Top Indian pharmaceutical companies have started a new business strategy of de-merging their R&D activities into a separate company for 'focusing more on New Chemical Entities and New Drug Delivery Systems'. Such de-mergers of R&D divisions of companies are seen only in India and not any other countries.

New molecular research continues to be a highly expensive proposition for international pharmaceutical companies with a sharp decline in number of new drug candidates coming out of their laboratories. In India too, the situation is no different with most of the dozen research intensive pharma companies like Dr Reddy's, Ranbaxy, Lupin, Glenmark, etc. are struggling to get one successful new drug into the market.

In situation like this what these research based companies are going to achieve by floating a separate company out of de-merger of the R&D divisions is something to be seen. Getting a successful drug candidate into the market after several years of clinical trials and tough regulatory procedures at the cost of several crores of rupees is highly unpredictable. If that is the case, few investors would be interested in investing such projects.

The pharma analysts are very sceptical and not sure about the positive outcome of the new strategy. The de-merger of costly R&D activities will certainly help to improve earnings of other business and earning per share of the main company. But the success rate of R&D activity will continue to be risky and time consuming. However, the valuation of new R&D companies and returns are difficult to predict immediately. Every thing will depend on development of final NCE and investors will have to wait for longer time for returns.

The R&D expenditures of leading 15 companies have gone up by 8.9 per cent to Rs 2,100 crore during 2006-07 from Rs 1,929 crore in the previous year. There net sales increased by over 26 per cent to Rs 25,871 crore without getting any significant returns from R&D investments. Their net profit moved up by 61.2 per cent to Rs 4,717 crore from Rs 2,925 crore. If these companies hive off their R&D activities into separate subsidiary or entity, the bottom line will go up to that extent and earning per share will also move up. However, there will be zero returns from new R&D company or it will take few years for break even.

The pharma analysts have pointed out that the creation of new separate company for R&D is not going to help in a big way unless the companies will come out successfully with the new final product. The development of new drugs is time consuming with greater risk of uncertainty. The de-merger of R&D activities will help the main company to reduce its cost and push earnings but ultimate results depend on success of new product. As it is R&D productivity is very low amongst even top global companies despite huge investments.

The manufacturing and research operations are carrying different risk profiles and separate company for R&D will help de-risk manufacturing in some way. The shareholders of R&D based companies will get returns only after commercialisation of NCEs in a big way. Going by the current world trend, it is very unlikely that Indian companies will be able to produce any worthwhile result in this front. It is possible that the government may offer some tax benefits and other concessions for R&D based companies in coming years. After de-merging R&D activities into a separate company, such benefits will go only to new company and not to the main company.

Some analysts pointed out that the investment in R&D by corporates from highly regulated markets have started coming into India and China. India is much ahead in pharma research and quality with strong talent pool as well as state-of-the-art manufacturing facilities. The de-merged R&D companies may tap this opportunity and try to tie-up with major international companies. This strategy may start giving early returns. Several global companies may start investing considering the high cost of discovering new drugs in their own country as compared to the cost in India.

Indian majors like Sun Pharma Industries, Nicholas Piramal, Ranbaxy Laboratories Glenmark Pharmaceuticals and Dr Reddy's Laboratories have decided or already de-merged their R&D activities into a new company. A few more companies may also consider same course of action.

Sun Pharma has de-merged its R&D activities into new company called - Sun Pharma Advanced Research Company Ltd (SPARC), with registered office at Vadodara in Gujarat. SPARC has two research centres - Vadodra and Mumbai. The new R&D based company received the entire innovative business comprising of research projects for new molecules and new delivery systems, scientists and intellectual property. The company is planning to invest US $60 to $75 million in next three year for research projects.

As per scheme of de-merger, Sun Pharma has transferred net assets of Rs 54.64 crore during 2006-07 to SPARC. The SPARC scrip commenced its trading in July with price of Rs 87 per share and the same went to its peak level at Rs 125 and lowest at Rs 66.60 during last three months.

Nichiolas Piramal India Ltd (NPIL) has decided to de-merge its NCE Research Unit into a separate company with effect from April 1, 2007. The listing of new company will be from June 2008 and it will take 2-3 years to generate revenue. NPIL incurred an R&D expenditure of Rs 39.67 crore in the second quarter of 2008. The NCE programme has a pipeline of 13 compounds in Oncology, Inflammation, anti-diabetes and anti-infective segments. Four of these compounds are in clinical trials and other are at different stages. The new product is likely to be introduced in 2011. Currently, 400 people are working in R&D activities and the company is spending around 5 per cent of total revenue. Thus, the investors will have to wait for three-four years for any returns from this new venture.

Ranbaxy Laboratories has decided to d-merge its Drug Discovery Research operations to use its present strengths more effectively. Ranbaxy has state of the art Research infrastructure and a highly skilled scientific talent pool. Malvinder Mohan Sing, CEO and MD of Ranbaxy, said, "The proposed de-merger of our DDR arm will provide greater flexibility and impetus to our DDR programmes while unlocking significant value for the company and its shareholders".

Dr Reddy's Laboratories (DRL) is increasingly focusing on NCEs pipeline and pursuing collaborative strategies to accelerate the development of new molecules. It has finalised four key collaborative deals for discovery during last couple of years with Perlecan, Rheosciennce, Argenta and ClinTec International.

DRL received Rs 98.5 crore during the year ended March 2005, of which Rs 45.3 crore was recorded as a reduction in the R&D expenses in 2006-07 - compared to Rs 38.4 crore recorded in previous year. As the terms of the R&D agreement with Perlecan Pharma Private Ltd during 2005-06, DRL received Rs 37.3 crore towards the reimbursement of expenses incurred by it in the development of NCEs assigned to Perlecan

Glenmark Pharmaceuticals is spinning off its generic business and incorporating a wholly owned subsidiary called Glenmark Generics Ltd (GGL). The main objective is to build end to end integration, scale and capabilities in pursuing a generic business and to build global capabilities. The company is planning IPO and resources will be used to further expand GGL's generic footprint globally through acquisitions, expansion of generics and focus entering into other niche segments.

Speaking on this development, Glenn Saldanha, managing director and CEO of GPL, said, "To address several challenges, to strengthen our focus in R&D and to accelerate our growth in the generics and API business, we are planning to reorganize our business by moving the generics and API businesses into a wholly owned subsidiary. The new company will handle the development, manufacture and marketing of generic formulation and API businesses."

Thus the more and more companies are likely to restructure their R&D efforts and try to reduce burden on bottom line. The new strategy may help them in short term with higher net profit and earning per share, but it may backfire if the outcome from R&D fail to achieve targets. As analyst pointed out, the best way to enter R&D partnership with the multinational companies rather than de-merging of R&D activities.