Description

RPG Life Sciences is a leading Indian generics company housed under the RPG Group, a family-run conglomerate with over 200 years of legacy across several verticals including industrials, software, and infrastructure. Formed as a joint venture between Searle USA and the RPG Group, the company was officially christened in 1993 when Searle withdrew from the partnership, followed eight years later by the divestment of the company's agrochemicals arm to focus on pharmaceuticals. Over the past decade, RPG has risen to dominate the domestic nephrology landscape with its leading line of immunosuppressants, a class of therapeutics used to temper the body's immune response. Of the four compounds in RPG's immunosuppressant class, the most widely used is azathioprine or Azoran, which currently constitutes ~70% of all of RPG's sales domestically and 90% internationally.

RPG's business is divided into three parts:

1. Domestic Formulations: This segment is responsible for ~62% of RPG's total revenues, with established sales primarily in India and Nepal. While nephrology is the leading therapeutic area, RPG sells the same suite of drugs across rheumatology, oncology, and gastroenterology as well. Other immunosuppressants outside Azoran include Mofetyl (mycophenylate mofetil), Arpimune ME (cyclosporine), and Imunotac (tacrolimus). One critical point – in India, generic drugs benefit from a name brand, a source of stickiness with physician networks and hospitals. RPG's most prominent branded generics can be found in Indian medical textbooks, representing a deep entrenchment in the existing system.Outside of the immunosuppressant brands, RPG also leverages a long-standing relationship with existing physicians through their textbook brands, or brands found in Indian medical textbooks. These include Azoran, Aldactone, Lomotil, Naprosyn, Serenace, and Norpace, and because of their relevance over the past decades in medical training, they now carry a long staying power in India. As such, they form the backbone of the domestic formulations segment. The domestic formulation segment grew only 1% in 2020, largely stemming from a reduction in transplant procedures, closures of clinics and dialysis centers, and acute portfolio deceleration. The reopening from COVID however should breathe new life into the segment, as evidenced by phenomenal Q1 domestic sales of $9.5mm relative to last year's $33mm.

2. International Formulations: Internationally, this segment contributes to ~21% of RPG's total revenues, with sales across regulated markets (Canada, UK, Germany, France, and Australia) and markets in third-world countries (Southeast Asia). 90% of international sales are dominated by azathioprine. Despite some disruption caused by COVID in various underrepresented geography, the segment grew ~15% in 2020.

3. API: For many of its leading brands, RPG competes on vertical integration through its API segment, which accounts for ~17% of sales. These APIs are typically high value, low volume compounds which drive the international formulations segment in geographies like LATAM, Germany, and China. The segment relies on a long-lasting relationship with Big Pharma companies though it is not a meaningful driver of growth.

Normally, considering the entrenched nature of Azoran and the remaining immunomodulatory portfolio, the growth opportunity could be considered limited. However, between new product lines and strategies, RPG sees a number of meaningful drivers for the category over the coming months.

1. Switch from acute to chronic indications: Until recently, RPG was positioned as a player in the acute generics space. Acute conditions are typically diseases that have quick onset like sudden inflammation, typically treated by low-margin medications that are less clinically meaningful. As a result, the acute market has been shrinking. To counter this, RPG has started to transition their immunomodulatory franchise into chronic diseases like diabetes and cardiology. In these areas, patients must take immunosuppressants to mitigate diseases that worsen over time. While the chronic disease bucket may not have implications in highly regulated and developed markets given the proliferation of biologics and specialty therapeutics, new chronic medications are significant in most underdeveloped markets including India. The concentration of Azoran users is therefore increasing among chronic doctors – while only 45-50% of Indian doctors prescribed Azoran five years ago, this share has increased now to ~85-90%.

   Ultimately, the goal will be to balance the acute and chronic populations and collect two lines of revenue as a result. To push the chronic disease bucket beyond Azoran, RPG has started developing and commercializing specialty therapeutics based around existing biologics to augment the specialty bucket. These include biosimilars for Trastuzumab, Adalimumab, Bevacizumab, Rituximab, Tofacitinib. Of course, each of these compounds are subject to competitive pressures that Azoran's brand is protected from, but they bring in a steady flow of high-margin cash flows with significant expansion opportunities both domestically and internationally.

2. International expansion: Since Sikri's arrival, the international reach of the Azoran franchise has expanded significantly. In developed markets like Canada and the UK, RPG has focused commercialization efforts on compounds that can only be manufactured in specific conditions. These compounds include nicorandil, a vasodilatory generic used to treat angina that requires low specificity and low temperature conditions for manufacturing, and sodium valproate PR, a complex generic delivered via intravenous injection to treat epilepsy and bipolar disorders. One catalyst: sodium valproate was recently approved and launched in the UK, and its progress will characterize RPG's international expansion strategy.

   RPG's primary international efforts however are being directed to their emerging markets sales. In the past, growth was driven by Myanmar, a key source of international sales that faced supply disruptions in 2020 due to widely reported political instabilities. Despite this, sales grew 15% from $9.5mm to $11mm from the previous year. As RPG begins looking into other emerging markets like Burma, Vietnam, Thailand, and Sudan, we believe the geographical inroads into emerging markets can set the international product line up for outsized growth this year.

