May 27, 2008| Pharmaceuticals

IPO Review

Bafna Pharmaceuticals Issue Opens

May 27, 2008
Issue Closes
May 30, 2008
Issue Price
Regulated growth … Rs 40

Bafna Pharmaceuticals is a Chennai-based company engaged in

manufacturing drug formulations. Currently, it sells its products to SUBSCRIBE
domestic institutional clients and unregulated markets. It now plans to
foray into the domestic retail and regulated markets. Analyst’s Name
Raghvendra Kumar
ƒ Foray into domestic retail and regulated markets raghvendra.kumar@icicidirect.com
Bafna is awaiting approval from the UK MHRA for its newly constructed
plant near Chennai. The facility is already EU GMP compliant. With the
approval, the company plans to enter the regulated market of UK, which
offers better growth and margin prospects. It also plans to enter the retail
prescription market, which is margin accretive. Fact sheet
ƒ Entry into CRAMS to boost growth outlook
Pre issue Post issue
The company intends to enter the CRAMS segment, which would boost its
Equity capital (Rs cr.) 9.58 15.98
growth outlook. CRAMS offers a better growth outlook due to low-cost
Promoters (%) 71.07 42.60
advantage in India. Others (%) 28.94 17.35
ƒ Well diversified therapeutic exposure Public (%) - 40.05
The company is well diversified in terms of therapeutic segment exposure
with presence in anti-infective, cardio-vascular, analgesic and antipyretic,
antihelmintics, appetite stimulants, cough & cold preparations, Issue details
antiulcerants, anti diabetic and vitamins.
Issue size (Rs crore) 25.6
No of shares on offer 64,00,000
Concerns Minimum lot size 150 shares
ƒ The company would be badly impacted if it does not receive approval Market cap (post issue) (Rs cr) 63.92
from the UK MHRA. Without the approval, it cannot sell its products in
the high-margin UK market and its revenue profile would remain
unchanged. It is currently operating on a wafer thin operating margin
of 5-8%.
ƒ Well established and bigger companies already have a presence in the Comparative return metrics
regulated markets. For a new entrant like Bafna, it may be difficult to Stock return (%) 3M 6M 12M
gain a foothold. BDH Industries -15.71 -57.04 -24.36
ƒ The company intends to enter into the very competitive domestic retail Celestial Lab 31.41 5.34
prescription market. We believe this would result in an increase in Jenburkt Pharma -7.32 -14.97 -32
marketing expenses and put pressure on the EBIDTA margins. Syncom
-16.13 -52.83 -18.54
Formulation
Valuations
The annualized EPS for FY08 (on a nine-month profit and post-IPO fully
diluted equity) of Rs 1.08 discounts the offer price of Rs 40 by 37.04x. The
annualized weighted average FY08 EPS (at full year equity of Rs 9.58) of Rs
1.82 discounts the issue price by 22x. Though the pricing looks expensive,
we believe the company’s foray into the lucrative regulated and domestic
retail markets would boost revenue visibility. Meaningful revenue would
accrue only from FY10 onwards. Investors with a long-term perspective
should subscribe to the issue.

Exhibit 1: Key Financials (Rs crore)

Year to March FY05 FY06 FY07 9MFY08
Net Sales 25.30 20.16 36.01 25.38
EBIDTA 2.05 1.83 2.07 2.06
Net Profit after exceptional income 0.89 0.85 0.97 1.29
EPS (Rs)
(Diluted on current equity) 3.89 2.19 2.51 1.35
Source: Company, ICICIdirect Research

ICICIdirect | Equity Research

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Company Background Objects of the issue

Bafna Pharmaceuticals was established in 1981 as a proprietary • To undertake a brand building

concern by Mr Bafna Mahaveer Chand. It started manufacturing exercise in the domestic and
operations in October 1984. The manufacturing operations took off international markets
with a tablets facility and subsequently capsule and oral syrup
facilities were added. • To part finance the cost of obtaining
UK MHRA approval for Grantlyon unit
So far, the focus of the company has been on institutional sales.
Apart from the domestic markets, the company also has presence in • To set up a R&D unit at Grantlyon
the unregulated international markets such as Ukraine, Sri Lanka,
Ghana and Laos. The company has 57 products registered in Sri • To meet its working capital
Lanka, 4 in Ukraine, 1 in Ghana and 3 in Lao. requirements

The company has two manufacturing facilities near Chennai (one in • To partly repay a loan taken from SBI,
Madhavaram and another in Grantlyon). The company is now Chennai
shifting its focus to the lucrative regulated markets and also the
ethical retail prescription based domestic markets. It has • To meet the public issue expenses
constructed a manufacturing facility in Grantlyon Village, near and to achieve listing on stock
Chennai to expand its operations to regulated market like US and exchanges
UK and also to manufacture its own products.

