Ranbaxy’s Acquisition by Daiichi

Dissertation* submitted by:

Dr. Akash S Rajpal Roll no. 080902

Times School of Business (Merger & Acquisitions)

Email: akash.rajpal@gmail.com

17 August 2009

Dissertation Guide: Prof. Renganathan Bashyam

* This Dissertation is derived after extensive research on the World Wide Web, referring to research papers, reliable news portals, class room discussions and mentor inputs.

1

CERTIFICATE

This is to certify that the dissertation entitled “Ranbaxy’s Acquisition by Daiichi”

submitted by Dr Akash S. Rajpal in partial fulfillment of the requirement of Times School of

Business (Mergers & Acquisitions), is a record of the candidate’s own work carried by him

under my supervision. The matter embodied in this dissertation has been submitted to my

complete satisfaction.

Date : (Prof. Renganathan Bashyam) Supervisor

2

Dedicated to

All the faculty, staff & colleagues at the Times School of Business (Mergers &

Acquisitions).

3

ACKNOWLEDGEMENT

I would like to thank all my faculty, staff & colleagues at the Times School of Business

(Mergers & Acquisitions) for bringing out the essence of Mergers & Acquisitions , a

complicated subject matter, in a very comprehensive and interactive manner.

I would like to specially thank my mentor and guide, Prof. Renganathan Bashyam to have

spared his valuable time to supervise my dissertation and provide his invaluable inputs.

I would also like to thank Mr. Harish Kumar Chandna who is from the pharmaceutical

industry with more than three decades of experience to have provided his invaluable

inputs

Dr. Akash S Rajpal

AGM Operations, Dr L H Hiranandani Hospital

4

PREFACE

With rising demand for cheaper medicines as the cost of healthcare is rising, governments

worldwide are formulating drug regulations favoring generic drug manufacturers. This

has forced many proprietary drug manufactures to diversify towards generic drug

manufacturing to balance out reduced sales and profits from their blockbuster and patent

owned drugs.

5

CONTENTS

ACKNOWLEDGEMENT 3

PREFACE 4

TABLE OF CONTENTS 5

I. Introduction 7

(i) Brief about the deal 8

II. Mergers and Acquisitions in the Indian Pharmaceutical Industry 9

III. A brief Background into the

Pharmaceutical Industry & Changing Scenario 11

IV. Generics – Why is it Important! 15

V. Background - Daiichi-Sankyo Co. Ltd 17

(i) About the Company 17

VI. Background - Ranbaxy Ltd 20

(i) About the Company 21

VII. The Deal 23

(i) Chronology of events – overview 24

(ii) Structure of the deal 25

(iii) Transaction breakup 28

(iv) Effect on financials 28

Contents continued on next page

6

CONTENTS (continued)

VIII. Key Implications Under Indian Laws 30

(i) Income tax liabilities 30

(ii) Exchange Control Regulations 30

(iii) Corporate law issue 32

(iv) Securities Law Issues 32

IX. Post Deal Objectives 35

X. Post Deal Integration 36

XI. Development Post Deal 37

XII. Synergy 40

XIII. Strategy 43

XIV. Valuation 44

XV. Conclusion 46

XVI. Glossary 49

XVII. Citations / Explanations 50

7

I. Introduction :

The pharmaceutical sector all over the world is restructuring its operations through

different types of consolidation strategies in order to face various challenges.

The cost of healthcare is increasing and is becoming more unaffordable, the

communities’ world over are demanding reduction in prices of important component of

healthcare - the drugs and medicines.

The proprietary patented drugs owned singly by a company can demand exorbitant price

and further rise the cost of healthcare manifold. Governments world over are now

succumbing to the affordability factor and is now allowing generic version of patented

drugs to be made at a fraction of the pricing to make such life saving drugs available to

the masses. This though benefiting consumers adds to huge amount of losses to

proprietary drug manufactures especially when huge amount of expenses are incurred in

research and development to innovate the unique drug molecule.

Proprietary drug manufacturers’ world over in the wake of expiring patents, government

intervention for pricing, looming competition and high incubation period required in the

business of patented proprietary pharmaceutical business are forcing such entities to

diversify into the generic drugs market to survive. The fastest way of such arrangements

is inorganic in nature & statistics validate this fact as 64 merger and 63 acquisitions

occurred in this industry during the post liberalization period.

This dissertation captures one such important acquisition of an Indian generic drug

manufacturing leader by a leading Japanese proprietary drug manufacturer - the Daichii

Sankyo LTDs acquisition of Ranbaxy LTD.

8

(i) Brief About The Deal

In the month of June, 2008, Daiichi entered into a share purchase and share

subscription agreement with Ranbaxy and the Singh family, the controlling

shareholders, to acquire controlling stake in Ranbaxy.

Daichii acquired the entire holding of the Singh family in the Company at Rs 737

per share. Daichii further acquired majority of shares of Ranbaxy at the same price.

This valued Ranbaxy at $ 8.5 billion. This is about 5 times Ranbaxy’s CY2007

revenues of USD 1.70 billion. This gives a PE multiple of 44.7 and EV/EBITDA

multiple of 27

The negotiated price of Rs. 737 represented a premium of 31.4% over the market

price of Ranbaxy on the day of the announcement.

9

II. Mergers and Acquisitions in the Indian Pharmaceutical Industry:

(Source: MPRA Paper No. 8144, posted 07. April 2008, Munich Personal RePEc

Archive)

64 merger and 63 acquisitions occurred in this industry during the post liberalization

period.

Out of the total 32 merging firms, 20 belonged to the domestic sector and in the case of

merged firms; it is 38 and 20 respectively. Even though the total number of mergers

during the post liberalization period is 64, only 32 merging firms were involved in the

process, which indicates that many merging firms engaged in multiple mergers.

Further, domestic firms are merging with the domestic firms, which constitute 64 percent

of the total number of mergers and many foreign subsidiaries merged with other foreign

subsidiaries, which constitute 26 percent of the total number of mergers.

From the size-wise classification of merging firms it is seen that the large sized firms are

mostly engaged in merging process, which constitutes almost 60 percent of the total

mergers, whereas that of the medium sized firms is around 38 per cent. From the size

distribution of the merged firms it is clear that almost all the merged firms were medium

sized, that is 27 out of the 28 firms come under medium sized category.

