With Ranbaxy said to be eyeing the world's fifth largest maker of the antibiotic cephalosporin, what  are the options before the K  Raghavendra Rao-promoted Orchid Pharmaceuticals & Chemicals? By Sourya Biswas.

Consider the following scenario: Bill Gates, fresh out of Harvard, incidentally without graduating, has already decided on creating Microsoft. However, hard-pressed for funding, he decides to raise funds from the open market and lists Microsoft right at its inception. To survive in the nascent computer industry, he decides to liquidate most of his personal stake in the company to raise money, and manages to increase its revenues twenty-five times within a decade.

However, IBM, the reigning emperor of the computer world, is not happy with the emergence of a pretender to the throne. Nor is it enthralled by the fact that though it enjoys a monopoly on computer hardware, it does not yet have a killer software product. And so, it plans a sneaky counter-attack.

It creates an entity, lets say Takeover Inc, specifically for taking over Microsoft, which waits and watches for the right opportunity. As soon as it finds that there is a general economic downturn and Bill Gates has a lot of debt, it strikes! Share prices are low due to the fall in stock markets worldwide, and Takeover buys a lot of Microsoft shares cheap. Eventually, it convinces institutional investors in Microsoft that the kind of money IBM can offer for their shares is much more they can hope to get in the next few years by staying on with Gates.

They agree and sell out. IBM becomes the new owner of Microsoft and shunts out Bill Gates. End of Microsoft. End of Bill Gates. End of Windows.

Many Mac users will say that wouldn't necessarily be a bad thing, but all criticisms of frequent hang-ups and blue screens of death notwithstanding, Windows still runs more than 90 per cent of the world's computers. And without Bill Gates and his Windows, computers wouldn't be as ubiquitous as they are today. In fact IBM chairman Thomas Watson had once predicted "I think there's a world market for about five computers."

A possible alternate history, though quite a bit dramatised. However, something similar is playing out right now in India, and in quite a different sector of pharmaceuticals. Just replace the names - Kailasam Raghavendra Rao for Bill Gates, Orchid Chemicals & Pharmaceuticals for Microsoft, Ranbaxy for IBM, cephalosporin for Windows and Solrex for Takeover Inc, and you have a perfect match.

Like Bill Gates,  K Raghavendra Rao is a a first-generation entrepreneur whose Orchid Chemicals & Pharmaceuticals grew in the early years on the strength of its product  cephalosporin, not unlike the ascent of Microsoft as Windows became the de facto personal computer operating system. Similarly, Ranbaxy is the biggest kid on the block, just like IBM had been in Microsoft's youth. And although IBM never made a serious play for Microsoft, Ranbaxy seems from its recent open market acquisitions of Orchid's stocks, very interested in its rival.

How did this all come to pass?

The story began in 1993 with the setting up of  Orchid Chemicals & Pharmaceuticals, by  IIM-Ahmedabad alumnus K Raghavendra Rao who chucked up a lucrative corporate career to strike out on his own. Though a first generation entrepreneur, he persevered and took the company to a constant-growth curve; from a Rs30-crore company in 1993, Orchid Chemicals & Pharmaceuticals recorded a turnover in excess of Rs1,000 crore in 2008.

Rao expanded his company's product portfolio. From a single product, the antibiotic  cephalosporin, its current range includes a variety of medicines in oral and injectable forms. From bulk actives Orchid invested in forward integration into finished dosages, and then moved from lesser regulated markets like China to the developed, and highly regulated, US and Japanese markets.

In the bargain the promoter picked up laurels like the Ernst and Young Business Achiever award and was felicitated by former President Dr.Shankar Dayal Sharma and former Prime Minister Atal Bihari Vajpayee for his contributions to the pharmaceuticals industry and a rare presidential visit from President APJ Abdul Kalam during his tenure as president in 2005 (See: Orchid Chemicals hosts presidential visit at its formulations complex)

Rao came from a middle-class background and getting into business was quite an alien experience. All this time, his personal ownership in the company never reached a controlling stake, unlike other Indian promoters. The last time he decided to increase his stake in the company was in March-June 2007, when Rao chose to hike his stake in the company from 17 per cent to 24 per cent after pledging his personal shares with Indiabulls and Religare, a Ranbaxy group brokerage house, to maintain the faith of investors in the company.

Sunk by the Bear Stearns crisis
The story of Orchid is, in many ways, a story of the ongoing sub-prime crisis. Even as Bear Stearns, one of the oldest names of Wall Street, went into bankruptcy recently, it sold shares it held worldwide in a futile rearguard action. Unfortunately for Orchid, one million of its own shares were among those sold by the beleaguered bank in March, resulting in a decline in Orchid's share price from a 52-week high of Rs328 to Rs200 by mid-March.

