Investment Highlights
Now is an opportunistic time to buy EastPharma shares as the stock is down substantially since its IPO in June 2007 from $11 to $4 and it offers investors 150%-200% upside. EastPharma is the only pure-play public pharmaceutical company in Turkey which gives investors exposure to this fast growing market. We believe the valuation is particularly compelling relative to comparable companies as it is trading at 0.9x 2009E sales and 4.8x 2009E EBITDA. Recent transactions in the space have averaged at 2.5x forward sales and 11x forward EBITDA. While there have been several management and operational issues at the company, these have been more than priced into the stock and we are at an inflection point as management is on a path to “right the ship”.
The following initiatives will likely start to bear fruit in the next 6 months:1) a reorganization of the sales force 2) the recent acquisition and licensing of 16 products from Roche 3) the completion of 2 large manufacturing plants that will triple the company’s production capacity 4) the instatement of a new general manager 5) the company has hired a Turkish bank to evaluate strategic options for enhancing liquidity in the stock 6) we would not be surprised to see a leading global pharmaceutical company buy EastPharma.
Company Overview
EastPharma was established in 2006 by GEM Global Equities as a holding company that set out to acquire pharmaceutical companies in the highly fragmented Turkish market. Its first acquisition in Nov. 2006 was a 97% stake in Deva, which is a public branded generic pharmaceutical company listed in Turkey with ~$130m in annual sales. In mid-2007, GEM listed EastPharma on the Aim in London, raising $175m in the IPO in order to do further acquisitions. In 2007, EastPharma acquired Saba, which had $14m in sales. They have also recently acquired and in-licensed 16 products from Roche. EastPharma is the 7th largest pharmaceutical company in Turkey in revenue terms with 3.5% market share, and the 3rd largest player in Turkey in terms of units sold.
EastPharma has been expanding outside of Turkey in order to leverage its production capabilities. EastPharma has set up representative offices in Russia (market size $8.96bn), Georgia, Kazakhstan, and Azerbaijan (market size $400m-$700m each). In the developed markets, EastPharma has set up representative offices in Australia (market size $1.43b) and New Zealand. EastPharma also has two new production plants nearing completion, one focusing on general production and the other on injectables, increasing total capacity from 100m to 350m units.
Currently, EastPharma is emerging from a corporate restructuring program that has involved the reorganization of its sales force, 2 new production facilities, and the implementation of a new management team.
Overview of Turkish pharmaceutical market
The Turkish pharmaceutical market is currently the 13th largest market in the world, worth $6.9bn in 2006 and is growing ~5%/year. The market is a branded generic market where most of the drugs sold are off patent but doctors and patients are loyal to a particular brand of the drug, making it very important for drug companies to have strong marketing and an effective sales force. There is a lot of room for consolidation as there are ~200 pharmaceutical companies, with the largest having only 9% market share. Healthcare spending is low as it is 7.5% of GDP vs. the 9% OECD average. Turkish per capita drug consumption of $95 is very low compared to European countries (Italy, Spain, Germany, UK ~ $400 per capita).
Issues since the IPO
EastPharma shares have been affected by several issues since its IPO which have lead to the share price decline.
1) Mismanagement- After GEM acquired Deva, they put in place a new CEO who did not have operational experience in the pharmaceutical industry and was unsuccessful at achieving the company’s stated targets at the time of the IPO. He was fired in March 2008 and the company just appointed a new General Manager who has extensive experience in the Turkish as well as international pharmaceutical markets. The new General Manager, was previously General Manager at Abdi Ibrahim Pharmaceuticals for 5 years and the Customer Relationship Director at Hedef Alliance, a drug distributor for the last 4 years.
2) Barrels investigation- GEM management lost credibility when just months after the IPO, they announced an investigation of 70 barrels containing an organic alcohol found under one of the company’s production plants. Ultimately, it was determined that these barrels were not toxic and the company had to pay a fine of $1.5m. (Note: The barrels were in the ground before the environmental laws went into effect.)
3) Hurt by appreciating lira in 2H07- Drug prices in Turkey are set at the lowest price for the same drug in a basket of 5 EU countries. In 2007, as the lira appreciated vs. the Euro, drug prices declined in lira terms but expenses, which are in lira, remained constant, leading to margin compression. However, the Ministry of Health has reevaluated prices as and has increased them by 5%.
Company Turnaround
1) Sales force reorganization- EastPharma has one of the largest sales forces in Turkey with over 1,000 reps (Abdi Ibrahim has the largest with 1,300 reps). The company recently reorganized its sales force so that reps are much more strategically focused as they are divided by therapeutic areas rather than by region as they were in the past.. Reps are also incentivized to sell based on the profitability of a product, rather than volume. As a result, EastPharma’s market share increased from 3.1% in 2007 to 3.4% YTD.