A closer look at the size of the firms further reveals the medium sized firms are getting

merged with large sized firms. About 64 percent of the mergers come under this category.

The preference for medium sized firms by the large sized merging firms may be due to

several reasons such as the ownership of well-known brands in some therapeutic markets,

well established marketing networks and their market share-even though they are not the

market leaders their small share may help the merging (acquiring) firm to gain market

leadership. Despite this, many medium sized firms are merging with the firms of their

own size in order to strengthen themselves to face acute competition from other firms.

10

Size wise classification of mergers Table 1

Most of the mergers in the pharmaceutical industry were horizontal type, which marked

more than 85 percent

Seventeen mergers can be further classified as vertical mergers as some mergers are between

bulk drugs and formulations producing firms with either formulation-producing firms or bulk

drug producing firms is one instance.

More than 70 percent of the cases are related in nature, which is a clear indication that firms

are trying to consolidate themselves in order to overcome the new challenges of competition

posed by the new market regime.

Category wise mergers

Table 2 Acquisitions: Unlike in the case of mergers there is a high incidence of cross-border

acquisitions, which makes around 28 per cent of the acquisitions. Relatively large number of

acquisitions occurred among the foreign owned firms. Interestingly many of the foreign

parent firms are trying to increase stake in their Indian subsidiaries, which was earlier

constrained by various regulations.

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III. A Brief Background Into The Pharmaceutical Industry & Changing Scenario:

The global pharmaceutical industry is valued at $ 700 billion (2007). With about 46

percent

share, the United States remains the largest individual market worldwide. Japan, with $

70 billion market, is the second largest market. In European Union, Germany is the

largest market valued at $ 31 billion.

The chart below illustrates how the proprietary drug market is shifting focus to non

proprietary generic market.

Movement in global pharmaceutical industry

Chart 1

12

Growing emerging markets:

The chart below illustrates how emerging markets are growing steadily and the reason why

leading global companies are eying these countries.

Table 3

13

High potential in emerging markets Chart 2

*BRICs: Brazil, Russia, India and China Source : IMS strategic management review 2006, Goldman Sachs Economic paper (2030 Pharmaceurical markets estimates). OECD Health Data.

The Japanese pharmaceutical industry: The industry achieved rapid growth since the

Universal Health Insurance (UHI) system was introduced in 1961 in Japan. However, the

industry growth has slowed down since the 1980s. In particular, the market for

prescription drugs has shown very low growth over the last decade.. The sales have

grown meagrely from ¥7000 billion in 2003 to just above ¥ 8000 billion in 2007, -a CAGR of

less than 4%. There are few proprietary branded players with presence outside Japan. The

Generic market has significant presence too.

14

This industry experienced growth only since the early 90s when the Japanese government

began taking steps to promote the use of lower-priced generics for reducing drug cost.

Table 4

The average age of Japanese population is on a rise,

and so is the health care cost. As a result, the

government is promoting the use of generic drugs and

cautiously reforming the reimbursement system. A

survey, conducted by McKinsey, showed that though

the propensity to consume generics drugs by Japanese

is very high. The generics market share in terms of

sales has increased from about 3% to 3.5% of total sales in the last 5 years.

The increase of generics market share during the same period in terms of volume has been

from 11.7% to 12.5% of total volume.

Indian Pharmaceutical industry: The size of the Indian pharmaceutical industry was in the

range of $ 17 billion in 2007 – 08.

Nearly 60% is the domestic market, while exports constitute 40%. It has been witnessing

phenomenal growth in recent years, driven by rising consumption levels in the country and

strong demand from export markets. In world rankings, the Indian pharmaceutical market

stood fourth in terms of volume and 14th in terms of value in 2005 and, as per a study by

McKinsey, is expected to be ranked among the top 10 largest pharmaceutical markets

worldwide by 2015.

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IV. Generic: Why Is It Important?

As illustrated above, the global shift of proprietary manufactures is shifting to the

cheaper generic drug manufacturing. This section will explain reasons for the same in

detail.

Patent disadvantage: Drug patents give twenty years of protection, but they are

applied for before clinical trials begin, so the effective life of a drug patent tends to be

between seven and twelve years only. A large amount of time and money is invested on

more than half of the patent period, and the remaining seven years may not be enough

to recover the investments. Moreover many developing countries allow life saving

drugs to be made generically even if the patent for the same still exists keeping in mind

the larger interests of the nation and affordability. This leads to millions of dollars of

losses to the original licence holder.

Generic advantage: Generic manufacturers do not incur the cost of drug discovery and

instead are able to reverse-engineer known drug compounds to allow them to

manufacture bioequivalent versions. Generic manufacturers also do not bear the burden

of proving the safety and efficacy of the drugs through clinical trials, since these trials

have already been conducted by the original owner of the proprietary drug.

Generic drug companies may also receive the benefit of the previous marketing efforts

of the brand-name drug company, including media advertising, presentations by drug

representatives, and distribution of free samples. Many of the drugs introduced by

generic manufacturers have already been on the market for a decade or more, and may

already be well-known to patients and providers.

The low cost demand: The demand for low-cost medicines is enormous, the number of

mega-brands coming off patent is significant, and the opportunity to build and create

value is wonderful.

The average age of population world wide is on a rise, and so is the health care cost.

16

As a result, the governments are promoting the use of generic drugs and cautiously

reforming the reimbursement system.

As per Harris Interactive, in just over 2 years, the percentage of Americans who would

choose generic prescription drugs over brand names has increased from 68% to 81%.

More consumers now purchase their prescriptions in discount stores like Wal-Mart and

Sam's Club -17% in December, 2008, up from 13% in October, 2006.

The golden opportunity: Generic companies also can seize opportunities that result

from the uneven penetration of generics in various markets, especially in Europe. For

example, the market shares of generics in Belgium, France, Italy, and Spain were each

less than 4% in 2001. However, growth rates of generics from the previous year were

highest in these countries, ranging from 53% in France to 291% in Italy, according to

estimates (refer table: ).

The share of the generics market is further expected to increase thanks to the

government’s steps to encourage the use of generics.

