Attractive Prospects

Established in 1978, Biocon Ltd. has come a long way since the time it developed simple industrial enzymes. Today this biopharma major is at the forefront of developing what has been called the holy grail of the diabetes market — oral insulin. Oral administration does away with the need to inject insulin. If Biocon is successful, multiple daily injections for diabetics would become a thing of the past. Oral administration would revolutionise the insulin market not only in India but the world over and Biocon would find itself in a sweet spot. This scenario will come true only when the new drug passes stage III trials. In the meantime, the company is keeping the cash registers ringing with a variety of revenue streams that are getting stronger by the day. Biocon’s entry into biosimilars, increased licensing income, and a strong presence in domestic formulations space put the company on a strong footing even if it takes time to deliver oral insulin.

Strengths and Opportunities
Pfizer deal: Biocon recently entered into an agreement with Pfizer for the global commercialisation of biosimilar versions of insulin that Biocon manufactures, namely, recombinant human insulin, Glargine, Aspart and Lispro. This deal will see Biocon receive an upfront payment of $200 million (Rs900 crore) and milestone payments of up to $150 million (Rs678 crore) between FY11-FY13. A recent report from Motilal Oswal Securities pegs this deal as having an incremental value of Rs25 per share.
The opportunity in oral insulin: If and when oral insulin sees the light of the day, it would possibly be the world’s first orally administered insulin. Commercialisation (successful out-licensing of the new chemical entity or NCE) is expected to be a game changer for the company.
Strong biopharma portfolio: Biocon has built up a strong portfolio of biopharmaceuticals which now accounts for 48 per cent of its net revenue. Excluding Axicorp (its underperforming German subsidiary), biopharmaceuticals saw a revenue growth of 22 per cent year-on-year (y-o-y) to Rs353.8 crore (December ’10 quarter), bolstered by branded formulations, immuno-suppressants and statins. Biocon currently services four clients in the US with Tacrolimus and expects to add another client to this list soon. In a bid to strengthen its immunosuppressant portfolio in the US it will file an additional Limus Drug Master File (DMF, see glossary for definition), with two more in the development stage.
Robust licensing income: Licensing income now brings in 10 per cent of Biocon’s revenue from a shade lower than 3 per cent just a year ago. Licensing income stood at Rs77 crore in the December ’10 quarter (Pfizer brought in Rs55 crore and Mylan Rs22 crore) as compared to Rs18 crore a year ago. After the Pfizer deal this stream of income should become consistent. Biocon could start receiving payments from Pfizer in FY12.
Strong domestic growth: Biocon has a strong presence in the domestic branded formulations space. The company’s key segments (diabetology, oncology, nephrology, cardiology, dermatology and comprehensive care) saw a strong 32 per cent y-o-y growth in the December ’10 quarter while the domestic insulin business grew 40 per cent y-o-y. Domestic formulations are expected to grow by a strong 18-20 per cent in the next two years.
Low-debt company: Biocon has a debt to equity ratio of only 0.13.

Concerns
Risk to bottomline: Biocon’s deal with Pfizer means that it will have to spend around $200-$225 million (Rs900-Rs1,000 crore) on research and development (R&D) of the concerned products and in scaling up its manufacturing facilities. This incremental spend on R&D and higher depreciation could impact bottomline in the near term. What’s more, industry experts say Biocon may not see the $200 million upfront money immediately; the amount could come in a phased manner depending on the number of international markets in which licenses for these products are acquired. This could delay payments by around two to three quarters from now and could take as many as three to four years to completely come into Biocon’s coffers.
Delay in oral insulin: Though recent stage III tests (on humans) in India did reduce HbA1c (glycated haemoglobin) levels, the control group which used a placebo (inert pill) showed better response than Biocon’s test drug. This means Biocon will have to go back to stage III testing all over again.
According to Ranjit Kapadia, vice president, institutional research, HDFC Securities, “The market is not yet discounting the success of oral insulin.” Kapadia points out that historically no Indian company has passed stage III earlier. Also, Biocon is not the only one taking a shot at orally administered insulin. According to Nimish Desai of Motilal Oswal, “Many attempts by innovator companies in the past to launch oral insulin have failed. So this remains a high-risk project.”
Also affecting possible commercialisation date is Biocon’s decision to go in for a global launch which will entail more tests abroad and could take as much as one- to one-and-a-half years from now, say market participants.
Flagging Axicorp sales: Biocon’s German subsidiary Axicorp brings in 30 per cent of the company’s consolidated revenue. This is lower than the 40 per cent that Axicorp contributed only a year back. A major reason for the decline in contribution is the German government’s directive to all drug companies to provide a flat 16 per cent rebate for the next three years. As a result, Axicorp saw net revenue fall 15.6 per cent y-o-y to Rs218.4 crore. Further compounding Axicorp’s problems is the fact that its had a very low operating margin of 3.7 per cent in the December ’10 quarter. Biocon plans to weed out lower-margin products from Axicorp’s portfolio in a bid to shore up margins. However, the pain could continue for some time. According to Siddhant Khandekar of ICICI Securities, “In future, we expect sales from Axicorp to decline on account of price cuts and the strategy of reducing the focus on low-margin products from the current portfolio.”
Overall Biocon’s prospects look good. “The stock’s valuation could improve as the contribution of the margin-reducing Axicorp comes down,” says Kapadia of HDFC Institutional Research. Moreover, the Pfizer deal may expand in future, says Kapadia, who cites that Pfizer has a tradition of adding other drugs to existing or single drug tie-ups. In other words, Pfizer could tie up with Biocon for sale of additional drugs — a plus for the latter. Then there is the chance of oral insulin actually succeeding and that would provide a further kicker to your investment.

Valuations
Biocon is trading at a 12-month trailing PE ratio of 16.89, which is significantly lower than its five-year median PE ratio of 23.41. The company currently has a PEG ratio of 0.8. In view of the company’s strong growth prospects and reasonable valuations, you may buy the stock with a minimum three-year investment horizon.