Active pharmaceutical ingredients are the chemical-based active compounds required in a drug and are produced mainly in countries like India and China. India, apart from being a very strong domestic market, having distinct manufacturing capabilities and a highly skilled workforce, is one of the largest producers of the APIs globally. The Indian API industry, standing tall at $11.9 billion within the $53.4 billion Indian pharmaceutical industry and derives over 60% of its revenue from domestic sales and rest from exports, is a compelling story of growth, consolidation and strategic transformation.
The Indian API industry has been an attractive investment segment, with private equity investors clocking a weighted average equity internal rate of return of 26.6% during the period 2005 to 2022. Out of a total of 13 transactions during the period, where investors have exited or companies have listed on the public markets, a remarkable 10 delivered EIRRs exceeding 15%, with the remaining three delivering 11–12% EIRR.
Delving deeper into the data, we dissected the EIRRs to ascertain the contribution of business performance (company-specific) versus the expansion of valuation multiple (industry-specific). Our analysis considered various factors, including the compounded annual growth rate in business performance during the investment horizon and alterations in the capital structure. Notably, we found that over two-thirds of the returns generated were attributed to the robust business performance of the firms, with the remaining stemming from valuation multiples.
The Indian API industry is projected to achieve an 8.31% CAGR over the next five years. This growth trajectory will be supported by three fundamental drivers:
Dual Sourcing Model
In the API manufacturing space, China has historically been India's primary competitor. However, a significant long-term shift is occurring post-Covid with the emergence of the China+1 model, global pharmaceutical companies mandating dual or triple sourcing strategies.
Currently, India's manufacturing costs are approximately 45–50% of those in the US, while China's manufacturing costs are around 35–40% of the US costs. While the costs are lower in China, the Chinese manufacturers have predominantly focused on producing high-volume, low- APIs, API intermediates and key starting materials required for the API production at large scale. On the other hand, Indian manufacturers' adherence to quality standards and regulatory compliance lend them a competitive advantage in manufacturing mid- to high-, low-volume APIs.
Strong Regulatory Accreditations
Indian firms have taken the lead in Drug Master File submissions in the US, accounting for 53% of the total filed in financial year 2020. Additionally, India boasts 182 US FDA-approved manufacturing plants, the highest globally, compared to China's 100. Despite undergoing more Food and Drug Administration inspections (223 versus China's 120) in fiscal 2022, India received a lower percentage of 'official-action indicated' decisional letters (a qualifying statement requiring further regulatory or administrative actions), with 13% compared to China's 38%.
Supportive Government Policies
The Indian government is actively supporting the API industry to reduce dependency on China. Through the Production Linked Incentive scheme, it has allocated Rs 6,940 crore for 53 APIs and API intermediates, and Rs 3,000 crore for setting up three bulk drug parks. These parks will offer shared research and development infrastructure, and testing facilities, helping companies reduce their initial plant setup costs and achieve economies of scale.
Consolidation Trends
Platform Creation
As the Indian API industry continues to grow, backed by the macro tailwinds, we are seeing a trend of consolidation among the players. The industry is currently fragmented, with the top 50 companies holding less than 50% market share. With a long tail, aggregating assets and consolidation seems eminent.
In line with this theme, three private equity-backed platforms have been created in the recent past.
A consortium of investors — PAG, CX Partners, and Samara Capital — set up Sekhmet Pharmaventures, a platform that aggregated Anjan Drug, an API manufacturer and Optimus Pharma, which produces an API, intermediates, and finished formulations.
Carlyle partnered with Viyash Life Sciences to build an integrated pharmaceutical platform. Viyash manufactures API intermediates, and holds a controlling stake in Symed Labs, which manufactures niche APIs, and Appco Pharma, a formulations player focused on the US market.
Advent International brought together its three portfolio companies under a new brand identity, Cohance Lifesciences, which it is further merging into Suven Pharma. The three portfolio companies are ZCL Chemicals, manufacturer of API and Intermediates, Avra Laboratories, a contract research and manufacturing firm, and RA Chem Pharma, manufacturer of API and Intermediates, while Suven Pharma is a contract development and manufacturing organisation.
In addition to external consolidation, pure-play API companies are pursuing distinct organic growth strategies as well:
Forward Or Backward Integration
The API companies have captured a wider chain through forward or backward integration. Granules India Ltd., previously focused on API and intermediates, diversified into final dosage products in 2008. By fiscal 2023, over 50% of the company's revenue came from FD products.
Changing The Product Mix
A few API firms have used their existing capability set, such as advanced chemistry expertise to establish a lucrative CDMO business, characterised by higher operating margins, enhancing the overall profitability. Additionally, these firms have extended their capabilities to regulated markets, potentially accessing more favourable pricing.
Formerly solely focused on API manufacturing, Neuland Laboratories and Laurus Laboratories entered the CDMO market, with over 35% of their revenues now attributed to this segment.
Summing up, we maintain a bullish outlook on the Indian API players, anticipating that future transactions will primarily occur through consolidation. With the sector's current fragmentation, these consolidation efforts are poised to drive transaction activity within the Indian API industry.
Shiraz Bugwadia is a senior managing director at o3 Capital and focuses on the firm’s life sciences and healthcare practices. He has more than 23 years of experience.
Prasanna Bora is a managing director at o3 Capital and focuses on the firm’s life sciences practice. He has more than 18 years of experience.
Disclaimer: The views expressed here are those of the authors and do not necessarily represent the views of NDTV Profit or its editorial team.
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