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INVESTMENT RATIONALE

Industry structure and outlook

During FY1998-2005, the global pharmaceutical industry logged an 11% CAGR.
The regulated markets, which make up 88% of the global market, grew at a
robust rate. Banking on its low-cost advantages, the Indian pharma space has
successfully projected itself as a preferred outsourcing partner to the big MNC
pharma majors. The domestic pharma industry registered a 19% CAGR over
FY98-06. Formulations account for 55% in revenue terms of the Indian pharma
sector. We believe the growth story will continue as India maintains its cost
advantage and abundant skilled staff. India also has among the largest number
of US FDA-approved plants. This would help it capitalize on the large generics
opportunity emerging in the regulated markets in the next few years. We
believe the persistent advancement in the manufacturing facilities by Indian
players to enter the regulated markets would further drive the exports.

R&D: The key to success in pharma business

Having recognized the importance of research and development (R&D) for the
regulated markets, Bafna plans to focus more on R&D going forward. Out of
the Rs 25.6 crore it plans to raise from the issue, the company plans to invest
Rs 3 crore on R&D. For the regulated markets, it would manufacture generic
drugs, wherein it would use the reverse engineering for the product, but the
technology that the company would apply should be non-infringing. R&D team
would become handy in finding new non-infringing processes for the reverse
engineered products. After India became a product patent compliant nation on
Jan 1, 2005, R&D is becoming a key success ingredient in pharma sector.
Moreover, in order to succeed in the formulations export to regulated markets
of US or Europe, which offers higher margins, a company needs to have
strong R&D team developing new processes for existing molecule. Bafna plans
enter the contract manufacturing business post the MHRA approval.

Proficient to produce multiple products

The company manufactures formulations under various therapeutic segments
such as anti-infective, cholesterol lowering agents, analgesic and antipyretic,
antihelmintics, appetite stimulants, cough & cold preparations, antiulcerants
anti diabetic and vitamins. The company’s manufacturing facilities are multi-
adaptable i.e. the facilities can produce multiple products using a combination
of process. The therapy distribution enables the company to capture the
growth in any therapeutic segment and ward-off the risk emerging from slow
down in a particular therapy area.

Diversifying into new markets

Bafna plans to enter regulated markets post to this IPO. The foray into new
markets would enable the company scale a new growth trajectory and also de-
risk its existing business. The company intends to diversify into a growing
market of formulations used in lifestyle disorder segments like diabetic,
cardiovascular and also enter growing anti-infective market by launching the
products and promoting them ethically through brand building exercise in
India as well as in the international market.

Increased contract manufacturing activities

India started recognizing the product patent in 2005, which boosted the
confidence of global pharma companies with strong IP (intellectual property)
based products portfolio to outsource manufacturing to India. This opened up
a new line of business for the Indian pharma industry – Contract Research and
Manufacturing Services (CRAMS). CRAMS has its roots in the outsourcing &
off-shoring strategy that is successfully being employed by the developed
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countries. Many large multinational pharmaceutical companies with large
discovery pipeline and proprietary products are expected to be affected by
declining research productivity and the number of drugs going off-patent. In
order to maintain their margins and protect their growth momentum, these
companies are emphasizing on reducing manufacturing cost. With the
objective of maintaining their margins, these pharma MNCs are likely to keep
the outsourcing thriving in the foreseeable future. Since Bafna has already set
up its new factory as per EUGMP guidelines and MHRA officials have made the
visit, we believe the company would bank on the recent outsourcing trend but
the essential ingredient would be MHRA approval of the plant.

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KEY CONCERNS

Pending approvals
Officials from the UK MHRA visited its plant near Chennai in early 2008 and the
company expects approval in few months. However, if the approval does not
come in, the revenue profile would remain the same. Currently, the company’s
operating margins are wafer thin at 5-8%.

Late entry into the regulated markets

Bafna has been late in entering the regulated markets. These markets are
highly regulated and competition is very high.

Very high input cost

The operating cost of the company is very high. Revenues may be high in the
regulated markets, but expenses are also high. The company is entering into
new markets (domestic retail prescription market and regulated markets),
accordingly there will be heavy expenditure to establish its presence in these
markets. The company is expected to breakeven in 18-24 months.

Pressure on EBIDTA margins

The company intends to enter the retail prescription market, which is highly
competitive with very large number of players. We believe the rise in
marketing expenses in coming few quarters will put pressure on the EBIDTA
margins.

