Equity Analysis /

The Searle Company: Acquisition of OBS Pakistan can be value accretive; Buy

    Yusra Beg
    Yusra Beg

    Senior Investment Analyst

    Intermarket Securities
    23 October 2019

    Acquisition details – lower-than-expected transaction cost

    The board of directors of SEARL have resolved to acquire 100% ownership in Luna Pakistan (the indirect owner of OBS Pakistan Pvt. Ltd) from Universal Ventures (Pvt.) Ltd. The transaction size of PKR8.6bn, is much lower than PKR10-11bn expected earlier. 

    OBS Pakistan is expected to increment sales revenue of SEARL by PKR c5bn (or c24% of FY 20f top-line of PKR20.5bn). The combined sales after the merger implies an acquisition P/S of c1.7x, much lower than the historical 2.0x P/S for the broader pharmaceutical sector. OBS Pakistan is expected to contribute between 5-19% to SEARL’s profitability, after adjusting for finance costs in case SEARL opts for debt funding with a net EPS impact of PKR0.62-2.25/sh 

    About OBS Pakistan 

    OBS Pakistan is one of Pakistan’s top corporations in the healthcare sector and is a leading producers of iron sucrose injections (brand name: Venofer), which contributes c25% to the overall topline. OBS has a relatively small drug portfolio where its top-5 drugs contribute c60% to the overall topline, all of which fall in the National Essential Medicines List. These are primarily concentrated in the following segments: nephrology, rheumatology, cardiovascular and antibiotics, etc.

    SEARL to offload Tarzz to partially finance acquisition 

    In order to finance the transaction, SEARL is transferring 100% stake in IBL Identity (textile manufacturer named Tarzz) to Universal Ventures. The fair value of this transaction is PKR3.1bn, and IBL Identity is booked at cPKR50mn cost on SEARL’s balance sheet, which may result in a gain of PKR3.05bn. We expect this gain to be transferred through statement of changes in equity, as per the classification opted by the company for IFRS-9 application on equity investments. It is pertinent to mention that SEARL has extended a PKR3.1bn to IBL Identity in FY 19.

    Remaining funds may be raised via debt and dividends 

    With little cash on its books (PKR262mn as at Jun’19), the balance of this transaction (PKR5.5bn) is likely to be funded via a mix of debt financing and dividends, in our view. Currently, SEARL is owed cPKR2.5bn in dividends from Searle Pharmaceuticals (Pvt.) Ltd, as at Jun’19. While we think this will help partially settle PKR4.25bn of the cash to be paid at the time of transfer we have run an initial sensitivity analysis to account for different funding options

    OBS acquisition can be value accretive 

    The aforementioned acquisition falls in line with SEARL’s strategy, having recently acquired the distribution and marketing rights for several flagship brands of Reckitt Benckiser (Gaviscon, Disprin, Bonjela etc.). We tentatively expect this transaction to add cPKR10-20/sh to SEARL’s existing target price based on a pharmaceutical target P/E of 15x. SEARL has shed 36% CYTD following sharp PKR devaluation (Dec’17-to-date: 32% vs. the US$). With the currency now largely stabilised, we expect gross margins to sustain at c.49% going forward (FY19: 48%). SEARL trades at FY 20f P/E of 11.6x and P/S of 1.5x, while offering a 19% upside to our Jun’20 TP of PKR188/sh (without incorporating OBS). We have a Buy rating on the name.

    Risks: Not applicable.