Ranbaxy: Nowhere to Hide

A little more than a week before Malvinder Singh finally hung up his boots at Ranbaxy, India’s largest drug maker, most employees were simply too busy battling the crisis to notice the activity inside the headquarters in Gurgaon. A few employees did, however, notice that several valuable paintings that adorned the walls of the headquarters had been removed and taken away.

Old Ranbaxy hands say that the collection had been put together by Singh’s father and art-loving former chairman, late Dr. Parvinder Singh. Some, like the Hussein in the old man’s room, were gifts from employees and well wishers. The new owner of Ranbaxy, the $8.8-billion Daiichi Sankyo, Japan’s third largest drug maker, did not bother much. It already had too much on its hands to worry about paintings worth a few crores of rupees.

Eleven months after its momentous deal to buy 64 percent stake in Ranbaxy for a whopping $4.6 billion, things unravelled in a way that the Japanese could never have imagined. Daiichi’s global balance sheet now had a gaping hole after a $3.45 billion write-off on account of goodwill and certain estimated losses. This followed a ban by the US Food and Drug Administration’s (FDA) decision to ban 30 drugs made at two factories of Ranbaxy, on grounds that the test results had been fabricated.

The Indian company has been saddled with mark-to-market losses of Rs. 919 crore on account of its overseas derivative contracts. The net loss in the quarter ended March 2009 was Rs. 777 crore. On May 26, the Ranbaxy board decided to replace Singh with Tsutomu Une, a senior Daiichi executive, as the new chairman. Atul Sobti became the CEO.

Clearly, it was a marriage gone horribly wrong. But the dalliance was spectacular. Even till December last year, the Japanese were spellbound by CEO Singh’s media savvy and high connections. Malav, as he is fondly called, had pulled off a coup: He arranged an audience for the visiting senior Daiichi officials with Prime Minister Manmohan Singh. The Japanese were simply thrilled. Shortly after that, they elevated him to chairman and managing director on the Ranbaxy board.

Yet, two weeks ago, when news of Singh’s exit trickled out, Ranbaxy stock jumped 20 percent in one day. “We feel the change marks the end of bad news,” says Shankar Sharma of brokerage firm First Global, who has researched the firm for over a decade. This rise was a contrast to the steep fall in the stock after the deal was announced last year. Sharma is now bullish on the stock after having downgraded it to a ‘sell’ three years ago.

On the face of it, the Ranbaxy deal made immense sense for Daiichi. As a research-based drug maker, it was looking to enter the generic drugs space and was ready to expand its global footprint. Ranbaxy, with its generic focus and international presence, was just the right fit.
So what went wrong? Daiichi officials in Tokyo did not respond to our email request for a telephonic interview. Singh didn’t reply to a detailed questionnaire.

The inside story begins way back in 1989, when Parvinder Singh was still alive. It didn’t start on a happy note. When a senior Ranbaxy executive requested a meeting with the regional director of Daiichi, he was rebuffed. Daiichi didn’t want anything to do with a “copycat” firm. But slowly, a relationship developed. Not many know that a few months before Parvinder Singh died, he was flown to Japan for treatment. Daiichi executives made all arrangements for his treatment and maintained complete confidentiality.

“Daiichi understood, and was extremely helpful,” recalls Sanjiv Kaul, managing director, ChrysCapital, who worked with Ranbaxy then.
Now, fast forward to the beginning of 2007, a year after Singh took the reins of the company.

The first stirrings of trouble had just begun to hit Ranbaxy. Managing operations spread across 50-plus countries was becoming too complex. Sales growth had begun to peter out in the global as well as local markets. A coterie had begun to form around the Singh family. Poor human resource practices led to high employee turnover. In research and development alone, four departmental heads resigned in quick succession. After remaining debt-free in the early part of this decade, Ranbaxy began piling up debt from 2006. The FDA investigation had just started but no one quite knew the extent of damage it would eventually inflict.

Sometime later that year, Singh perhaps had an inkling that things were getting out of control. Unable to kick-start growth, he finally made a choice to quit the business. Around the same time, Daiichi had mandated investment bank Mehta Partners to search for a generics player with an international presence. It didn’t take more than a few months to convince the Singh family to close the deal. They would walk away with $2.6 billion in cash for their 34 percent stake, a premium of 31 percent over the market price then.

