With little patience & luck, Daiichi could come good on second bet

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Japanese drugmaker Daiichi Sankyo Co, which offloaded its stake in Ranbaxy to Indian generic major Sun Pharmaceutical for $2.02 billion in exchange for a 9 per cent stake in the latter and no cash, might take up to 42 months to recoup its loss from the transaction should luck and patience eventually turn in its favour, and Sun Pharma live up to market expectations as a successful turnaround artist and investor favourite.

We worked on simple arithmetic to arrive at this conclusion. For the record, Daiichi invested $4.6 billion to acquire 63.41 per cent stake in Ranbaxy in 2008. Going by the $2.02 billion valuation at which Daiichi exchanged Ranbaxy shares for a 9 per cent stake in Sun Pharma, the Japanese drugmaker would have booked a loss of $2.58 billion.

But its 9 per cent stake in Sun Pharma is interesting. The Sun Pharma share has registered a compounded annual growth rate (CAGR) of 25.81 per cent over the past six years, between June 2008 and April 2014, during which Daiichi controlled Ranbaxy.

Should the share continue to clock the same CAGR of 25.81 for the next three years and six months, the value of Daiichi's 9 per cent stake in Sun (pegged at $2.02 billion right now) would rise to $4.6 billion, helping it wipe out its entire loss on the deal in a little more than half the time that it has owned Ranbaxy.

Such a possibility, though of immense interest to Daiichi shareholders in Japan, comes with a big 'if'. And the big question is whether the Sun Pharma stock would rise at the same pace as in the past six years.

While there is little doubt that management of Sun Pharma has shown tremendous ability to take over companies and turn them around, a company's stock price is not only determined by its corporate fundamentals but also several other factors, including the broader economic growth numbers and whether high risk trade is in vogue or not. These imponderables are beyond any management's control or wishful thinking, which is why, predicting future stock price behaviour is hazardous business.

One of the biggest factors contributing to the outperformance by Sun Pharma in the past six years was the defensive bet placed on all pharma stocks listed on Indian bourses. Sectors considered defensive tend to perform better compared with the broader market indices in a slowing economy. This discounting has moved pharma stocks higher in the past six years. Right now, most have been trading at the upper end of their valuation zone in which they have historically traded.

Going forward, all this could change. Should cyclicals and industrial stocks stage a comeback after the elections and attract greater investor interest, then the current valuations given to pharma stocks will come under investor scrutiny. Cyclicals have already gained weight in the past two months, while pharma and other defensive stocks have underperformed indices.

Should this situation persist, all pharma stocks could underperform under a prolonged corrective spell. In that case, Sun's valuation could contract. On the other hand, if cyclical stocks are unable to attract investors post polls, good cash would continue to flow into pharma and Sun Pharma would continue to show a high probability of beating broader indices.

Daiichi has bet a second time on India. The success of its gamble this time depends on whether high risk trades resume on Indian bourses.


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