The fall of the dominoes had started. Margin calls were triggered by the firms which had provided margin funding - Indiabulls and Religare - and Rao was forced to offload seven per cent of his holding to meet their demands. On 17 March, the Orchid share tanked by 38 per cent to around Rs110, and hit its 52-week low of Rs106.50 on 24 March, leaving it a vulnerable takeover target.

This is where Solrex, apparently an investment firm said to be controlled by Malvinder and Shivinder Singh of Ranbaxy, made  an appearance. As late as the end of the last fiscal on 31 March, it did not have any significant holding in Orchid, later revealed to be 4.6 per cent. However, since this was below the 5 per cent mark, Solrex was not required to make the information of its shareholding public.

However, it found in the low share price a perfect buying opportunity, and picked up an additional 3.4 per cent stake from the open market on 3 April. Since the cumulative 8 per cent mandated a disclosure, the information was made public by Solrex. Solrex continued mopping up Orchid shares, and after deals made on 8th April and 12th April, is now the owner of an estimated 14.7 per cent of  Orchid Chemicals & Pharmaceuticals. This figure is quite close to the 15 per cent stake that would necessitate an open offer to other shareholders as per Indian law, if the company decides to launch an acquisition.

Of course, the share price hasn't languished all these weeks. It has risen spectacularly since the news of Ranbaxy's interest came in and is now trading in the Rs245 range. In fact, Solrex's latest deals were struck at this price at the stock exchanges on Friday. However, analysts opine that even after this increase in recent times, the stock trades at an attractive PE ratio of 18.44.

Considering the enormous advantages that Ranbaxy can accrue from such an acquisition, odds are on that Ranbaxy mounts a hostile takeover bid for Orchid through Solrex, notwithstanding its management's assertations to the contrary.

What does Ranbaxy stand to gain from such an acquisition? A lot, apparently.

For one, it gets expertise in a field in which it didn't have any – high-end antibiotics. Additionally, it gets a lot of capacity addition in the cephalosporin space, where Orchid is India's biggest and amongst the world's top five manufacturers. Orchid is already notching up impressive sales abroad, and even with this ongoing share drama, the company has found time to expand its footprint in to Japan last week (See: Orchid Chemicals announces Japanese subsidiary). Orchid's product range can also function as an appropriate feeder for Ranbaxy's healthcare subsidiary Fortis. 

Another very important benefit that Ranbaxy will obtain by acquiring Orchid is access to assets and technologies that have been approved by regulatory authorities across the world, including the US FDA (Food and Drug Administration), the UK MHRA (Medicines and Healthcare products Regulatory Agency). This is especially significant in the light that as much as 75 per cent of Ranbaxy's revenue comes from exports, and recently it has had several face-offs with the FDA.

With several pre-approved products, the acquisition of Orchid can enable Ranbaxy consolidate its position in the overseas market.

How can Rao prevent his company from being swallowed by the giant?

One option is to increase his own stake in his company, for which he will require funds. Also, if the other institutional investors, who collectively hold a 38 per cent stake, decide to stand by him and refuse to sell out to Solrex, he stands a good chance of riding out this storm.

For the first alternative, Rao can convert 5 million warrants in his ownership to an additional 7.6 per cent equity stake. This option was unattractive till three days ago, but a 34 per cent rise in the company's share price since Monday has made the conversion price of Rs202.58 per share look cheap. However, even for this, Rao needs to rustle up some Rs.90 crore.

As for the second option, he has already received support from the largest shareholder Life Insurance Corporation of India (LIC), which hold a 7.8-per cent stake, and has expressly opposed a hostile takeover by any party as a matter of policy. However, the other big investors, notably DSP Merrill Lynch (5.3 per cent), Harpline (4.5 per cent), Macquarie Bank (4.1 per cent), Credit Suisse (3.3 per cent) and Fidelity (2.7 per cent) are yet to decide on their stakes in Orchid Chemicals & Pharmaceuticals.

Now, a third option has come to the fore – join hands with another player in the pharmaceuticals industry. Ranbaxy has already diversified from its forte in manufacturing to service through its subsidiary Fortis, which took a stake in Chennai-based Malar hospitals last year, right in Apollo Hospitals' backyard. Apollo's founder and chairman Dr Prathap C Reddy is not one to take a challenge lying down, and sources indicate that he may be in talks with Rao to counter Ranbaxy's unbidden interest in ORchid. However, this hasn't been officially confirmed.

Matters right now are at the moment of climax – will the David defeat the Goliath, or will history be rewritten in the Indian pharmaceuticals industry? Answers may well emerge this week itself.