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Dr. Reddys Laboratories Acquires Cipla

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. Reddys and Cipla with peer group industries. Share Price Performances of Cipla and Dr. Reddys 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

A Merger Deal Overview

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Transaction Summary
Purchase Method of Accounting is considered. Dr. Reddys will acquire a 100% stake in Cipla thereby Cipla will become a subsidiary of Dr. Reddys 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.

Deal Overview
Purchase Price Total Deal Size (INR MM) Total Deal Size (USD Billion, At 1USD=50INR) Implied Price Per share Resulting Ownership of Cipla by Dr. Reddy's Laboratories Transaction fees (INR MM) Exchange ratio Cap Accounting Issues Form Consideration Number of shares issued (MM) Proposed Transaction Debt @19% Premium (INR MM) Tax Considerations Transfer Taxes (INR MM) 0.25% of shares transferred Rs. 377.35 Rs. 3,01,883 6.04 Rs. 375.98 100% 1,555.0 0.23x Rs. 445.83

Purchase Accounting 50% Stock & 50% Cash 90.93

1,52,504.3

Legal Aspects Share holder Approval Synergy Value FY12E Revenue Synergies Cost Synergies Other Income Synergies Less Transaction expenses Total Synergies

Share holders of Cipla and Dr. Reddy's Laboratories will have to approve the deal 8,025.6 395.6 -1,555.0 6866.2

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Industry Analysis
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

Indian Domestic Pharma Sector

Projected size of Indian Pharma Market USD billion 55 Size of Individual Segments USD Billion, 2009 1 3 0.3 0.2 12.6

18.9 12.6 2009 2012 2020

0.1

Generics

Patented

Consumer Biologics Healthcare

Vaccines

Public health

Total Market

Historical Growth of the Indian Pharma Market Percent Mean 15

Mean 8
18 13 10 8 5 7 9 10 17 16.5 15.7

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Source Corporate Bridge India Pharma Domestic Sector review

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Industry Analysis
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.

Drivers of Growth
Burden of Diseases in India, Non-Communicable diseases in Lakhs, % change 2005 to2015
No. of Hospitalizations Injuries-deaths COPD and Asthma Cardiovascular Diseases cancer diabetes Mental Health
0 2 4 6

Share of average Household Income Spent

%,In Thousands, INR 60 39 82 140 248

29.4% 11.8%

2015F 2005

52

61

69

47.2% 68.4% 23.8%

61

48

39

31 2025F

1995 46.9%

2005E

2015F

Necessities

Discretionary

23.1%
8 10

Expenditure Trends on Healthcare in India 2,198 INR millions

1,940 1,708

Hundreds Government Expenditure on Healthcare % GDP

1,516

0.93% 0.88% 0.84% 0.84% 2005-06 2005-06 2006-07 2007-08 2008-09 2006-07 2007-08 2008-09

Public Expenditure

Private Expenditure

Source Corporate Bridge India Pharma Domestic Sector review

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Company Profile
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.

Cipla
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 founders 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 Key Financials Income statement INR MM Net Sales % Growth Gross Profit % Growth EBITDA % Growth EBIT % Growth Pretax Income % Growth Net Income % Growth Balance Sheet INR MM Total Current Assets Total Assets Total Current Liabilities 2011 61,303.1 33,832.5 14,268.3 11,747.6 11,645.7 8,993.5 2011 46,599.3 86,302.4 11,790.9 19,641.0 66,661.3 2012E 70,498.6 15% 38,774.2 15% 18,329.6 28% 15,580.1 33% 15,054.8 29% 11,291.1 26% 2012E 53,390.4 99,593.1 14,160.8 23,246.6 76,346.4 2013E 81,073.3 15% 44,590.3 15% 21,079.1 15% 17,743.0 14% 17,145.8 14% 14,493.6 28% 2013E 61,294.0 1,14,773.5 16,284.9 25,539.4 89,234.0

Cipla holds the highest market share in the Indian Domestic Pharma market with 5.72% share Name
Y. Hamied M. Hamied S. Radhakrishnan Ranjan Pai V. Kotwal H. Manchanda Pankaj Patel M. Raghavan Ramesh Shroff
Promoters Public Institutions Public Non-institutional

Position
Managing Director Executive Director Whole-time Director

Share Holding Pattern Cipla, % of Shares

36.8
Non-Executive Directors

63.1

33.3 29.8

Total Liabilities Total Equity

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Company Profile
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. Ciplas export business is slated to grow on the back of a weaker rupee and strong production capacity addition from the Indore SEZ plant.