3. Competent and proven management: CEO Yugal Sikri joined the company in late 2018, following a failed attempt by prior management to focus the company away from Azoran and toward entirely new product lines like Tricaine and Minmin tonic for oncology treatments. The goal at the time was to switch to higher-need indications, which could theoretically increase margins – but it failed as specialty biologics arrived. Sikri had already been a member of the board for two years starting in 2016. Prior to this, Sikri had already established himself as a veteran in the industry. He spent fifteen years working up the ladder at GSK India and juggling both manufacturing and marketing roles, followed by a senior director role at Pfizer managing the Indian pharmaceutical portfolio. He joined RPG Life Sciences first in 2002 as a Vice President, leaving only a year later to take on an SVP role at Novartis and a Global Head role at Ranbaxy.

   At RPG, Sikri's attempts to refocus the portfolio away from new product lines, and towards repurposing existing drugs for new indications has kept the company's sales forecasts largely intact. Revenue from operations have increased from $45mm to $53mm since he has joined, a 4.2% annual growth rate consistent with prior years. As the chronic indications and new product lines ramp up, combined with the increased costs with COVID, these should continue to increase. Sikri's true impact, however, reflects in his bottom-line improvements, with EBITDA improving from $4.67mm to $9.62mm over the past two years. He stimulated this with a focus on "basic business fundamentals" – which for a generic pharma company refers to a greater volume of prescriptions with lower unit costs through efficient manufacturing, and a focus on organization-wide systems and processes. Sikri prioritizes sales hygiene, a term that has become increasingly relevant with SaaS models to describe a high degree of customer success with low product returns, expiries, accounts receivables, and inventories. By incorporating such operational efficiencies, Sikri and his management team have improved EBITDA margins from 10% to 18%, which will only improve going forward as they streamline further.

4. Customer Connect Portal Reduces Backend Costs: One aspect worth mentioning behind this gross margin improvement is RPG's Customer Connect Portal. In the backdrop of COVID, RPG began their digital push with a portal used to interact directly with physicians. This was supplemented by the Sikri describes the portal as a "pull" rather than a "push" mechanism – whereas pharma sales normally involves sales reps pushing their products onto doctors, doctors communicate with the company to attend webinars, teleconsultation services, and e-CMEs, providing feedback on where COVID is most effective. While the portal's efficacy has yet to be proven, RPG has managed to connect to 8000 individual physicians, providing a platform for efficient sales going forward.

5. Reopening boost: In 2020, RPG's sales reached $53mm. In the first quarter alone of 2021, sales reached $15mm. Of course, one must take into account how COVID has evolved in India over the past two years; India has effectively undergone two waves, one in Q3 of 2020 and another in Q1 and Q2 of 2021. Using Apple's mobility graphs, one can visualize these dips quite clearly – from a baseline pre-pandemic average, driving reduced -85% during the initial scare in April, and -50% between April and June of this year. COVID only really settled in India a few months ago, resulting in a delayed reopening of transplant clinics. We believe RPG will benefit greatly during FY2021 and FY2022, leading to an increase in our assumptions.

Key Risks

RPG Life Sciences has faced competition over the past decades from competing Indian generics companies that benefit from similar unit economics. So far, branding has been key to the strategy. However, further expansion has required RPG to invest in biosimilars – refashioned versions of existing biologics – and gliptins for diabetes. The biosimilars industry is fast-emerging but highly competitive, and RPG is focused on cross-selling into existing therapeutic areas and capturing the pie first. It is unclear how far the strategy will extend beyond looking into expiring patents and executing quickly, but we believe this is countered by the fact that cutting-edge medicines are currently less accessible in the developing world. Sikri's biggest value-adds have been streamlining operations by cutting costs internally and reprioritizing the sales strategy. Whether his new product strategies are as effective remains to be seen.

Valuation

Two immediate catalysts may affect the next quarter's earnings. The first is the return to normalcy in Myanmar, where supply disruptions are likely to clear-up, providing a large boost to RPG's international segment. The second is the Indian subcontinent's reopening, which provide a short-term boost in-line with most other international generics companies. To account for this, we conservatively attach a revenue increase of 10% - well above the prior two years' increases at 4.67% and 6.64% (the latter despite COVID's impact). After this, we attach the prior 4.67% revenue growth rate. Looking longer-term, we believe Sikri will continue to introduce new operational efficiencies on the back end, including scaling down the sales force as well as introducing new IT systems and sales methodologies. SG&A costs decreased around -6% during RPG's last year, and we believe they will remain relatively constant going forward. COGS as a % of revenue has stayed largely constant over the last four years. Altogether, we believe '22 EBIT will increase to $11.5m from a current value of $8.1mm, and to $19.7mm in '26. At the current 16.3x EV/EBIT multiple, this implies EV will grow from $131mm today to $328mm in 2026, or a 5-year IRR of 17% annually.

(All numbers above converted from INR to USD)

Catalyst

Reopening of Transplant Clinics in India

Expanded Pipeline Across Chronic Populations

International Expansion

Easing Political Tensions in Myanmar