2) New management - EastPharma has gone through difficulties with its management team but we believe that they have started to settle this issue. After GEM acquired Deva, they placed one of their portfolio managers as CEO. This did not work out changed its CEO and hired a new General Manager who has previously worked at other Turkish and international pharmaceutical companies
3) Acquisitions- EastPharma has been executing on its stated acquisition strategy and has recently completed an acquisition of Saba Pharmaceuticals and 16 products from Roche.
a) Saba- In May 2007, EastPharma purchased Saba $13.7m. Saba is Turkish generic pharmaceutical manufacturer with 13 products currently on the market. Through the acquisition, EastPharma gained 80 sales people and increased its doctors visited from 7,300 to 21,000, and pharmacists visited increased from 2,200 to 7,400. The number Lastly, EastPharma began transferring the production of Saba products to EastPharma factories to cut costs.
b) Roche deal- In June 2008, EastPharma paid ~$60m to acquire 8 products from Roche which had annual sales of $100m as well as exclusive rights to in-license 8 products. These products are focused on the cardiovascular and central nervous systems and are expected to grow sales by 10%. EastPharma will also receive the rights of export to Russia and all CIS countries for one of the eight products. EastPharma will also receive a transfer of 90-100 sales people from Roche
This deal was done at a very attractive price as EastPharma paid 0.6x sales, well below recent generic transaction multiples. These acquisitions follow EastPharma’s ongoing pursuit of expanding its product line, increasing exposure to these therapeutic fields, and moving into new markets. As a result of this acquisition, EastPharma became the 3rd largest Turkish pharmaceutical company in terms of units, from its current position as 5th, and the 7th largest in terms of revenue, previously, it was the 11th largest.
4) New manufacturing sites- EastPharma is completing the construction of 2 new manufacturing sites which will increase their production capacity from 80m units to 350m units. In order to fund the construction of these factories, which costs $100m, EastPharma sold one of their factories located in the center of Istanbul for $80m.
5) Appointment of financial advisor- On 8/15/08, EastPharma appointed a local Turkish bank to evaluate options to increase liquidity of its stock. This may involve in relisting the company on the Turkish exchange which could prompt research coverage by local Turkish banks and would also prompt them to be included in the ISE National 100 Index in Turkey.
6) Attractive acquisition target- EastPharma is an attractive asset for a leading global pharmaceutical company because it has exposure to a fast growing pharmaceutical market. EastPharma trades at a substantial discount to recent transactions in the space which have averaged at 2.5x sales and 11x EBITDA. EastPharma trades at 0.9x 2009E sales and 4.8x 2009E EBITDA.
7) International Expansions- EastPharma is looking to expand outside of Turkey in places such as Russia and other CIS countries to capitalize on their production capabilities in Turkey and the strong growth of pharmaceuticals in those markets. Currently, EastPharma has opened several international offices in order to start working on its registration in those markets.
· Russia– EastPharma has opened an office in Moscow. The office is in the process of registering select Deva and Saba products with the Russian pharmaceutical licensing authorities.
· Azerbaijan, Uzbekistan, and Georgia– EastPharma opened representative offices in Azerbaijan, Uzbekistan, and Georgia as a further step in advancing its presence to what it views as very under-penetrated CIS markets.
Risks
- Drug prices may be adversely affected by an appreciation of the Lira to the Euro. Although the Lira is currently down 15% YTD, with price increases expected in the coming twelve months, a rapid appreciation of the Lira could reverse this trend.
- EastPharma performance is strongly tied to the execution of its various plans for expansion. These plans include the successful completion of two production facilities, completing the restructuring program, and planned product launches for the coming year.
- If there is continued mismanagement of its operations
We believe that EastPharma, while it has had its share of management and market related issues is an attractive investment at current levels as the valuation is depressed and we should start to see management’s initiatives bear fruit.
Valuation
Industry Average Multiples 2009E
EV/Sales 2.2x
EastPharma EV $741.0
EastPharma Market Cap $744
Price/Share $11
Upside 177.1%
EV/EBITDA 10.4x
EastPharma EV $657.9
EastPharma Market Cap $661
Price/Share $9.77
Upside 146.1%
Target Price $10.39
Upside 161.6%
| Comps |
EV/Sales |
|
EV/EBITDA |
|
|
|
2008E |
2009E |
2008E |
2009E |
|
EastPharma |
1.6x |
0.9x |
8.0x |
4.8x |
|
Egis |
0.8x |
0.7x |
5.0x |
4.3x |
|
Gideon Richter |
2.5x |
2.2x |
9.4x |
8.3x |
|
Hikma |
1.7x |
1.5x |
14.8x |
11.8x |
|
Zentiva |
2.7x |
2.5x |
11.6x |
10.2x |
|
Cipla |
1.2x |
3.5x |
19.6x |
17.1x |
|
Dr. Reddy's |
2.0x |
1.7x |
11.7x |
10.0x |
|
Ranbaxy |
2.9x |
2.5x |
19.2x |
15.4x |
|
Teva |
3.3x |
2.9x |
11.5x |
9.7x |
|
Barr |
3.5x |
3.2x |
12.5x |
11.1x |
|
Watson |
1.4x |
1.4x |
6.7x |
6.5x |
|
|
|
|
|
| Average |
2.2x |
2.2x |
11.8x |
9.9x |
- There has recently been a plethora of M&A activity in the generics space at lofty valuations, reinforcing the attrativeness of EastPharma to a potential acquirer as it is trading well below recent transaction multiples and has exposure to a growing market
- Exmaples of recent M&A in the space include Teva acquiring Barr for 3.0x orward revenue and 13.3x forward EBITDA and Ranbaxy acquiring Daiichi Sankyo for 2.65x forward Sales, and 16.3x fwd EBITDA
- Most notable, was Zentiva's acquisition of Eczacibasi, a Turkish generic company in March 2007 for 13.7x EBITDA
- Potential listing on the Turkish exchange and broker initiations
- Continued M&A/consolidation chatter in the generics industry at lofty valuations