Why Quadria Capital’s Amit Varma Is Bullish On The Pharma Sector
Amit Varma sees a positive trend in healthcare investing as post-Covid, people have started to focus more on their health.
Amit Varma, managing partner at Quadria Capital, is betting on the contract development and manufacturing organisation, or CDMO, space within the larger pharma sector.
Indian pharma companies are not completely dependent on US generics, as there is a greater boost towards flexible manufacturing, he said. Digital automation, relationship-building with global pharma companies that extends to strategic relationships, along with growing demand for personalised medicine are some of the reasons why Varma is positive about the sector.
The trend in healthcare investing continues to be bullish, because post-Covid, people have started to focus more on health. “I also see another positive change that the realisations have gone up, and that is again beginning to augur well for our industry.”
In terms of CDMO players to invest in, Varma said that they focus more on the company’s ability to specialise and work on dedicated molecules that are hard to reproduce. He would prefer to invest in a company, which is good at fermentation like Concord Biotech Ltd., he said.
“These are the kind of companies we look for, that have their own niche which have their own specialisation, which others will not be able to reproduce,” he said.
As for the diagnostics space, Varma believes that there are new growth initiatives taking place and that all the large listed, branded players together don't even make 10% of the market. So, there is a 90% huge mom-and-pop market out there, which is "ready for roll-up", he said.
According to him, diagnostics players should focus more on their balance sheet by improving their networking capital and generate more free cash flow. "Once they have scale and size, they'll be able to lower their costs because of the volume," he said.
Watch the full conversation here:
Edited Excerpts From The Interview:
It has been about six months since we last spoke to you. Have things changed quite dramatically in healthcare since then, or has the investing trend largely remained the same?
Amit Varma: So first, let me start off by saying I need to be honest, because you quiz me every six months. So I need to be clear that my consistency stays. The trend in healthcare investing continues to be bullish. It is very positive not just in India, but across the region.
I think a lot of it is depending upon the case utilisation and the fact that there is a high throughput through all facets of healthcare and this is a post-Covid phenomenon, where I think people have started to realise and focus a lot more on their health.
I also see another positive change that the realisations have gone up and that is again beginning to augur well for our industry.
Before 2023 began, the conversation was whether there will be pricing pressure in the US markets. Maybe, for the Indian players, generic Revlimid has been the saviour. Has it run its course, because it's typically a cyclical business, or do you believe there is merit in looking at this US generic player’s market a bit more constructively, even now?
Amit Varma: Let me try and answer it beyond Revlimid. I will come back to it in a second.
I do believe that there is a US pharma macro that is playing out. There are huge number of drug shortages in the US and most importantly from an Indian player, we are beginning to see price stabilisation.
I think, that is happening especially in the small molecule category. So that is enabling a shift that's taking place and I think also the upcoming patent cliff issues where a lot of drugs are going to go off patent, especially between FY25 and FY28, the macro is coming together to make it positive for most drug manufacturers out of India.
I think, also when the pricing pressures were taking place, and the world wasn't looking as good for Indian pharma, Indian pharma played it smarter. For example, we got out of an unprofitable product line.
So all in all, while Revlimid is great for a few players, we think it's going to wane off, but I still continue to stay extremely positive, especially in the small molecule space.
Commentary from CDMO companies indicates that while the pressure still exists, there might be some change over the second half of the current financial year in India. How do global R&D spends look like currently, versus what they might? Is the slight hope that is being exhibited justified?
Amit Varma: One of the things that I have always been consistent with you in our interactions is that we are extremely bullish on the CDMO sector. Let me try and explain to you why.
So, I'll break it up in many ways, because we know it grows 11–12% year-on-year. It's a nice $16-billion market for us and it will continue to grow.
But if I were to break up the way I look at the CDMO space today, what are our priorities? When I look at the priorities, it is about refining our price strategies. We want to make sure that we expand the business through innovative strategies and most importantly, all of us in this space are now looking at newer markets. So we're not just hanging our hats on the US generics.
Now, clearly, as I look at trends, there is this great impetus towards flexible manufacturing. There is a lot of digital automation that's taking place. Now, there is relationship building with the large global pharma, going beyond transactional to strategic relationships. That is a very, very important trend that we're beginning to see. And also the last, which is very, very important is the personalised medicine demand and I think that is something that's going to take off.
So, except for the challenge of the ever-evolving regulatory landscape, I am extremely positive about how CDMO is going to take off in the next few years.
For some time now, the CDMO players have been requesting investors to be patient because these relationships take time to establish. First, they need to set up capacities. Only then, will the global companies place orders.
Do you think the companies want investors to keep a venture capital mentality—which is very long term and patient—depite being listed and having to show quarter-on-quarter performance? How should investors approach these players?
Amit Varma: We need a very patient understanding of how it plays out. There's a lot of dating, a lot of conversations before it leads to consummation. So to my mind, it requires a specific breed of investors, who are willing to wait it out for 3–5 years to get the returns that they're looking for. This is not going to be a slam dunk.
How can one ascertain a CDMO player's probability of success?
Amit Varma: I'm not going to pretend that we are smarter than a lot of other smart people out on the street. I can tell you our approach.
When we are analysing companies in this space, a lot of focus goes into their ability to specialise and work now on dedicated molecules, which are hard to reproduce.
