India's largest generic drug company by market cap, Sun Pharma (Bombay: 524715) [link to analysis of this market], and Israel-based Taro Pharma (TAROF.PK) have one month to reach agreement on an outstanding tender offer of $7.75 per share by Sun Pharma to acquire its smaller rival or the Israel Supreme Court will decide on the case. In early 2007, Taro agreed to the deal as it was struggling to survive and Sun invested $60M as part of a private placement to resolve Taro's liquidity issues.
However, in May of this year Taro cancelled Sun Pharma's takeover of the company and in September a Tel Aviv District Court dismissed Taro's argument that Sun must make a special tender offer for the founding shares of Taro. The $7.75 per share tender offer values Taro at about 0.9X sales or $283M, compared to a closing price yesterday above the offer at 9 bucks for a market cap of $328M. As of 3Q08, Taro had $313M in trailing 12-month sales, a PE of about 15X, $66M in cash, and net debt of $123M.
If Sun Pharma is willing to pay 0.9X sales for Taro, that is over 3X the current valuation of Caraco Pharma (CPD), which is trading at under 0.3X sales – so a similar valuation would put Caraco over 10 bucks a share. Also, Caraco has a much stronger balance sheet with zero debt, $33.6M in cash, and is already a 76% subsidiary of Sun Pharma. Caraco has guided for sales growth of 25% for the 2009 fiscal year and has responded to the FDA's warning letter on quality control issues.
The observations set forth in the warning letter include, among other things, the inadequate and untimely investigation by the quality control unit of certain incidents at the facility contrary to the company's standard operating procedures (SOPs). Sun Pharma has clarified that dispensing errors were made at Caraco's Detroit manufacturing facility highlighted in the warning letter, but no products made it to the market and the sale of existing products were allowed to continue.
Caraco is a key to Sun Pharma's U.S. sales and growth strategy, accounting for about 20% of the 96 abbreviated new drug applications (ANDA) filed by Sun for new generic drug products. Since the FDA may withhold approval of ANDAs until the warning letter is resolved, it is in the interests of both companies to resolve the issues in a timely manner and Caraco filed its complete response to the agency with a request for a meeting.
As illustrated in the accompanying one-year chart (click to enlarge), Caraco has lost over two-thirds of its market value in the past year and is extremely undervalued compared to its generic drug peers such as Taro, Mylan Labs (MYL), and Hi-Tech Pharmacal (HITK). I own Caraco and will continue to hold the shares until the market places a reasonable valuation on the company, which I believe is north of 10 bucks based on Sun Pharma's tender offer for Taro at 0.9X sales despite a weaker balance sheet at Taro which includes net debt of $123M.
