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Investors to lose from changes in pharmaceutical FDI policy

The government will now play nanny to inbound mergers and acquisitions (M&As) in the pharmaceutical sector, a throwback to the pre-liberalization era. Fresh investments will be allowed as usual, but “brownfield” investments will need approval, initially from the Foreign Investment Promotion Board and, after six months, from the Competition Commission of India (CCI). Specific rules may be framed by CCI for the healthcare sector, in addition to rules that already cover M&As in the country.

The government’s decision is a rude shock to both Indian companies and investors. It could slow the M&A process and affect valuations of Indian pharmaceutical companies who are possible takeover targets. The gainers are the incumbents who are seeing growing competition in the markets from foreign companies.

The Indian pharmaceutical industry has grown steadily over the years. Domestic operations of most companies are profitable, and their long-term prospects are admirably bright. Growing population, rising disposable incomes and widening disease incidence, all point to growing demand for pharmaceutical companies. This is an industry that does not cry out for protection. The government’s decision is prompted by a rising incidence of Indian promoters of pharmaceutical companies selling out to foreign players. The perception is that the sector is strategic, and if it becomes predominantly foreign, then prices of generic drugs may go up. So far, there is no evidence of that happening. In fact, in the anti-infective therapeutic category, companies have been reporting that the past few quarters have seen an increase in price-led competition. That indicates growing, and not lessening, competition.

The hunger of multinational companies (MNCs) for acquisitions stems from their new strategy for India and other emerging markets. Their focus has shifted to the large branded generics market, as many of their drugs lose their patent status. Their strategy now mimics that of their Indian counterparts. They are launching off-patent drugs, expanding their field force, entering new product categories and markets, and even going to rural markets. The acquisitions give them a base business and infrastructure, which they will grow further by making fresh investments.

It is surprising why the government thinks that foreign companies can dominate a market that is so fragmented. In 2010, Cipla Ltd had the highest market share of 5.2%, while the next two were MNCs, Ranbaxy Laboratories Ltd at 4.7% and GlaxoSmithKline Pharmaceuticals Ltd at 4.2%. With such small market shares, the argument over ownership seems less relevant. As long as competition remains unaffected, consumers will benefit.

Even when large Indian companies were present in the market, upstarts such as Alkem Laboratories Ltd and Mankind Pharma Ltd succeeded in growing rapidly. If foreign companies hike generic product prices, new players will enter the market and take away share. Nothing prevents them from doing so.

The government’s decision may backfire. By keeping aggressive foreign companies out, incumbents may have an easier time in the market. An undercapitalized company, witha disinterested promoter, is less of a threat to incumbents than an MNC with a point to prove to its overseas shareholders.

Stock valuations may get affected, too. If a promoter wants to sell out, the preferred bidder is likely to be an MNC, for they are willing to pay a hefty premium. This has been seen in recent acquisitions, such as Abbott Laboratories​’ acquisition of Piramal Healthcare Ltd. But if pharma MNCs lose interest due to government regulations, Indian players will get an edge, but valuations will drop. One thing appears certain, minority shareholders will lose as a result of the change in the FDI policy.