Mylan's taking a controlling stake in Matrix is going to help the Indian company jump to the next level. Matrix will get a larger market access across the world and funding growth will not be a problem.

For generics players like Matrix, the going has been tough in the past two years - there has been immense pricing pressure in the US and European markets.

The super-profits that a generic launch brought a few years ago are a thing of the past. So, with Mylan's deep pockets, Matrix can return to what it does best: produce drugs at a lower cost than most of its competitors.

While Mylan's entry augurs well for the company in the long term, the open offer from Mylan at Rs 306 per share is a good opportunity to exit, for shareholders of Matrix in the short term. The stock is currently trading at around Rs 270.

Mylan matters

Matrix has a presence in generic APIs (active pharmaceutical ingredients), ARVs (anti retro virals), finished dosage forms and hospital products.

Over the years, it has been actively expanding its global presence. It acquired companies like Docpharma (Belgium), Explora (Switzerland) and Mchem (China).

Mylan's purchase comes at a time when generic players are facing margin pressure and the industry is undergoing consolidation. The number of big generic players has reduced from 14 to 6 in three years, as companies like Teva and Ivax have merged.

Matrix can leverage Mylan's strong presence further in the US market in generic and proprietary products. Mylan will help Matrix strengthen its position in the European market.

In fact, analysts feel that Matrix could even end up as a manufacturing hub for Mylan, rather than be limited to marketing its own products. Given the scale of Mylan's operations and its huge customer base, it is a good proposition.

According to Motilal Oswal Securities, future growth for Matrix would be driven by new product launches abroad and by its ARV business, even as competition is strong.

Matrix's chairman, N Prasad says, "Mylan is an industry leader. This transaction creates greater growth opportunities for Matrix. It will allow us to accelerate our existing expansion plans in India and abroad."

He adds, "The additional financial resources that Mylan brings will allow us to enhance our manufacturing and product development capabilities and expand Docpharma's portfolio and presence across Europe."

Matrix expects to draw on Mylan's strengths to advance its anti-viral initiatives to bring them to patients at lower cost.

Mylan's strong balance sheet could be utilised for lowering Matrix's debt. While analysts are not bullish on general APIs, where margins could fall from 14-15 per cent to 9-10 per cent, complex APIs would be beneficial. In ARVs, it has to compete with companies like Aurobindo Pharma [Get Quote] and Cipla, even as the latter is much larger and has the low cost advantage.

In the finished dosage forms, Matrix has scope to grow in the lifestyle diseases segment. For Mylan, the acquisition is expected to significantly strengthen its back-end, as it gains access to Matrix's ten APIs and intermediate plants.

A presence in India will also result in cost savings and help it effectively fight competition in the US. Also, Mylan would get access to European markets through Docpharma and Matrix's ARV business.

But analysts caution that the deal raises uncertainties on the long-term sustainability of Matrix's supply arrangements with various generic companies abroad, since it now becomes a direct competitor for them. Matrix's CRAMS initiatives could also get negatively impacted.

Moreover, doubts are also raised about the transfer pricing between Matrix and Mylan, which would have a bearing on the US API profitability.

The deal

In late August, US-based Mylan Laboratories decided to acquire up to 71.5 per cent of Matrix's share capital for Rs 306 per share. This includes purchasing 51.5 per cent stake from investors like Temasek, Newbridge Capital and Spandana Foundation, as well as some of Prasad's stake.

Mylan has also made an open offer to the remaining shareholders to acquire up to an additional 20 per cent. If the offer is fully subscribed, the total purchase price is expected to be $736 million or Rs 3,400 crore (rs 34 billion). Matrix would continue to be a publicly traded company and operate on an independent basis.

Financials

While, Matrix's Q4 FY06 consolidated results were lower than expected, the first quarter of FY07 has turned out well. Net sales shot up to Rs 442.2 crore (including acquisitions during the year) as against Rs 154.3 crore in previous June quarter, while the net profit increased to Rs 33.8 crore (Rs 338 million) from Rs 25.3 crore (Rs 253 million). The operating margin inched up from 11 per cent in June 2005 to over 12 per cent.

"The growth in ARV and CRAMS businesses was robust, even as there was an increase in R&D expenses and a loss from the Fine Chemicals Corporation JV," says Motilal Oswal analyst.

In segments, generic APIs accounted for 29 per cent, ARVs 23 per cent, finished dosage forms 26 per cent, hospital products 14 per cent and CRAMS was at 8 per cent. Mylan's consolidated total revenues have increased by nearly 14 per cent over the past five years to $1.26 billion in 2006, even as gross profit inched up 0.6 per cent to $628 million.

At the deal price (same for the open offer) of Rs 306 per share, Matrix is valued at about 21x FY08E EPS, 2.7x FY08E enterprise value/sales and 18.3x FY08E enterprise value/operating profit.

Analysts add that the recent acquisitions made by Ranbaxy [Get Quote] (Terapia) and Dr Reddy's (Betapharm) have been in the range of 11-12x EV/EBITDA and 3-4x EV/sales.

This indicates that the price that shareholders are getting in the open offer is quite attractive.

In fact, analysts have a one-year target for the Matrix stock of Rs 290-300. So shareholders would be better off in exiting from Matrix and investing elsewhere. Plus, they will not have to deal with the uncertainties of how the Mylan acquisition will shape up.