Kotak - Sun Pharma

Sun Pharma plans to raise Rs35 bn (US$850 mn) by issue of equity/convertible bonds. This will imply a 16.5% dilution, assuming an issuance at market price. With a cash-chest of US$850 mn, Sun will likely continue its prowl for under-utilized assets. Thus far, the acquisition strategy seems to have been value accretive.
Clearly with two events (closure of Taro acquisition and fund raising) outstanding, the
stock is un-likely to move up in the short-term. However, the long-term growth strategy seems to be getting stronger.
Sun recently announced its intent of acquiring Taro Pharma at an EV of Rs22.5 bn (not factored into our estimates). Only the deal price of US$454 mn will reduce our FY2008 net profit estimate by 8% (loss of interest income). In CY2005, Taro had sales of US$298 mn sales and net profit of US$6 mn (65% gross margin and 14% operating margin). However numbers have significantly deteriorated in CY2006, with sales of US$180-200 mn and net loss of US$95-120 mn. This will likely be skewed towards non-recurring charges in our opinion. This deal will be negative to EPS for FY2008, and as per the management be accretive in FY2009.

We have fine-tuned our model. For FY2008, we estimate revenue growth of 23% and EPS growth of 16% to Rs43.4. Despite assuming 280bps margin expansion, our EPS growth is constrained by sharp drop in other income. Our EPS will likely drop by another 8%, if we were to assume the fund outflow for the Taro acquisition. For FY2009, we have modeled 21% revenue growth and 25% EPS growth to Rs54.2