“Daiichi’s lack of understanding of generic business was apparent in the valuation paid for acquiring Ranbaxy. The general impression is that inadequate due diligence was done considering the size, scale and scope of the deal, reflecting its naiveté in the understanding of India and the generic world,” says Kaul. Daiichi did not have the depth of talent for its new acquisition. It was natural for it to rely on Singh and his team to continue running things at Ranbaxy.

Daiichi may have made some cardinal mistakes in the pre-deal due diligence. It needed to estimate the full extent of the legal risk arising out of the US FDA letters, asking for information on plant inspections done in 2006 and other regulatory submissions made by Ranbaxy. It should have also reviewed the spate of overseas investments, including some complex derivative instruments with open positions.

“It seemed that Daiichi was blinded by [the] size of its own actions. They simply held back all the questions,” says a senior executive who was involved in the negotiations. Daiichi bought Singh’s repeated assurance that the FDA eventually would call off the probe. Yet in August, FDA made its first damaging revelation. It has a long list of requirements, one of which is that companies should store copious quantities of drugs they make and test them for stability over long periods of time. In Ranbaxy’s case, it found that data for two drugs — a common antibiotic, ciprofloxacin and an antifungal drug, flucanazole — were falsified.

According to the FDA report, Ranbaxy’s quality control scientists had chosen to take shortcuts on the stability tests for at least two major drugs. They had conducted these tests on the same day or within a few days of each other, not over nine months as claimed by the company.

Ranbaxy had also falsified data submitted as a part of its application to market new generic drugs in the US, apart from keeping hundreds of improperly stored samples in its factories in Paonta Sahib and Dewas. The news was a huge setback for Daiichi.

On his part, Singh continued to maintain that he expected that FDA probe to be dropped soon. He blamed Big Pharma and “negative elements” for Ranbaxy’s travails and promised to spare no effort to protect key new drugs the company hoped to manufacture in Paonta Sahib and sell in the US. In September, Ranbaxy employed the services of noted lawyer Rudy Giuliani, the former mayor of New York, to fight its case against the FDA.

Meanwhile, the FDA kept the pressure on: It came back with more queries even after Ranbaxy had replied to its earlier questionnaires — by then, it knew that the company had something to hide.
Inside Ranbaxy, caution had been thrown to the wind. During his tenure, Dr. Parvinder Singh had laid down a standard operating procedure. For example, the analytical research and quality assurance (QA) departments were always kept at arm’s length. After all, the QA department was meant to police the activities of the research unit. In the recent past, the company brought both departments together. In a culture where bad news was simply not tolerated, the move meant that the true picture of any reporting slip-ups would not get out. The internal blame game continued. Eventually, the onus fell on Ranbaxy’s over-100-strong US FDA-related regulatory department. It today faces a huge exodus of hard-to-find professionals.

On its part, Daiichi is said to have done only a cursory due diligence on the FDA documents. It termed the event as a “risk call” and decided to tackle it when presented with the problem rather than spend time evaluating the risk. A senior executive with a law firm that specialises on pharmaceutical law suits says, “Just like the FDA, Daiichi could have spent money and time investigating completely if they wanted to.”

In May, Daiichi-Sankyo announced a one-time write-down of $3.45 billion. Today, Daiichi is clearly worried, not just about the financial losses but also about the FDA restrictions. In a meeting that Daiichi-Ranbaxy executives had with the FDA in the US in April, the latter apparently said that they “don’t trust the senior management.” In May, a concerned Daiichi Sankyo said, in a statement quoted by the Press Trust of India, “These regulatory actions could exert a significantly adverse impact on the group.” Soon after, Singh was replaced.

The hurry to acquire Ranbaxy has now come to hurt Daiichi in a big way. It had paid a hefty premium, partly to acquire Ranbaxy’s basket of 30 drugs for which the company had approvals in the US.
Among these were 10 drugs for which Ranbaxy had exclusive sales right to sell for six months after the expiry of their patents. Now, none of these can be exported as only the banned Paonta Sahib unit has the facilities to make them.

During the post-due diligence stage, Daiichi was asked by its auditors to take a hit and write it off the balance sheet as goodwill. But given Ranbaxy’s unexpected setbacks in the US, Daiichi decided to summarily double that figure. It was a saga that Daiichi executives are unlikely to forget in a hurry.

More: Autl Sobti in an exclusive interview with Forbes India