must make their own investment decisions, based ontheir own investment objectives, financial positions and needs of specific recipient. This report may not be taken in substitution for theexercise of independent judgment by any recipient. The recipient should independently evaluate the investment risks. I-Sec andaffiliates accept no liabilities for any loss or damage of any kind arising out of the use of this report. Past performance is notnecessarily a guide to future performance. Actual results may differ materially from those set forth in projections. I-Sec may haveissued other reports that are inconsistent with and reach different conclusion from the information presented in this report. This reportis not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of or located in any locality,state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation orwhich would subject I-Sec and affiliates to any registration or licensing requirement within such jurisdiction. The securities describedherein may or may not be eligible for sale in all jurisdictions or to certain category of investors. Persons in whose possession thisdocument may come are required to inform themselves of and to observe such restriction.

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