Cipla Business Overview

Cipla Revenue Break Up FY12 Cipla International Business Break Up FY12
17% 6%

43.0% 46.5% 53.5%

40%

13%

10.5%
24%

Domestic Exports - APIs & others

Exports - Formulations
Americas Africa Australasia Middle east Europe Total

Cipla Historical Growth INR crores

8,000.0

Cipla Stakeholder Returns

7,050 6,130 50.0% 25% 20% 15% Rs. 10 20.0% 10% Rs. 8 5% 0% FY07 FY08 FY09 FY10 FY11 FY12E RoAE % Net Profit Margin EPS Rs. 6 Rs. 4 Rs. 16 Rs. 14 Rs. 12 30.0%

40.0%

4,961
4,000.0

5,360

4,010 3,438

10.0%

0.0% FY07 FY08 FY09 FY10 FY11 FY12E

Net Sales

EBIT

Net Sales Growth Rate

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Company Profile
Dr. Reddys 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. Reddys has had a history of inorganic growth via acquisitions and mergers from its inception. Dr. Reddys 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. Reddys Laboratories Company Profile

A Brief Description of Dr. Reddys Laboratories
Dr. Reddys Laboratories was started in 1984 by Dr. K Anji Reddy. Dr. Reddys currently has 18 manufacturing facilities with 15 in India, 2 in USA and 1 in Mexico Dr. Reddys ranks second by market share in the Indian Domestic market after Cipla

Dr. Reddy's Laboratories

Income statement Net Sales % Growth Gross Profit % Growth EBITDA % Growth EBIT % Growth Pretax Income % Growth Net Income % Growth Balance Sheet 10,520.0 2011 47,517.0 88,650.0 23,628.0 48,332.0 71,960.0 12,359.0 12,500.0 15,950.0 49,419.0 2011 72,368.0 2012E 93,973.9 30% 62,022.8 26% 20,538.0 29% 15,682.5 25% 15,358.5 24% 12,357.2 17% 2012E 51,877.8 99,202.4 28,124.8 48,087.8 76,212.6 2013E 1,08,045.0 15% 71,309.7 15% 24,029.5 17% 17,407.6 11% 17,117.7 11% 13,764.3 11% 2013E 57,705.5 1,11,128.3 32,718.5 47,940.5 80,659.0

Dr. Reddys 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.

Share Holding Pattern Dr. Reddys, % of Shares

16.81 57.58 25.61

Total Current Assets 40.85 Total Assets Total Current Liabilities Total Liabilities

16.73
Promoters Public Non-institutional Public Institutions Shares held by Custodians

Total Equity

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Dr. Reddys Laboratories has strong growth prospects going into FY12 and has been projected to grow at a CAGR of 16%. Although its 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

Company Profile

Dr. Reddys Business Profile

Dr. Reddy's Sales by Geographies FY12 INR MM Dr. Reddy's Sales by segments FY12
69%
India

1%

2%

14.5% 17.8% 21.7% 31.0% 14.9%

North America Russia and other CIS countries Europe Others

Pharmaceutical Global Generics Services and Active Ingredients Proprietary Products Others Total

29%

Dr. Reddys Historical Growth INR Lakhs

10000

Cipla Stakeholder Returns

25% Rs. 90

9,335 6,790 4,914 6,852 7,237

60%

20%
30%

6,435
5000

Rs. 60 15% 10% Rs. 30 5%

0%

-30%

2007

2008
Net Sales

2009

2010

2011
Net Income

2012E

0% 2007 2008 2009 2010 2011 2012E RoACE (%) % PAT Margin

Rs. 0 EPS (Rs)

Net sales Growth

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Share Price Performances

Share Prices have been steady

Analyst Reviews 1-5 Linear Scale
(1) BUY (2) OUTPERFORM (3) HOLD (4) UNDERPERFORM (5) SELL No Opinion Mean Rating

CIPLA Current
13 13 11 2 1 0 2.12

Share Price Comparisons

Base 100, April 2011 to May 2012
150 140 130 120 110 100 90 80 70 60 01-Apr-11
Takeda Pharmaceuticals in preliminary talks with Cipla and Lupin for a possible buy out Cipla announces Q4FY12 results which were lower than analyst expectations Dr. Reddys 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

Source Reuters.com/IndiaMarkets Analyst Consensus 1-5 Linear Scale

(1) BUY (2) OUTPERFORM (3) HOLD (4) UNDERPERFORM (5) SELL No Opinion Mean Rating

Dr. Reddy's Current

19 11 8 2 2 0 1.98

01-Aug-11 BSE30 Sensex Cipla

01-Dec-11 Dr. Reddy's SUN Pharma

01-Apr-12 Lupin

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Share Price Comparisons for the last 5 fiscals

Dr. Reddys 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 SubPrime crisis the Pharma sector will post strong growth

