Primary Offer. Eris Lifesciences (IPO): Expensive solution

The initial public offer of Ahmedabad-based specialty pharma company Eris Lifesciences (Eris) is underway. The issue is an offer-for-sale by promoters and other shareholders in the price band of ₹600-603.The company has charted a strong growth path so far on the back of its focus on lifestyle-related specialised therapeutic areas in the Indian market, a high growth opportunity.

A low base has also helped, with the company just about a decade old. The company’s growth prospects seem bright. Strong balance sheet and expansion through acquisitions and entry into new product categories are positives too. Its India-only business model also offers comfort in the current scenario of many export-oriented pharma firms facing regulatory heat abroad.

But the offer has been priced at a stiff premium, that factors in all these positives and more. At the upper end of the price band (₹600-603), the issue’s valuation (price-to-FY17 earnings) is nearly 34 times — much higher than the S&P BSE Pharma’s valuation of about 26 times.

Even compared with the high valuations of some India-focused pharma MNC subsidiaries (24-32 times), the Eris Lifesciences issue seems pricey. The steep valuation of some of the MNC pharma companies can also be called into question.

While the company has been growing faster than many peers, its pace could moderate as size increases and the base gets bigger. Besides, benchmarking valuations with pricey MNC pharma stocks could be tricky, given the different organisation profiles, brand positioning, and premiums due to delisting possibility incorporated in many MNC stocks. Investors can wait out the primary issue and look for more attractive price points to buy into the stock after its listing.

Incorporated in 2007, Eris Lifesciences manufactures and sells high-margin branded pharmaceutical products only in India. Unlike many India-based pharma peers, the company does not export to foreign markets. Its focus is the fast growing lifestyle-related therapeutic categories in the country. The product portfolio includes niches in high-growth chronic and acute categories such as cardiovascular, anti-diabetics, vitamins, gastroenterology and anti-infectives.

The company operates mainly through the prescription-led business model, with high focus on specialists and super specialists such as cardiologists, diabetologists, endocrinologists and gastroenterologists. More than three-fourth of the company’s revenue comes from metros and Class 1 towns.

Eris is among the top five companies in India by prescription share. The number of doctors prescribing the company’s products increased to 50,282 in FY17 from 37,842 in FY13. It had 1,500 marketing representatives as of March 2017.

The product portfolio comprised 80 mother brand groups as of March 2017. The chronic category, one of the fastest growing segments in the Indian pharmaceutical market (IPM) due to increasing incidence of lifestyle-related diseases, has driven Eris’s growth.

Driven by cardiovascular and anti-diabetic therapies, the company’s chronic category posted revenue at a compounded annual growth rate (CAGR) of 29 per cent between FY13 and FY17, double the industry pace in the segment.

The segment accounted for 66 per cent of overall revenue in FY17 and helped the company grow faster than its peers. The FY17 acquisition of Amay Pharma’s trademarks of 40 brands in cardiovascular and anti-diabetics space has strengthened its presence in the category. The company has also acquired 75.5 per cent stake in Kinedex which focuses on mobility-related disorders in the musculoskeletal therapeutic area. The acute category, which contributes 34 per cent of the company’s overall revenue, primarily comprises vitamins, with presence also in gastroenterology, acute pain-analgesics, anti-infectives and gynaecology.

Many of the company’s brands have seen strong growth, outpacing the industry. For instance, the flagship products Glimisave (anti-diabetics) and Eritel (hypertension), that together account for about a third of FY2017 sales, have seen CAGR of 29 per cent each between FY13 and FY17. Its top 10 brand groups that contribute about three-fourth of the total business, have leading market positions.

The focus on categories linked to lifestyle disorders should aid sustainable growth, given that such drugs are prescribed over an extended period. The company plans to foray into new chronic therapies such as neurological pain and dermatology. Its strong balance-sheet allows for inorganic growth through more acquisitions.

Eris’ revenue grew at a CAGR of 17 per cent between FY13 and FY17 to ₹725 crore, compared to the 11 per cent growth of the overall Indian pharmaceutical market.

The company’s profit rose at a much faster 43 per cent annualised in this period to ₹242 crore, indicating good pricing power and cost control that aided profitability. The operating margin rose to 37 per cent in FY17 from 22 per cent in FY13. The balance sheet is debt-free and cash-rich.

Risks include the company’s dependence on a single manufacturing facility, extended pricing controls and the government’s push to generics. Currently, the company depends on its sole facility in Assam for most of its production.

Any disruption in the facility will impact business. This facility is entitled to avail of certain tax incentives, including income tax and excise duty exemption until FY24/FY25. Dilution of these incentives could hurt margins.

Many pharma companies selling drugs in the domestic market have taken a hit due to Drug Price Control Order (DPCO) imposed by the government.

For Eris, given its competitive pricing structure, only molecules pertaining to around 12 per cent of total revenue have been under the National List of Essential Medicines (NLEM). But continued addition of new drugs under the NLEM could pose a risk.

The recent notification requiring doctors in India to provide prescriptions in terms of generic pharma names could also impact the company’s business.

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