The global generic pharmaceuticals market was about $70 billion in 2007, with market

growth noticeably higher than that of the overall pharmaceutical market.

Other: The FDA also offers a 180 day exclusivity period to generic manufacturers in

specific cases such as when a generic manufacturer argues that a patent is invalid or is

not violated in the generic production of a drug. The exclusive period of 180 days –

which allows one manufacturer to sell generic product –acts as a reward for the generic

manufacturer who is willing to risk liability in court and the cost of patent litigation

with the original/branded manufacturer.

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V. Background - Daiichi Sankyo Co. Ltd (DIS):

• Formed by a merger of Daiichi Pharmaceuticals Co. Ltd and Sankyo Co. Ltd in April

2007. Both these companies are about a century old. Daiichi was established in 1915

and Sankyo in 1899.

• Daiichi Sankyo is a pharmaceutical innovation based company with a strong R&D

pipeline.

• Daiichi Sankyo is a professionally managed company with no promoters or

controlling shareholders.

• 79.40 % of Daiichi Sankyo is held by the FIIs/Mutual Funds/Financial

Institutions/Banks and 20.60 % by the public (including the government, companies,

individuals & treasury stock).

• Daiichi Sankyo is listed on the Tokyo Stock Exchange and has a paid up capital of

JPY 50 billion and a market capitalization of JPY 2139 billion approximately.

• Daiichi Sankyo has subsidiaries in 21 countries worldwide.

• Daiichi Sankyo had revenues of JPY 907 billion and net profits of more than JPY 97

billion for the year ended 31st March, 2008.

(i) About the Company

Major products of Daiichi-Sankyo Group

• Benicar (olmesartan medoxomil)

• Mevalotin (pravastatin)

• Loxonin (loxoprofen)

• Olmetec (olmesartan)

• Captopril

• Zantac (ranitidine)

• WelChol (colesevelam HCl)

• Cravit (levofloxacin)

• Evoxac (cevimeline)

• FloxinOtic (ofloxacin)

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DIS has its main R&D activities in Japan, though it has opened centers in other

parts of the world.

The number of R&D employees in various part of the world are: 2625

Two third of sales and operating income of DIS came from Japan. In the

international market, the US was the largest market. In terms of products,

Olmesartan –Anti hypertensive drug –is the largest selling product of DIS.

Moreover it is also the fastest growing. Levofloxacin –Synthetic antibacterial agent

–is the second largest product. However, it has been on a declining phase.

Daiichii Sankyo’s corporate vision for 2015 (official excerpts)

To be a Global Pharma Innovator in 2015 with an international scope of corporate

activities and a productive pipeline of innovative drugs.

• To Operate pharmaceutical businesses in major countries

• To have consolidated sales of JPY1.5 trillion

• To have operating profit margin of 25% or more

• To have overseas sales ratio: of 60% or more

Target 2009:

To bring in improvement of business efficiency by appropriate staff allocation and

establishment of functional subsidiaries

To have consolidated sales of JPY960 billion

Other objectives:

Acquire presence in emerging countries–

Enhance sales operations in Eastern Europe and Asia

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SWOT - Daichii

Table 5

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VI. Background - Ranbaxy Ltd: Chart 3

• Formed in 1937, listed on BSE in 1973

• Consolidated sales : Rs 74.3 billion

• Consolidated PAT: Rs 7.9 billion

• Ranbaxy has a marketing presence in 49 countries

and manufacturing facilities in 11 countries and its

brand presence in 150 countries.

• Focus on Generic business.

• 12000 employees, 1400 R&D staff. Ranbaxy has one of the largest R&D

infrastructures in the country with more than 1,000 scientists. Ranbaxy spends over

US$ 100mn annually on R&D, of which US$ 25mn is spent on innovation research.

• Largest pharmaceutical company in India in terms of consolidated sales (FY2007)

• Ranbaxy is a promoter owned company with promoters holding about 34.81 %

shares. The balance of 65.19 % is held by the public (including the FIIs, DFIs,

Mutual Funds, Insurance companies, companies, individuals, and GDRs).

• Ranbaxy is listed on the National Stock Exchange and the Mumbai Stock Exchange.

It has a paid up capital of Rs.1.866 billion.

Ranbaxy derived its name from that of its founders-Ranjit Singh and Gurbax Singh. It started out as the Indian distributor of vitamins and anti tuberculosis drugs for a Japanese pharmaceutical company. It ventured in manufacturing drugs by setting up its first plant in 1961. Ranbaxy’s first real breakthrough came in 1969 with Calmpose, a copy of Roche patented Valium tranquillizer. Ranbaxy’s growth was fuelled by two major developments in the Indian pharmaceutical industry. The first one was introduction of the Process Patent Act in 1970, which required Indian companies to recognize international process patents. The Act did not recognise product patent. In 1978 Ranbaxy became the first Indian company to develop a novel process for the manufacture of the antibiotic doxycyclin. It also gained worldwide recognition after it developed a non patent infringing process for the antibiotic cefaclor. This was remarkable, as the molecule was complex and Eli Lilly, the product originator, had protected it with twenty two process patents. The second legislation was the Price Control Act which impacted Ranbaxy’s strategy. By capping the drug prices in India, the government made the profits and growth prospects limited. This prompted Ranbaxy to look at export markets to realize its growth targets. During the years 1986 to 1996 exports grew at an annual growth rate of 34%. In February 2004 Ranbaxy crossed a $ 1billion mark in its turnover.

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(i) About the Company Chart 4

FY2008 Sales growth: 18%~20% Profit after tax growth: 20%~25% Source: Ranbaxy

Chart 5

** CIS: Commonwealth of Independent States (Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyzstan, Moldova, Russia, Tajikistan, Ukraine, Uzbekistan)

22

Ranbaxy has local operations in 49 countries (Refer Map 1).

Map 1

In 2008, Ranbaxy achieved a growth of 4% on its top line. Emerging markets like

Russia, Ukraine, Brazil and India led the growth. Among the developed markets,

Canada and Japan outperformed. Interms of therapy focus, anti-infectives were the

largest revenue generator for the company. Gastrointestinals –third largest segment –

had growth of 56% in 2008.