Share Price Comparisons

Share Price Comparisons: Cipla & Dr. Reddy's
Base 100, April-2007 to May-2012
300.0
Dr. Reddys expands portfolio in Russia and CIS countries by inlicensing deals Dr. Reddys announces Q1FY10 Results PAT growth of 120%, Revenue Growth 21% Dr. Reddys announces strategic partnership with Merck to develop new anti-cancer drugs

250.0

200.0
Low export demands results in lower than expected income growth

150.0

100.0
Cipla Ltd receives demand notices from the Government for Rs. 424.64 crores for overcharging drugs

50.0

Rupee Appreciation hurts exports of Indian Pharma companies

Cipla announces Q4FY10 results exports growth at only 5%

02-Apr-07

02-Jan-08 Cipla

02-Oct-08

02-Jul-09

02-Apr-10 mean

02-Jan-11

02-Oct-11

Dr. Reddy's

BSE30 Sensex

Source BSE Website

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Share Price Comparisons

Cipla has been more actively traded than Dr. Reddys at the BSE since the high price range of Dr. Reddys makes it inaccessible for potential investors Comparatively both companies have maintained a stable price range over the period analyzed

Price Volume Charts

400.0 300.0 200.0 100.0 01-Apr-11 16,000.0 12,000.0

Cipla

8,000.0 4,000.0 volume traded WAP

01-Aug-11

01-Dec-11

01-Apr-12

2,000.0 1,500.0 1,000.0 500.0 01-Apr-11

16,000.0 12,000.0

Dr. Reddys

8,000.0 4,000.0 Volume traded WAP

01-Aug-11

01-Dec-11

01-Apr-12

Source BSE Website

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Financials
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. Reddys Dr. Reddys growth will be derived mainly from India and North America Cipla will hold its position as the largest Indian Pharma company by market share in the near future

Dr. Reddys vs Cipla Financial Snapshot

Financials in INR millions
Sales Dr. Reddy's Laboratories Cipla EBITDA Dr. Reddy's Laboratories Cipla EBIT Dr. Reddy's Laboratories Cipla PBT Dr. Reddy's Laboratories Cipla Net Income Dr. Reddy's Laboratories Cipla

2011
1,33,671.4 72,368.0 61,303.4 30,218.6 15,950.0 14,268.6 24,227.1 12,500.0 11,727.1 23,984.2 12,359.0 11,625.2 19,493.0 10,520.0 8,973.0

2012E
1,63,205.2 93,973.9 69,231.2 37,358.7 19,358.6 18,000.1 30,978.4 15,682.5 15,295.9 30,250.0 15,358.5 14,891.5 23,520.4 12,357.2 11,163.3

2013E
1,86,229.4 1,08,045.0 78,184.4 42,585.2 22,257.3 20,327.9 34,590.0 17,407.6 17,182.4 34,014.4 17,117.7 16,896.7 26,430.8 13,764.3 12,666.5

2014E
2,13,276.9 1,24,108.4 89,168.5 48,750.1 25,566.3 23,183.8 38,950.9 19,413.2 19,537.7 38,568.2 19,184.8 19,383.4 29,949.7 15,418.8 14,530.9

2015E
2,45,183.8 1,43,040.3 1,02,143.5 56,023.6 29,466.3 26,557.3 44,203.9 21,864.6 22,339.3 44,045.5 21,734.1 22,311.4 34,187.9 17,461.5 16,726.3

Relative Multiples
Ebitda Multiples Dr. Reddy's Laboratories Cipla P/E multiples Dr. Reddy's Laboratories Cipla

2011
16.62x 17.53x 14.44x 28.27x

2012E
13.69x 13.90x 11.97x 22.72x

2013E
11.91x 12.31x 10.65x 20.03x

2014E
10.37x 10.79x 9.40x 17.46x

2015E
8.99x 9.42x 8.23x 15.17x

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Financial Snap Shot

Pro forma Income Statement

Sources of Funds INR MM
Excess Cash Acquisition Debt Financing Target Debt Assumed Stock Issued Total 1,52,504.3 4,191.6 1,50,949.2 3,07,645.0

Uses INR MM
Transaction Expenses Purchase of Equity Target Debt Assumed Total 1,555.0 3,01,898.4 4,191.6 3,07,645.0

Purchase Price Allocation INR MM

Write Up of Assets Addition to Intangibles Amortization over years To Good will Financing fees Advisor fees

25% 7.0 75% 1% 30.0

Income Statement INR MM Net Sales Sales Synergies % Change Cost of Sales (excluding D&A) COGS Synergies Gross Profit % Change SG&A Expense SG&A Synergies Other Expense/ (Income) Income Synergies EBITDA % Change Depreciation Amortization new Amortization % sales EBIT % Change Interest Expense New Interest expense on debt Interest Income Pretax Income Income Taxes Net Income % Change

2012 1,63,205 22% 64,421 (2,245.0) 1,01,029 24% 69,338 (2,416) (7,913) (230) 42,250 40% 5,670 710 3,838 2.8% 32,031 32% 852 7,529 (124) 23,774 4,279 19,494

