Syncom Healthcare IPO Review

Syncom Healthcare (SHL) is an Indore based pharmaceutical company promoted by Ajay Bankda and his family. The company manufactures and markets pharmaceutical formulations under its own brands in ethical, OTC, generic and herbal segments. It company established its first manufacturing facility at Selaqui, Dehradun, in Uttarakhand, for manufacturing all types of formulations in November 2006.

SHL came into existence on July 29, 2002 during family partition to carry the domestic formulation business of Syncom Formulation (SFL). Subsequently, SHL and SFL entered into an agreement on use of certain trademarks/copyrights/brands in the domestic and export markets. Under the agreement, SHL cannot sell its products in export markets under the ‘Syncom' brand for the products covered in the agreement, whereas SFL cannot sell these products in domestic market.

SHL started by marketing pharmaceutical products manufactured by others under its own brand. After commencing its own manufacturing facility, it also started contract manufacturing. The company produces more than130 products in the generic segment, 40 products in the OTC segment, 20 products in the ethical segment and 25 products in the herbal segment.

As a growth strategy, SHL is planning to enter overseas market. For this purpose, it proposes to set up a UK MHRA, US FDA and WHO-cGMP compliant formulation manufacturing facility at Indore SEZ. To boost revenue from contract manufacturing, the company is upgrading existing plant and planning to get WHO approval.

The object of the issue is to raise funds to finance its future plans (1) to set up new manufacturing unit at Indore SEZ for manufacturing various pharmaceutical formulations: Rs 20.48 crore; (ii) to undertake the upgradation/ modernization of manufacturing facilities at the Dehradun plant: Rs 6.62 crore; (iii) to meet working capital requirements: Rs 15 crore; (iv) to set up an export office at Mumbai: Rs 4.00 crore; and (v) to undertake brand & product registration and approval: Rs 3.00 crore. The balance is for general corporate purposes as well as public issue expenses.

Strengths

* The manufacturing facility at Dehradun was set up in a tax-free and duty-free zone. The company enjoys 100% excise duty exemption for 10 year from the year of commencement of production (2006), 100% income tax exemption for first 5 years from assessment year, and 30% exemption for subsequent 5 years.
* Currently, the company is undertaking contract manufacturing (a healthy margin business) for domestic and international companies. Top clients are Lupin, Piramal Healthcare and Galpha Labs.
* The promoter has experience of over 26 year in the pharma sector.

Weaknesses

* The trade agreements between SHL and SFL limit exports of many existing branded products of the company. However, the company can sell these products in export market with different brand names.
* The company has not entered into any agreement for acquiring land for the new manufacturing facility. It expects to acquire land by March 2010 and commence commercial production by December 2010. The process will be affected if there is any delay in project execution / regulatory approvals.
* There is considerable delay in getting approvals from US FDA / UK MHRA of late. By thumb rule, it takes at least two years for getting approval from UK MHRA and US FDA for manufacturing facility. So, for significant revenue from advanced markets from the Indore facility, the company / investors may have to wait for even up to three years from now.
* The company's cash flows from operations were negative in four out of the last five years. Even for the four months of the current fiscal, they are negative.
* The revenue contribution from Top 10 clients increased from 40.25% in 2005 to 68.95% in 2009. There is high concentration of revenue from top 10 clients. Loss of any one or more of these clients could adversely affect the company's performance. In the same way, the top 5 suppliers constitute more than 50% of purchases. If any these suppliers fail to provide raw materials of specified quality and quantity at proper time, it will also impact the company's performance.
* The company gets a sizeable portion of its revenue from domestic generic market. To push through its products in this competitive market, it appears to have given huge credit, with 47-52% of the revenue remaining as sundry debtors in the last few years. This not only locks the company's funds, but also exposes it to high credit risk.
* The company's margins have been steadily eroding from 17.6% in FY 2007 to 15.8% in the four months ended July 2009.

Valuation

Sales of SHL increased by 17% to Rs 60.56 crore for the year ended March 2009. But its net profit rose mere 3% to Rs 3.81 crore, on fall in margins. The company recorded sales of Rs 20.99 crore (i.e. 35% total sales of FY 2009) and profit of Rs 1.79 (i.e., 47% of profit in FY 2009) for the four months ended July 2009. At the offer price band of Rs 65-Rs 75, the EPS of Rs 2.2 for FY 2009 is discounted by 29.5 to 34.1 times. However, at annualized EPS of 3.1 for the four months ended July 2009, the P/E stands at 21 to 24.2 times at the lower and upper band respectively. But the TTM P/E of the Pharma – Formulation sector is just 8.8.

Syncom Healthcare IPO Analysis

Investments can be avoided in the initial public offering of Syncom Healthcare, which is engaged in the manufacturing and marketing of pharmaceutical formulations in the domestic market. At the price band of Rs 65-75, the offer is priced at 23-26 times its likely FY10 per share earnings on a post offer equity base. This seems expensive considering that many of the top tier pharmaceutical companies with better business fundamentals, market reach and growth potential are available at much lower valuations. The company's presence in a highly competitive market and it's relatively low experience in manufacturing operations also necessitate a cautious outlook .

Company overview

Catering primarily to the domestic market, Syncom manufactures and markets pharmaceutical formulation under its own brand name in four product segments — generics, OTC (over the counter), ethical and herbal. The company also undertakes contract manufacturing for various pharmaceutical formulations, neutraceutical products, food supplements and cosmetics for domestic companies such as Lupin and Piramal Healthcare. Further, it recently added other companies such as Wockhardt, Klar Sehen and Canixa Sciences to its existing list of contract manufacturing companies.

Prospects, challenges

Though the growth undercurrents in the domestic formulation business are getting stronger, the presence and increasing focus of bigger players on the domestic market may make it doubly challenging for Syncom to chart its growth path; the bigger players cater to a chunk of the market already. The rest of the market is characterised by many small and unorganised players.

It will be Syncom's distribution reach, brand presence and product launches that would help it scale growth in future. While the company has scored decently on these counts so far, growing its revenues at a compounded rate of over 42 per cent in the two years after it set up a manufacturing facility in Dehradun, it was on a low base and driven by volume increase. High competitive pressure and price sensitivity of the domestic market appears to have kept realisations capped, suggesting this could very well be the way forward too.

The company derives a significant share of its revenues from too few a clients; the top ten made up over 69 per cent of its revenues last fiscal. While this per seisn't reason enough for concern — such high dependence is quite common among companies with smaller scales of operation — what may be discomfiting is its working capital management.

High dependence on a handful of clients and little bargaining power appear to have strained the company's cash flows, with its working capital cycle increasing to 198 days in FY09 from 153 seen a year earlier — over 57 per cent of the total debtors exceeded six months. While an extended credit cycle to some extent is typical of the OTC segment, the company's revenue exposure to the segment was just about 24 per cent in the last fiscal.

via BL