The top 20 products of Ranbaxy in 2008 were:

Simvastatin, AmoxiClav Potassium, Isotretinoin,Amoxycillin & Combinations,

Ketorolac Tromethamine, Omeprazole & Combinations, Cefuroxime Axetil,

Cephalexin, Loratadine & Combinations, Clarithromycin, Ginseng+ Vitamins,

Diclofenac & Combinations, Ranitidine, Cefaclor, Cefpodoxime Proxetil, Efavirenz,

Atorvastatin & Combinations, Fenofibrate, and Ofloxacin & Combinations.

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VII. The Deal:

Press excerpts:

"The proposed transaction is in line with

our goal to be a Global Pharma

Innovator and provides the opportunity

to complement our strong presence in

innovation with a new, strong presence

in the fast growing business of non-

proprietary pharmaceuticals. This

complementary combination represents

a perfect strategic fit and delivers a

considerable opportunity for the future

growth of the new Daiichi Sankyo

Group… “said Takashi Shoda, President & CEO of Daiichi Sankyo Company, Limited.

“I am delighted to announce our association with Daiichi Sankyo

Together with our pool of scientific, technical and managerial resources & talent, we would

enter a new orbit to chart a higher trajectory of sustainable growth in the medium and long

term in the developed and emerging markets organically and inorganically. This is a

significant milestone…”

said Mr. Malvinder Mohan Singh, CEO and Managing Director of Ranbaxy

Laboratories Limited

“It is a very good price. The deal is a sharp move by ranbaxy and very timely. It makes

eminent sense” said Novartis’s Ranjit Sahni.

“I cant’t imagine selling my company at whatever value” said Dr Reddy’s Labororatorie’s

Anji Reddy.

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(i) Chronology of events – an overview Table 6 Date Event June 11, 2008 Signing of Agreement by Daiichi with Ranbaxy and its Promoters. June 14, 2008 Public announcement by Daiichi to the shareholders of Ranbaxy to acquire

additional 20% equity shares at Rs.737 per share under the Takeover Code. June 18, 2008 Ranbaxy announces its settlement with Pfizer over Lipitor litigation

worldwide. June 27, 2008 Submission of draft letter of offer by Daiichi to SEBI for its observations . July 15, 2008 Approval of preferential allotment of equity shares and warrants to Daiichi

by the shareholders of Ranbaxy

August 4, 2008 Daiichi receives SEBI’s observation on the draft letter of offer August 6, 2008 FIPB approves the proposed investment, subject to approval of CCEA August 11, 2008 Daiichi issues revised schedule of activities due to delayed receipt of SEBI

observation August 16, 2008 Opening of open offer September 4, 2008 Closing of open offer

October 3, 2008 Receipt of approval from CCEA for foreign investment October 15, 2008 Acquisition of 20% equity stake by Daiichi pursuant to open offer October 16, 2008 SEBI rejects Promoter’s application to sell their equity stake through a

block deal on the stock market

October 20, 2008 Ranbaxy becomes subsidiary of Daiichi upon increase in Daiichi’s stake to 52.5% (including preferential allotment and transfer of 1st tranche shares from Promoters)

November 7, 2008 Daiichi acquires balance 11.42% shares from the Promoters off the stock market and the deal is concluded. Daiichi’s equity stake in Ranbaxy up to 63.92%

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(ii) Structure of deal

Chart 6

26

Modes and steps:

1. The transaction was financed through Daichii-Sankyo’s existing internal financial resources and bank loans.

2. Acquisition of shares held by the founding family and affiliates (“promoters”) of

Ranbaxy by Daichii.

3. Daiichi Sankyo subscribe to new equity shares

4. Share warrants issued through a preferential issue

5. Open offer executed

6. Upon executing the above transaction steps, Daiichi Sankyo to acquire 50.1% or more stake in Ranbaxy by exercising the warrant rights if its stake is still under 50.0%

27

Chart-7

28

(iii) Transaction breakup

Table 7

Method Number of shares (million share)

Cash amount (Rs billion)

1. Purchase of shares from promoters

130 96

2. Preferential allotment of new shares

46 34

3. Open Offer in the market

0-93 0-68

4. Warrants for new shares

24 2-18

Price: Rs737 per share

31.4% premium on the price last traded (June 10, 2008)

53.50 % higher than the 3 months average closing prices on the NSE

Aggregate amount of the purchase will be Rs147 to 198 billion

Above is estimated to be JPY*369 to 495 billion

*Rs1=JPY2.5

Ranbaxy maintains stock exchange listing.

When the deal closed in November 2008, DIS had acquired 63.92% of the equity

share capital of Ranbaxy

(iv) Effect on financials:

Dilution in equity:

Daiichi will be issued 46.30 million fresh equity shares at Rs. 737/- per share.

Also 23.80 million warrants will be issued with the option to acquire one equity

share per warrant at Rs. 737/- per share. While this leads to dilution in equity, the

price is much higher than the book value.

29

The reduction of the FCCB conversion price will add 35 million shares to

Ranbaxy’s equity.

Due to the proposed issue of shares & warrants to Daiichi and the readjustment of

the FCCB conversion prices, there is an expected 22 % dilution in Ranbaxy’s

equity.

Debt free status:

With the cash inflow from issue of shares, Ranbaxy plans to retire all of its debt.

Hence it will become debt free. However as of today they have not yet paid of all

the debt.

Strong liquidity:

With cash infusion of USD 1.2 billion and the debt repayment, the cash rich

status will help Ranbaxy in aggressive growth strategy.

30

VIII. Key Implications Under Indian Laws:

(i) Income Tax Liabilities:

As per the current Income Tax Act, 1961 (“ITA”), Long-term capital1 gains

arising on transfer of listed equity shares on a recognized stock exchange in

India will be exempt from capital gains tax in India provided securities

transaction tax of 0.125% is paid on the consideration2.

Such sale, if executed off the floor of the stock exchange, would, however, be

subject to a long term capital gains tax of 11.33%3 as per the ITA and the

transfer of shares from the Promoters to Daiichi, off the stock exchange, would

have a capital gains tax implication of Rs.10,000 million (approx.) (~ USD 227

million4).