2013 1,86,229 14% 73,431 (4,405.9) 1,17,204 16% 79,226 (4,754) (9,013) (451) 52,195 24% 7,028 967 3,838 2.6% 40,362 26% 635 12,963 (60) 26,823 4,828 21,995 13%

2014 2,13,277 15% 84,060 (5,043.6) 1,34,260 15% 90,781 (5,447) (10,314) (516) 59,756 14% 8,537 1,262 3,838 2.4% 46,119 14% 418 12,963 (36) 32,773 5,899 26,874 22%

2015 2,45,184 15% 96,601 (5,796.1) 1,54,379 15% 1,04,410 (6,265) (11,850) (593) 68,677 15% 10,219 1,601 3,838 2.2% 53,019 15% 209 12,963 (50) 39,897 7,182 32,716 22%

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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

The Overall deal will create synergies

Valuations Summary DCF Analysis
344.9 892.2

INR Billions
59.7 48.2

Valuations Summary Pricing Analysis

INR

419.9 410.7 389.6 Offer Price 376.0 350.7

487.6

348.2

343.6
Relative valuations

Value of Dr. Value of Cipla Reddy's

Value of Combined Firm

Synergy

Premium Paid DCF Analysis Comparables

DCF Assumptions
Indian Risk free rate Market Risk Premium Growth Rate Beta (Cipla) Beta (Dr. Reddys) Beta (Combined) Tax Rate (Dr. Reddys) Debt Interest rate 8.5% 7% 8% 0.33 0.6 0.93 18% 8.5%

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 COGS SG&A Expenses NA 6% 6%

Other Income

5%

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Accretion/Dilution Analysis

The Acquisition will be Accretive

Accretion/Dilution to Dr. Reddy's Laboratories FY12 Market Premium 2% 0% Equity Financing 25% 50% 75% 100% 0% 6.8% 7.5% 8.0% 8.4% 8.7% 10% 6.8% 5.6% 4.8% 4.2% 3.8% 20% 6.8% 3.7% 1.8% 0.4% -0.7% 30% 6.8% 2.0% -1.1% -3.2% -4.8% 40% 6.8% 0.2% -3.8% -6.6% -8.5% 50% 6.8% -1.5% -6.4% -9.7% -12.0% Market Premium
0% market premium 6.8% 7.5% 3.7% 1.8% 0.4% -0.7% -6.4% -9.7% -12.0% 50% market premium 8.0% 20% market premium 8.4% 8.7%

-1.5%

0%

25%

50% Equity Financing

75%

100%

EPS Analysis of combined firm INR FY12 Market Premium #REF! 0% 10% 20% 30% 0% 25% Equity Financing 50% 75% 100% 73.72 75.01 75.90 76.55 77.05 73.72 73.66 73.63 73.60 73.58 73.72 73.72 72.37 71.11 71.49 69.47 70.87 68.33 70.41 67.50

0% Market Premium
73.72 75.01

50% Market Premium

75.90 76.55 77.05

40% 73.72 69.91 67.56 65.97 64.82

50% 73.72 68.74 65.75 63.77 62.35 0%

68.74

65.75

63.77

50.00

62.35

25%

50%

75%

100%

Equity Financing

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Synergy Analysis
Without the consideration of synergies the transaction becomes dilutive and the break even synergies have been computed Cipla and Dr. Reddys do not possess significantly overlapping product portfolios The Combined entity will benefit from a relatively broad range portfolio

Break Even Synergies

Synergies from 8 FDA approved manufacturing facilities of Cipla combined with 18 of Dr. Reddys 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 Ciplas range of Antiretrovirals and Anti cancer drugs Strong R&D prospects of the combined entity
Dr. Reddys Omez Stamlo Ketorol Reditux Top Brands Cipla Asthal Seroflo Viraday Ciplox Norflox Novamox Triomune

Nise Exifine
Cetrine

P/E Analysis of Dr. Reddy's Laboratories after merger FY12 in INR Market Premium 23.154 0% 10% 20% 30% 0% 22.52x 22.52x 22.52x 22.52x 25% 22.13x 22.53x 22.94x 23.34x Equity Financing 50% 21.87x 22.55x 23.22x 23.90x 75% 21.68x 22.55x 23.42x 24.29x 100% 21.54x 22.56x 23.58x 24.59x

Break even Synergies for EPS neutral transaction INR MM

40% 22.52x 23.75x 24.57x 25.16x 25.61x 50% 22.52x 24.15x 25.25x 26.03x 26.63x

2012E 2013E 2014E 2015E

4,411.0 8,732.8 7,297.8 5,671.1

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Credentials

Corporate Bridge Research Consultants

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

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