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FINANCIALS

Bafna Pharma is entering into the lucrative businesses of regulated markets

and retail segments which may generate handsome revenue and margins
could expand substantially. But all depends upon the approval from UK MHRA.
The company is also foraying into the domestic retail segment, which is a
lucrative segment and offers good margins. But we believe that the company
would take around 15-18 months to break even as the domestic market is
highly competitive with so many players.

The company reported a 19.29% CAGR in top-line over FY05-07. But there was
a de-growth in bottom-line during the same period from Rs 0.48 crore to a loss
of Rs 0.33 crore. For the nine-month period ended Dec 31, 2007, the company
reported a net profit of Rs 2.21 crore on sales of Rs 25.38 crore.

The revenue of the company de-grew year-on-year in FY06, but it grew by

76.88% in next year (i.e. 2007). The sudden rise was due to increase in sales
from the EoU (export-oriented unit) at Madhavaram. The nine months revenue
for the year ending 2008 is roughly maintained at the same level as of the
previous year.

For the full year FY07, the company reported a profit before tax of Rs 1.19
crore against Rs. 1.06 crore in FY06. Though the company improved its
performance, it was not been able to improve its profit margins. The profits
margins have bounced back to 10.83% in the nine months for year ending
2008.

VALUATIONS

The annualized EPS for FY08 (on the basis of nine-month profit and post-IPO
fully diluted equity) of Rs 1.08 discounts the offer price of Rs 40 by 37.04x
while the annualized weighted average FY08 EPS (at full year equity of Rs 9.58)
of Rs 1.82 discounts the issue price by 22x. The pricing looks to be on higher
side factoring the current financials. The company is foraying into the lucrative
regulated markets and domestic retail segment. We believe the meaningful
revenue would come from FY10E onwards. Investors with a long-term
perspective should subscribe to the issue.

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FINANCIAL SUMMARY

Profit & Loss A/c (Rs crore)

Year to March FY05 FY06 FY07 9MFY08
Net Sales 25.30 20.36 36.01 25.38
Total expenditure 24.57 19.54 36.55 22.63
EBIDTA 0.73 0.82 -0.54 2.75
Other Income 0.91 1.18 1.24 0.20
Interest 0.49 0.50 0.51 0.45
Depreciation 0.17 0.27 0.37 0.26
Profit Before Tax 0.98 1.24 -0.18 2.25
Tax 0.50 0.14 0.15 0.04
Net Profit before Adjustments 0.48 1.10 -0.33 2.21
Adjustments 0.40 -0.25 1.30 -0.91
Net profit as adjusted 0.89 0.85 0.97 1.29
OPM (%) 2.88 4.03 -1.51 10.83
NPM (%) 3.50 4.16 2.69 5.09
Outstanding Shares (Cr) 0.23 0.39 0.39 0.96
EPS (Rs) 3.89 2.19 2.51 1.35
(Diluted on current equity)

Balance Sheet (Rs crore)

Year to March FY05 FY06 FY07 9MFY08
Sources of funds
Equity Share Capital 2.28 3.87 3.87 9.58
Advance against share capital 0.30 0.28 2.77 0.00
Reserves & Surplus 1.68 1.54 2.50 2.37
Secured Loans 6.72 11.46 15.85 22.78
Unsecured Loans 0.06 0.00 1.26 1.31
Current liability 5.17 4.05 27.50 23.61
Provisions 0.51 0.16 0.13 0.13
Deferred Tax Liability 0.14 0.11 0.13 0.12
Total Liabilities 16.85 21.46 54.01 59.90
Application of Funds
Net Block 2.16 3.59 2.49 2.35
Capital work in progress 1.47 4.45 23.02 26.52
Investments 0.00 0.00 0.00 0.00
Cash and bank balances 1.16 1.08 1.77 1.36
Inventories 5.85 4.97 6.56 6.76
Sundry debtors 4.27 4.96 18.41 20.61
Loans and advances 1.92 2.35 1.72 2.27
Miscellaneous Exp not w/off 0.02 0.06 0.05 0.03
Total Assets 16.85 21.46 54.01 59.90

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RATING RATIONALE

ICICIdirect endeavors to provide objective opinions and recommendations. ICICIdirect assigns ratings to its
stocks according to their notional target price vs. current market price and then categorises them as
Outperformer, Performer, Hold, and Underperformer. The performance horizon is 2 years unless specified and
the notional target price is defined as the analysts' valuation for a stock.

Outperformer: 20% or more;

Performer: Between 10% and 20%;
Hold: +10% return;
Underperformer: -10% or more.

Pankaj Pandey Head - Research & Advisory pankaj.pandey@icicidirect.com

ICICI direct Research Desk,

ICICI Securities Limited,
Mafatlal House, Ground Floor,
163, H T Parekh Marg,
Churchgate, Mumbai – 400 020

research@icicidirect.com

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