Hence a way to do a capital gains tax free transfer could be to execute the

transfer on the stock exchange, through a block deal window. Introduced in the

year 20055, block deal window facilitates negotiated deals on the floor of the

stock exchange. However, such negotiated deals should be done at a price not

exceeding +1% from the ruling market price / previous day closing price, as

applicable. 6

With the slump in the financial markets, the prices of Ranbaxy dropped to

around Rs.265 (approx.), which was far less than the negotiated price of

Rs.737. Accordingly, the Promoters sought Security and Exchange Board of

India’s (“SEBI”) approval to waive the +1% ceiling for this block deal.

However, since there was a huge difference between the deal price and the then

existing market price, such permission was not granted by SEBI and an off

market deal was executed after paying the capital gains tax.

(ii) Exchange Control Regulations:

1. RBI Approval for transfer of shares

31

As per RBI/2004-05/207 A.P. (DIR Series) Circular No. 16 dated 4th

October, 2004, transfer of shares from Indian resident to non Indian

resident, which attracts the provisions of the Takeover Code would require

prior approval of the Reserve Bank of India (“RBI”). Accordingly, we

understand, RBI approval was obtained by Daiichi in the month of October,

2008.

2. Approval of Foreign Investment Promotion Board (“FIPB”):

(a) Approval under Press Note No. 1 (2005): Press Note 1 (2005)

issued by the Department of Economic Affairs, Ministry of Finance,

mandates prior approval of FIPB, if the foreign investor is already

having an existing joint venture or technology transfer / trademark

agreement in the ‘same’ field7, as on January 12, 2005.

Since Daiichi was already holding equity stake in Uni-Sankyo

Limited, a company engaged in ‘same’ business as Ranbaxy, prior

approval of FIPB was obtained.

(b) Issuance of warrants: Warrants are essentially options that give a

right to the investors to obtain equity shares at a later date. Under the

current exchange control regulations, subject to sectoral caps, if any, a

company can issue equity shares and compulsorily convertible

preference shares / debentures under automatic route.

The current exchange control regulations though do not expressly

mandate an approval, and therefore FIPB has been insisting for a prior

approval before issuance of warrants to non residents, as warrants

have not been expressly included in the definition of capital8.

There is still ambiguity on whether such FIPB approvals would be

required by a listed company since issuance of such warrants would

be made as per the SEBI guidelines. However, clarity on this is still

32

awaited from FIPB and companies have been making an application

seeking such prior approval on a conservative basis.9

3. Approval of Cabinet Committee on Economic Affairs (“CCEA”) :

Any foreign investment in excess of Rs.6000 million (~ USD 136 million10)

would also require prior approval of CCEA. Accordingly, final clearance

was received from CCEA by Daiichi in the month of October, 2008.

(iii) Corporate Law Issue

Nomination of Independent Director:

As per the Agreement, post completion, the board of directors of Ranbaxy

would consist of 10 directors, of which a combination of four independent and

non-independent directors will be nominated by the Promoters and six

independent and non-independent directors will be nominated by Daiichi.

Such nomination of independent directors raised doubts on whether such

practice would affect the independence of the directors.

As the corporate governance code11 stands today, mere nomination / proposing

a name of independent director by the Promoters or person in control should

not have an impact on their independence unless accompanied by a material

pecuniary interest in some form.

However, corporate governance code merely sets boundaries and the onus is on

the companies to go beyond the formal code and evaluate whether such

practice would create some kind of a dependence on the Promoters and Daiichi

and adversely affect the independence of the independent directors.

(iv) Securities Law Issues

Takeover Code:

33

As per Regulations 10 and 12 of the Securities and Exchange Board of India

(Substantial Acquisition of Shares and Takeovers) Regulations, 1997

(“Takeover Code”), acquisition of shares / voting rights in a listed company,

which will, in aggregate, give the acquirer 15% or more of the voting rights in

the company or acquisition of control over a listed company, would

immediately trigger an open offer requirement.

Pursuant to the Agreement entered into by Daiichi to acquire controlling stake,

an open offer to acquire upto 20% of the paid up capital of Ranbaxy was made

by Daiichi to the shareholders of Ranbaxy.

The open offer was made at a price of Rs.737 per share to all those who were

shareholders of the Company as on June 27, 2008.

The open offer, concluded in the month of October, 2008, gave Daiichi an

additional 20% equity stake in Ranbaxy for an aggregate consideration of

Rs.68,000 million (approx.) (~ USD 1.5 billion12).

Further, due to delay in receipt of statutory approvals, there was a delay in

payment in consideration to the shareholders and hence an interest @ 10% p.a.

for 25 days was paid by Daiichi to the shareholders. 13

Insider Trading:

Just a week after the deal was announced, Ranbaxy further hit the news with its

settlement of long pending litigation with Pfizer over Lipitor drug.

The short timing of these two announcements raised doubts on whether the deal

was influenced by this unpublished price sensitive information14 (“UPSI”) and

if yes, would it amount to violation of the Securities and Exchange Board of

India (Prohibition of Insider Trading) Regulation, 1992 (“Insider Trading

Regulations”).

34

However, such discussions were more in the trade circles and no such

possession of UPSI was proved nor did SEBI instigate any investigation till

date.

Dealing in shares15 may not trigger Insider Trading Regulations, if such

acquisition was as per the Takeover Code. However, today the language in the

law is bit unclear on what is exempted; the shares which have been acquired

under open offer or even those shares, the acquisition of which actually

triggered the open offer.

Further, the price paid to the Promoters for transfer by Daiichi was same as

the price paid to other shareholders of Ranbaxy under open offer. Hence,

did the Promoters derive any unfair economic benefit out of the whole deal,

is something that should be kept in mind before coming to a conclusion on

the insider trading speculations.

35

IX. Post Deal Objectives:

(i) Daiichi-Sankyo’s focus is to develop new drugs to fill the gaps and take

advantage of Ranbaxy’s strong areas.

(ii) To overcome its current challenges in cost structure and supply chain, Daiichi-

Sankyo’s primary aim is to establish a management framework that will

expedite synergies.

(iii) Reduce its exposure to branded drugs in a way that it can cover the impact of

margin pressures on the business, especially in Japan.

(iv) In a global pharmaceutical industry making a shift towards generics and

emerging market opportunities, Daiichi-Sankyo’s acquisition of Ranbaxy

signals a move on the lines of its global counterparts Novartis and local

competitors Astellas Pharma, Eesei and Takeda Pharmaceutical.