Just to give you an example, I would certainly like to invest in a company which is good at fermentation. Fermentation is a lot more of science and art, and that is harder to reproduce. Concord Biotech Ltd., as you know, we had invested...
So, those are the kind of companies that we look for, companies that have their own niche and have their own specialisation, which others will not be able to reproduce.
Congrats on this deal. What explains this investment? What did you like about this ecosystem? Is it a NephroPlus specific investment, or do you believe the space at large in India has promise?
Amit Varma: We've been tracking this company for almost 10 years. It's a rock solid management team. We've come quite close twice to make an investment.
I guess, you have to wait for the time when it's right. The first time, the company was too small. The second time, we could not get close to the price they wanted. But I think the stars have aligned and decided now (for us) to be the single-largest investor now in the company.
I think before I try to explain why dialysis, it's very important to talk to you about the unfortunate provenance of chronic renal disease in our country. We create 2.2 lakh new patients every year. About 129 patients per million population need to be on dialysis. Unfortunately, in our country, at least 75% of those patients with chronic renal failure will not get dialysis and will end up dying.
Now, these are chronic-stage patients, who require endless care over 5–7 years. As you may know, we don't do enough kidney transplants in our country. So, it is a chronic disease.
Having said that, we have identified the need to provide high quality, low-pricing dialysis for these chronic patients, which as you can imagine, are extremely sticky. So the thesis was around the fact that there is a need, there is a demand, the patient exists, this is highly underpenetrated.
There is now a lot of government support. So the Prime Minister's National Dialysis Fund has been established. So there's a lot of opportunity for PPP. There's a lot of opportunity for us to establish dialysis centres in government hospitals. Clearly, with scale and size, we can bring in the cost arbitrage to make these businesses profitable.
From the statistics that you are giving me, it seems that the space is large enough for not just NephroPlus but others to survive and thrive this ecosystem to get built out in the country?
Amit Varma: I have always maintained for a country our size is going to take 100 Nephroplus’, before we make a difference and this could be any spectrum. It's just the historic underinvestment that we've seen over the years and while government support exists, the private sector will continue to play an important role.
One of the themes that we've seen that coterie execute over the past couple of years is a great belief in specialisation of verticals of disease profiles, whether it's gastric, whether it is cancer, kidney, we like to go down the speciality route because we believe that then we end up controlling the arbitrage in the entire P&L, not just on revenue, but also on calls.
When Covid was at the peak, some diagnostics chains suffered on the capital markets because their numbers were not quite up there. This quarter, they have changed the manner of numbers' delivery and guidance for the next year. What are your thoughts on diagnostics chains specifically?
Amit Varma: We continue to be extremely bullish on the diagnostics space because this is again about scale and size. When was the last time you showed up at a doctor's and did not get a plethora of tests written out for you?
I think, the fundamentals of what is happening is rising life expectancy, increased per capita and more importantly, awareness especially in the wellness space, which augurs very well for this industry.
There are new growth initiatives. There are lots of rollup models taking place. All the large listed branded players together don't even make 10% of the market. So there is a 90% huge mom-and-pop market out there, which is ready for rollup.
I also believe that the per capita tests are rising. There's a lot more specialisation taking place. So, the yield per blood draw is going up.
If I were to list what I think the diagnostic players should do, would be to focus a bit more on their balance sheets, where they need to improve the networking capital. I would like to see a lot more free cash flow getting generated. And I think once they have scale and size, they'll be able to lower their costs because of the volume.
Do you think that your earlier thesis of the branded diagnostic chains slowly gaining market share, pricing power, etc, holds true? In between, there was a threat to that business from some of the tech-based players—Tata MG, Thyrocare and some others.
Amit Varma: Interestingly, this is one space where I think a lot of different models come into fruition daily.
So while you have the standard brick-and-mortar ones like the SRS and others, we've also experimented and made investments in the newer wave of diagnostic players like Redcliffe, where the model was to go to very small towns and use digitisation to improve it.
And then, you have Tata 1MG and all who've been using a lot of the discounting practices. To my mind, there is going to be a shakeout at some point of time, where it may not just be on cost.
I do believe again, specialisation and quality is going to play a role, and clearly having a brand that is identifiable with quality and science will help you in your pricing machine.
Dr. Varma, on hospitals, you had told me earlier that Mumbai might be a separate case but India-wide, those players who create or spend money on building a brand will be successful in the long term. Currently, there are two or three more in the offing. Do you stay constructive despite the valuations?
Amit Varma: Valuations in Indian healthcare continue to be—for want of a better word—crazy. There's no other word.
Having said that, one has to be rational about approaching what the growth parameters look like. I have started believing that trying to establish a pan-India model is going to be incredibly hard to pull off. So, kudos to Apollos, Fortises and Manipals of the world.
But I think, when we look at it from a portrayal perspective, we have now gotten a lot more into regionalisation. The south, the west, the east, the north—they behave very differently and what we've started to do is that whatever brands we own, we are taking them deep vertically rather than trying to diffusely spread ourselves.
So as you will see our investments, let's say in Maxivision Hospitals, you will see us penetrate a lot more in the south and west rather than worrying about coming out to the north and east. And again, in the hospital space, as I mentioned in diagnostics, there is a need for 50 more brands before we actually make real penetration for the Indian customer.
