Pliva: Europe is Not Enough

Buying Sobel Holdings makes Croatia's Pliva one of the first eastern European companies to buy into the US market. It's doing so cleverly, leveraging future revenues from its biggest product, azithromycin, to fund the deal, and executing it through a tax-efficient Hungarian subsidiary.

Having built up its presence across western Europe through a string of acquisitions over the last two years, Croatian drugs group Pliva DD —whose $635 million (€639 million) revenue comes mostly from generics—has made its first foray into the US. Pliva's acquisition of New Jersey-based Sobel Holdings Inc., a subsidiary of Sobel NV , for $212 million makes it one of the first eastern European companies to buy into the world's largest market [See Deal]. Pliva—which was privatized in 1993—had been wooing this target for over a year and reportedly beat Indian generics companies Ranbaxy Laboratories Ltd. and Wockhardt Ltd. to the deal.

Sobel Holdings owns Pliva Inc., a branded and generics drugs manufacturer and distributor with 40 generic products on the market, and Sidmak's subsidiary Odyssey Pharmaceuticals Inc. , which in-licenses branded drugs. Sobel's new operations—which last year reported net sales of $100.4 million and $4.3 million in earnings—will bring Pliva marketing and distribution facilities in the world's biggest generics market, where 42% of prescriptions are already generic, and where the share of such products is likely to increase: 121 patented drugs are due to lose protection in the US before 2010, according to IMS.

The US deal is Pliva's biggest international expansion, but not its first. Pliva has moved into ten western European countries since its privatization; in the last two years alone it acquired Dominion Pharma Ltd. in the UK [See Deal], AWD.pharma GMBH in Germany [See Deal] and 2K Pharmaceuticals AS in Denmark [See Deal].

But despite these moves, Croatia still accounts for 25% of Pliva's group sales, reflecting the company's difficulties in gaining market share outside its historical market. The firm also remains heavily dependent on revenue from its proprietary antibiotic azithromycin, whose HRK616 million ($84 million) sales made up 11% of Pliva's turnover. Azithromycin is sold by Pliva in central and eastern Europe as Sumamed, and licensed to Pfizer Inc. in the US and the rest of the world where it is sold as Zithromax. Pliva gets 9% royalties on the drug—worth HRK1.2 billion to the Croatian group last year—and is the exclusive supplier of bulk material to Pfizer.

Pliva's slow development outside Croatia, its portfolio of mostly old generics, and the fact that azithromycin's patent will expire in 2005, help explain why the group has a relatively low valuation. At an estimated eight times earnings, Pliva's shares—listed on the London and Zagreb stock exchanges—are valued substantially below both the regional average of 15 times earnings, and the 16-25 times earnings seen at the international level, according to Merrill Lynch specialty pharmaceuticals analyst Paul Woodhouse in London.

With its shares trading at such a low price, Pliva isn't using equity to buy Sobel. Nor will it use its own cash, as it did for previous acquisitions, since this deal is far bigger. It's instead leveraging its future revenues from azithromycin to pay for the very deal it hopes will reduce its dependence on this drug. Pliva has secured a $165 million credit facility on revenues from azithromycin over the next three years—just in time for the product's US patent expiry. "It is a highly innovative way of financing the deal," sums up Woodhouse.

It's also an extremely cost-effective and tax efficient way. Pliva has set up an international financing affiliate—PAM Property Management LLC—in Budapest, Hungary, in order to benefit from the country's lower cost of capital (interest rates are as low as 2.5%, compared to 3.25% in the EU and 4% in the UK). Being in Hungary also exempts the company from a 30% withholding tax that would normally be imposed on azithromycin's royalties, thanks to a recent treaty between Hungary and the US. What's more, corporation tax in Hungary is only 18% compared with 33% in the UK.

Pliva has also gotten Sobel inexpensively, according to analysts. The Croatian group will pay $153 million cash and assume a debt of $59 million for Sobel, whose forecast 2002 sales are $120 million. Paying 1.75 times sales—compared with an average of 1.5 to 2.5 times sales in the generics business—makes it "a very reasonable price," according to Woodhouse.