(v) Managing the different working and business cultures of the two organizations,

undertaking minimal and essential integration and retaining the management

independence of Ranbaxy without hampering synergies.

(vi) Ranbaxy and Daiichi-Sankyo will also need to consolidate their intellectual

capital and acquire an edge over their foreign counterparts.

36

X. Post Deal Integration:

(i) 10 board members

– 5-Diachii

– 5-Ranbaxy

(ii) Malvinder Singh CEO for next 5 years – Earnout16?

A recent study revealed that earnouts serve two non-mutually-exclusive functions: as risk reduction mechanisms against misvaluation of high asymmetric information targets, and as retention bonuses for target human capital in mergers with feasible contract implementation. Around the merger announcement, bidder shareholders show significant positive responses, which are not reversed over the subsequent 3 years. In the postmerger period, the frequency of earnout payment and the percentage of target managers staying beyond the earnout period are high, supporting the use of earnouts as retention bonuses16.

37

XI. Development Post Deal:

Pfizer & Ranbaxy settlement on LIPITOR:

One week after the DIS announcement, Ranbaxy announced that it had entered into

an agreement with Pfizer Inc. to settle most of the patent litigation worldwide

involving Pfizer’s cholesterol fighting drug Lipitor (generic name Atorvastatin).

Lipitor is the world's largest selling drug with worldwide sales in 2007 of $ 12.7

billion. Under the terms of the agreement, Ranbaxy will delay the start of its 180 days

exclusivity period for a generic version of Lipitor, until November 2011. While the

settlement avoided further legal cost for Ranbaxy in fighting against Pfizer, if it had

won the case, Ranbaxy could have introduced generic version as early as March

2010. After the announcement of the agreement, Ranbaxy shares declined by 7.7% as

against market decline of 2.2%.

In 2008, Ranbaxy had settled with AstraZeneca on its $ 7 billion heartburn drug

Nexium, GSK on its $ 985 million migraine medicine Imitrex and its anti-herpes drug

Valtrex with sales of $ 1.3 billion.

FDA Issued Warning Letters to Ranbaxy:

The Food and Drug Administration (FDA) issued two Warning Letters to Ranbaxy

Laboratories and an Import Alert for generic drugs produced by Ranbaxy's Dewas

and Paonta Sahib plants in India on 16th September 2008. Import Alert, under which

U.S. officials could detain at the U.S. border, any API and finished drugs

manufactured at these Ranbaxy facilities. The Warning Letters identified the agency's

concerns about deviations from U.S. current Good Manufacturing Practice (cGMP)

requirements at Ranbaxy's manufacturing facilities in Dewas and Paonta Sahib

(including the Batamandi unit), in India.

Ranbaxy after this announcement agreed to cooperate and work with FDA to improve

the suggested inadequacies in these two plants.

38

Analysts estimate the loss of business to Ranbaxy as a result of blocking the sale of

30 generic medicines to be at $ 40 million. The news saw Ranbaxy scrip end the day

down 6.6% on BSE

HR speculations:

Post the deal, there were doubts raised, since there has been no recent example of a

generic company being integrated into an innovator company. Some also highlighted

the possibilities of cultural clashes – innovator companies have always seen

themselves as superior to generic companies. Besides, the Japanese culture of

consensus-building and team playing could be new for promoter-run company.

There have been no news validating the above mentioned speculations; however Mr

Malvinder Singh resigned prematurely from the helm of affairs.

DAIICHI SANKYO Records Valuation Loss, Goodwill Wri te-down:

DAIICHI SANKYO Recorded a Valuation Loss, Goodwill Write-down, on

Investment in Ranbaxy Laboratories on January 5, 2009 for the fiscal third-quarter

ended December 31, 2008.

On a non-consolidated basis, Daiichi Sankyo plans to record a non-cash valuation

loss of 359.5 billion yen on its shares in Ranbaxy in its fiscal third-quarter to reflect a

more than 50% decline in the market value of these securities versus the purchase

price. On a consolidated basis, Daiichi Sankyo estimates a non-cash loss of 354.0

billion yen related to the write-down of goodwill associated with its investment in

Ranbaxy in linewith the valuation loss on Ranbaxy shares accounted for on a non-

consolidated basis.

However, these items will have a significant negative impact on the Company’s

consolidated financial results forecasts for net income for the nine-month period

ended December 31, 2008 and for fiscal year 2008 ending March 31, 2009.

39

Background

Daiichi Sankyo has based its estimates for the one-time write-down of goodwill on its

investment in Ranbaxy to fully reflect the impact of the current unprecedented

turmoil in global equities markets. The Company has taken this step to meet the

strictest accounting standards to ensure it remains on the firmest financial footing.

40

XII. Synergy:

(i) Ranbaxy is India's number one Generic pharmaceutical maker and has presence

in more than 150 countries. This would give the Japanese company will get a

green card entry into Indian generic market, Europe and Africa where Ranbaxy

has a strong presence in generic domain.

(ii) Developmental focuses include metabolic, inflammatory, and respiratory

illnesses. The company also has a groundbreaking anti-malarial candidate in

late-phase trials.

(iii) Daiichi has a strong R&D focus which has potential downturn once the patents

expire. Its entry in generic market is outmost necessity to survive and to even

out proprietary down falls in demands. This hybrid model not only disperses

risk, it also sets Daiichi firmly on the path toward sustainable growth by

securing new growth opportunities.

(iv) Ready Indian retail market as Ranbaxy has very strong retail presence, logistics,

supply chain and competitiveness.

(v) In India, through Ranbaxy, Daiichi will sell its own patented drugs. On the

other hand, it will open up Japanese market to Ranbaxy generics.

(vi) 98 pending approvals of Ranbaxy

(vii) 18ANDA17 for 180 day exclusivity with potential sales of USD 27 billion (07-

09)

(viii) Existing major products with 180 day marketing exclusivity with turnover of

USD 8 billion (07-08). Major drug includes Lipitor-anti-cholesterol (10USD-

Billion market. Pfizer had the original patent which expires in 2010.)

