Nicholas Piramal India’s share price is up by 16% over a week, closing today at Rs 288. Its decision to float a separate company, to which it will transfer its new drug research business, and list it on the bourses is behind this excitement.
Traditionally, demergers have ended up rewarding shareholders and NPIL’s shareholders too expect the same. They have a precedent to go by in the form of Sun Pharmaceuticals. What binds these companies closer is that they have now embarked on a similar business model. Sun Pharmaceuticals hived off its research division into a separate company, Sun Pharma Advanced Research Company (Sparc), which is now valued by the market at about Rs 1,535 crore.
Sun Pharma’s market price itself has jumped by 26% since Feb’06 when it had first announced this restructuring plan. The situation is a tricky one. At one level, new drug research is expensive and risky, out of 8-10 candidates, only one or two may find their way into the market. It requires money, grit and luck. It can also play havoc with funding requirements and valuations, as it sponges off the cash flows from the current business. Hiving them off presents investors with an option to let go of the new drug research business. And, investors with a greater appetite for risk may even give the new drug division a better valuation.
That’s why Sparc gets this market valuation, though none of its drugs have gone on the shelves. In the case of Nicholas too, investors would be expecting a similar development. Nicholas has three drugs in the clinical trials stage, and expects five more to enter clinical trials by end of 2008. Its market value has gone up by Rs 843 crore since this announcement.
The demerger will take some time to complete due to the legal formalities involved. Nicholas will be transferring cash of Rs 95 crore and assets worth Rs 90 crore and Nicholas’s shareholders will get one share of the new company for every 10 shares held. The near term effect will be twofold. One, Nicholas’ performance will improve as the research expenditure gets transferred to the new company. Its earnings per share is expected to be Rs 17 instead of Rs 14, as per the company’s guidance. Two, the new company will be separately valued by the market.
While these are valuation games that the market will play out over the next so many months, a moot question is whether this model is right. Research, after all, is the soul of a pharmaceutical company. Separating it just because it weighs down valuations does not make sense. Even if one of the drugs from these research divisions makes it to market, the new company’s valuations will skyrocket. At that time, they may rush to merge the companies back with themselves.
But will the new company’s shareholders be interested in that. Will the current promoters wield enough power to get the companies to merge? What if institutional investors adopt a different stance? It will be interesting to see how events play out. What do you think?