The acquisition doubles Pliva's gearing to around 50%, however (pre-acquisition Pliva had $74 million in cash and debts of $245 million; its debt level, with this acquisition, will now reach $380 million). Yet Ž eljko Covic, Pliva's president and CEO, thinks he can lower the debt/equity ratio back to the pre-acquisition level of 36% next year, since the deal is expected to produce revenue growth of 25% this year, up from the 20% pre-acquisition estimate. This is equivalent to $1.70 earning per share instead of $1.38 pre-acquisition, according to Woodhouse.

Much of this short-term growth will come from exploiting cross-selling opportunities between portfolios. Sidmak gives Pliva sales, marketing and regulatory expertise as well as a platform from which to market its generic products in the US—including, potentially, azithromycin, once the exclusive marketing agreement with Pfizer expires with the patent. And Pliva will be able to market Sidmak's products (eight of which are generic market leaders in the US, according to IMS Health) in Europe.

The acquisition will also help Pliva exploit maximum value from its pipeline, according to Covic. Although Pliva's existing marketed products are old, it has a rich generics pipeline, according to Bram Buring, pharmaceuticals analyst at Raiffeisen ZentralBank (RZB) in Budapest. Pliva's development capabilities apparently extend to oncology generics and, potentially, biotech generics, according to Merrill Lynch's Woodhouse. Pliva acquired biotech product expertise when it bought Mixis Genetics Ltd. , a combinatorial genetics company with expertise in recombinant proteins, in 1999 [See Deal].

Pliva is also trying to build up its proprietary pipeline. Focused on anti-infective and anti-inflammatory drugs, it has three products in the clinic and five in preclinical, as well as collaborations with GlaxoSmithKline PLC for the development of an anti-infective [See Deal], with Trine Pharmaceuticals Inc.[See Deal] for the development of a broad spectrum antibiotic, and with Signal Pharmaceuticals Inc., now a division of Celgene Corp. , for an anti-inflammatory discovery program on tyrosine phosphorylation.

The company, however, is hardly a research powerhouse. It spends just 8% of revenues on R&D—or about half the spending of the average mid-sized European drug company (See "Middlemen: R&D spend at European Midsized Companies," In Vivo Europe Rx, June 2002 (Also see "Middlemen: R&D Spend at European Midsized Companies" - In Vivo, 1 Jun, 2002.)). Most of that money goes to developing generics and just a third to proprietary projects. As the branded product pipeline isn't rich, Pliva is hoping to use its new US businesses, and Odyssey in particular, to buy in small, proprietary products. Odyssey's current portfolio includes drugs such as bethanechol (Urecholine) for incontinence and depression drug protriptyline (Vivactil), both acquired from Merck & Co. Inc. , as well as trimipramine (Surmontil) for depression and disulfiram (Antabuse) for treating alcohol abuse, acquired from Wyeth . Pliva says it may acquire further small branded products in the US following this acquisition.

Pliva will also benefit in the US from a manufacturing advantage. The company has access to substantial chemical manufacturing facilities in Croatia, meaning it can provide bulk drug to its US subsidiary at rates that US generics companies, who have to buy from third parties, cannot beat, according to Paul Kleutghen, president and CEO of the US subsidiary of Lek Pharmaceuticals DD, a Slovenian company that offers similar advantages to its US based organization. Unlike Pliva, Lek did not acquire a company in the US but choose the cheaper solution of hiring a sales force locally when it opened its US subsidiary in July last year.

While Pliva intends to build up Sidmak's product line, and build up Odyssey with further product purchases, its next major acquisition is likely to be in Spain, Italy or France, where other generics firms, too, are betting that business will boom as government incentives to encourage generics use kick in (See "Teva and Ivax Bet on French Generics", IN VIVO, June 2002 (Also see "Teva and Ivax Bet on French Generics" - In Vivo, 1 Jun, 2002.)).

-by Sabine Louët

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