41

(ix) 47% stake in Zenotech which has 220 employees, 50 scientists, with a strong

portfolio of A class oncology generics and speciality injectibles.

(x) Besides Zenotech, Ranbaxy has small stakes in Jupiter Biosciences and Orchid

Chemicals, both small niche players in the pharma industry.

(xi) Ranbaxy earlier acquired Be-Tabs in South Africa, which makes it the 5th

largest generic pharmaceutical company in South Africa. It also acquired 13

dermatology products from Bristol Myers Squibb in the USA. It also acquired a

strategic stake of 14.9 per cent in Jupiter Biosciences. This now would fall into

Daichii’s kitty.

Strong legal cell:

(i) The company filed 29 ANDAs in the US, and received 18 approvals in 2007.

(ii) The cumulative ANDA filings stood at 239 with 141 approvals. In the

European Union, the company received 50 National approvals in 8 EU

Reference Member States and 4 Mutual Recognition Procedure approvals in 21

EU Concerned Member States.

(iii) On a global basis, it made 526 product filings, comprising various drug

formulations across multiple therapies, and received approval for 457.

Advantage Daichi

(i) Daiichi Sankyo already has business operations in 21 countries. The addition of

Ranbaxy Laboratories will dramatically extend its global reach. With

operations in 56 countries, including many where Daiichi-Sankyo has so far not

operated, such as Mexico, Russia and East European countries, Ranbaxy will

help them build a stronger presence in emerging markets. In India they will be

one of the biggest pharmaceutical companies in terms of sales. They will also

extend the marketing network into East Europe and Asia, while on the African

continent.

42

(ii) The main benefit for Daiichi-Sankyo from the merger is Ranbaxy’s low-cost

manufacturing infrastructure and supply chain strengths. Ranbaxy gains access

to Daiichi-Sankyo’s research and development expertise to advance its branded

drugs business. Daiichi-Sankyo’s strength in proprietary medicine complements

Ranbaxy’s leadership in the generics segment and both companies acquire a

broader product base, therapeutic focus areas and well distributed risks.

(iii) Ranbaxy can also function as a low-cost manufacturing base for Daiichi-

Sankyo. Ranbaxy, for itself, gains smoother access to and a strong foothold in

the Japanese drug market.

Synergy Highlites:

(i) The two companies’ businesses are complementary to each other. Ranbaxy the

generic company and Daiichi strong in R&D with virtually no overlap.

(ii) The deal replicates the earlier Novartis-Sandoz business model by creating a

combination of generic and branded pharmaceuticals business.

(iii) The joint group would have a global reach with presence in almost all the

countries, developed and emerging markets.

(iv) Cost competitiveness by optimization of the R&D and the manufacturing

facilities of both the companies.

43

XIII. Strategy:

(i) Sellout by Ranbaxy before the valuation drops

(ii) Good exit strategy

(iii) Family tangle. There had been a lot of in-fights and disputes in the Singh

family.

(iv) Post 2011 less revenues out of patents

(v) The immediate benefit for Ranbaxy is that the deal makes it virtually debt-free

and imparts more flexibility into its growth plans.

(vi) Possible second business line expansion on mind - Fortis-potential largest

hospital chain/chemist chain which is also growing in inorganic way by

acquiring other major hospitals.

Growth Strategy:

While DIS grew at 4.7% in 2007 to $ 7.12 billion, Ranbaxy grew at over 10% to $1.6

billion. This reflects the story of the innovator and the generic companies. While the

world pharma industry grew at 6%, the generics segment is growing at 11%. The

pursuit of a dual business segment strategy will help DIS to improve its growth rate

substantially.

Jointly, the two companies will rank 15th in the global pharmaceutical market,

whereas independently Ranbaxy stood at 50th and DIS at 22nd.

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XIV. Valuation:

In the absence of any forecasted cash flow, Daiichii-Sankyo management seems to

have decided to use comparables as the method of valuation and reaching the

negotiated price per share.

The chart below (Table 8 & 9) provides an insight into different multiples which gave

completely different results.

Based on EV/EBIDTA, Ranbaxy – at 17.34 - was already at the higher end of generic

companies. Merck Co had higher EV/EBIDTA as compared to Ranbaxy by 18%.

Ranbaxy also had the highest EV/Total Assets multiple (1.94) amongst the generic

companies. Glaxo’s multiple was 23% higher. The EV/Sales multiple was more

reassuring, for DIS. As compared to TEVA and Mylan, Ranbaxy appeared

substantially under priced.

Therefore price of Rs 737 paid by DIS appeared justified.

Table 8

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Table 9

46

XV. Conclusion:

Daiichi Sankyo considers its investment in Ranbaxy as essential in ensuring

sustainable business growth and fully realizing the Group’s long-term business

strategy. Daiichi Sankyo remains absolutely committed to pursuing its unique hybrid

model dedicated to the needs of patients in developed and emerging markets. Those

needs encompass innovative new medicines and established off-patent products.

On a non-consolidated basis, Daiichi Sankyo plans to record a non-cash valuation

loss of 359.5 billion yen on its shares in Ranbaxy in its fiscal third-quarter to reflect a

more than 50% decline in the market value of these securities versus the purchase

price.

This valuation loss of $ 3.86 billion was much more than what DIS had anticipated.

Immediately, post acquisition announcement on 11th June 2008, the question that had

been in his mind was if DIS over paid for Ranbaxy. As the reality sunk in, this

question is now replaced by more operational issue of how DIS and Ranbaxy are

going to take advantage of each other to create value for their shareholders.

Even after this, Daiichi Sankyo said, it sees no impact on its forecasts for non-

consolidated net sales, operating income or ordinary income for the fiscal third-

quarter as a result of these anticipated extraordinary losses. The Company also sees

no impact on cash flow.

Daiichi Sankyo in its official press release said that it remains committed to a year-

on-year increase in its shareholder dividend for fiscal year 2008, in step with the

Company’s current dividend policy.

47

Foreword - Changing Business Model:

Apart from higher growth of generics, the other change in the global pharma industry

is in the business models followed by large pharma companies. For a long time, the

pharma industry has been dominated by large innovator companies, using R&D to

develop block buster drugs. To strengthen R&D pipeline, the companies endeavoured

to grow bigger through M&A. For example, Astra merged with Zeneca to form

AstraZeneca, Glaxo Wellcome and SmithKlineBeecham merged to form

GlaxoSmithKline, Novartis was created through merger of Ciba-Geigy and Sandoz,

merger of Rhone-Poulenc and Hoechst AG resulted in Aventis, and Pfizer merged

with Warner – Lambert.

Many factors are responsible for these changes. Declining research productivity

coupled with rising R&D costs, falling revenues of block buster drugs due to patent

expiry (block buster drugs worth $ 90 billion will be going off patent by 2011) and

the concerns by various governments of the rising health care bill are all forcing

innovator companies to look for new business models.

The PWC report, ‘Pharma 2020: The Vision – Which Path Will You Take?’ puts the

predicament of innovator companies very well. “The current pharmaceutical industry

business model is both economically unsustainable and operationally incapable of

acting quickly enough to produce the type of innovative treatments that will be

demanded by global markets. Pharmaceutical companies are facing a dearth of new

compounds in the pipeline, poor share value performance, rising sales and marketing

expenditures, increased legal and regulatory constraints and tarnished reputations.”

The report highlights the core challenge as lack of innovation. “The industry is

investing twice as much in R&D as it was a decade ago to produce two-fifths of new

medicines it then produced. It is simply an unsustainable business model”. Even

generics companies are realising the importance of scale. Teva, the world’s largest

generic company, has acquired Barr - an American rival – for $ 7.5 billion. Barr and

Mylan, another big American generics firm, have been busy acquiring smaller firms.

48

Actavis, a once – obscure Icelandic generic outfit, has swallowed over two dozens

rivals in the past decade to become a global force.

Generics business is attracting the global companies. In June 2008, Japan’s Daiichi

Sankyo bought Ranbaxy for $ 4.6 billion. In July 2008, GSK said it would enter the

generics market through a joint venture with Aspen, a South African firm. In March

2009, Pfizer entered into an agreement with Aurobindo Pharma to market off patent

drugs. The products expand Pfizer’s growing generics portfolio and are versions of

drugs originally made by companies other than Pfizer.

Over a period of time a phase of consolidation is expected and a hybrid model of

generic and innovator drug manufacturing would be a common phenomenon.

49

XVI. Glossary:

Generics: A generic drug (generic drugs, short: generics) is a drug which is produced

and distributed without patent protection.

180-day exclusivity period: Some generic manufacturers make Paragraph IV

application. They argue that patent is invalid or is not violated in the generic

production of a drug.

Big pharma company will almost always sue for patent infringement within 45 days

of Para IV filing, and that delays FDA decision on generic application for 30 months

(or until litigation is resolved earlier). For generic companies, litigation costs are

considerable. If generic company succeeds, it gets 180-day exclusivity.

It has been estimated that the first generic manufacturer gets 94% of branded product

price. With two manufacturers, the price they get is 52%. Post exclusivity period,

price goes to 26%.

API: Active Pharmaceutical Ingredient. Or bulk active, is the substance in a drug that

is pharmaceutically active.

Blockbuster drug: A blockbuster drug is a drug generating more than $1billion of revenue for its owner each year

50

XVII. Citations / Explanations:

1Shares of a company, listed on a recognized Indian stock exchange, if held for more than 12 months are treated as long-term capital assets.

2Over and above, if the seller of shares are companies owned by the Promoters, then a Minimum Alternate Tax @ 11.33% would be payable on the book profits.

3Rates without indexation and inclusive of a surcharge of 10% on tax + an education cess of 3% on tax and surcharge

4For the purpose of this analysis 1 USD = 44 INR (approx.)

5SEBI circular no. MRD/DoP/SE/Cir- 19 /05 dated September 2, 2005

6One other alternative could be a bulk deal sale. Though the price band of +1% does not apply to a bulk deal segment, they would be governed by the normal trading circuit of +20%.

7For the purposes of Press Note 1 (2005 Series), the definition of ‘same’ field would be 4 digit NIC 1987 Code.

8Regulation 2(ii) of Foreign Exchange Management (Transfer or issue of Security by a person resident outside India) Regulations, 2000.

9In view of lack of clarity on the subject, we understand that the Ministry of Finance was supposed to write to FIPB on whether issuance of warrants would mandate prior approval. However, response from the Government in this regard is still awaited.

10For the purpose of this analysis 1 USD = 44 INR (approx.)

11Clause 49 of the Listing Agreement executed by the listed company with the stock exchanges

121 USD = 44 INR (approx.)

13As per Regulation 22(12) of the Takeover Code, the consideration should be paid by the acquirer within a period of 15 days from the date of closure of open offer. 14 “Unpublished” means information which is not published by the company or its agents and is not specific in nature. – Regulation 2(k) of the Insider Trading Regulations

51

15 “Dealing in securities” means an act of subscribing, buying, selling or agreeing to subscribe to buy, sell or deal in any securities by any person either as principal or agent - Regulation 2(d) of Insider Trading Regulations.

16 Kohers, Ninon and Ang , James S., Earnouts in Mergers: Agreeing to Disagree and Agreeing to Stay. Journal of Business, Vol. 73, No. 3, July 2000. Available at SSRN: http://ssrn.com/abstract=229189).

17ANDA: Abbreviated New Drug Application

Citations

(i) Shah, Shreyash, Jain, Gautam, Tambade, Amit, Khatri, Chitra and Fakih,

Shuaib M.,The Ranbaxy - Daiichi Sankyo Deal: Where Do They Go

Now?(June 2, 2009). Available at SSRN: http://ssrn.com/abstract=1415972\

(ii) Revision of Earnings Forecasts- Tokyo, January 30, 2009, official release on

http://www.daiichisankyo.com/

(iii) MPRA Munich Personal RePEc Archive-Mergers and Acquisitions in the

Indian, Pharmaceutical Industry: Nature, Structure and Performance Beena, S

Centre for Development Studies (JNU), Kerala, India 28. June 2006 Online at

http://mpra.ub.uni-muenchen.de/8144/

(iv) Ranbaxy - Daiichi Deal Dissected - Ruchi Biyani / R. Vaidhyanadhan Iyer /

Nishchal Joshipura Nishith Desai Associates, Legal & Tax Counseling

Worldwide