BHAVIKK SHAH's BLOG: SYNGENE INTERNATIONAL LTD: MAKING YOUR PORTFOLIO HEALTHY !!!

Scrip Code: 539268 / SYNGENE

CMP: Rs. 417.70 ; Market Cap: Rs. 8,354.00 Cr; 52 Week High/Low: Rs. 402.00 / Rs. 250.00

Total Shares: 20,00,00,000 shares; Promoters : 14,90,92,154 shares – 74.55 %; Total Public holding : 5,09,07,846 shares – 25.45 %; Book Value: Rs. 42.29; Face Value: Rs. 10.00; EPS: Rs. 9.81; Dividend: 00.00 %; P/E: 42.57 times; Ind. P/E: 27.37; EV/EBITDA: 29.10x

Total Debt: Rs. 155.00 Cr; Enterprise Value: Rs. 8,509 Cr.

SYNGENE INTERNATIONAL Limited: The Company was founded on November 18, 1993 and is headquartered in Bengaluru, India. It is a subsidiary of Biocon Limited, a global biopharmaceutical enterprise focused on delivering affordable formulations and compounds. The company was earlier known as Syngene International Private Ltd and changed its name to Syngene International Ltd on March 26, 2007. The company came out with an IPO on July 27, 2015 offering 2,20,00,000 equity shares of Rs. 10 each for Rs. 250 per share raising Rs. 550 Cr. The shares of the company got listed on August 11, 2015 at Rs. 295 making a high of Rs. 310.40 on listing day. The object of offer for sale was to achieve the benefits of listing and enhancing visibility and brand image among existing and potential clients and to provide liquidity to the existing shareholders. Syngene International is India-based contract research organisations (CRO), offering a suite of integrated, end-to-end discovery and development services for Novel Molecular Entities across industrial sectors including pharmaceutical, biotechnology, agrochemicals, consumer health, animal health, cosmetic and nutrition companies. Their services in discovery and development cover multiple domains across small molecules, large molecules, Antibody-Drug Conjugates and oligonucleotides. Syngene offers customized models as per their client’s requirements. These offerings range from a Full-Time Equivalent to a Fee-For-Service model, or a combination thereof. It also offers discovery chemistry services, including medicinal chemistry, synthetic chemistry, library synthesis, biomolecules, computational chemistry and organic electronic materials, and discovery biology services in the areas of recombinant deoxyribonucleic acid (DNA) engineering, cell line development, hybridoma technology, protein sciences, screening and assay biology, in vivo pharmacology, toxicology and biologicals. The Company also offers safety assessment, large molecule development, chemical development, formulation development, polymer research, integrated discovery and development, and clinical development services. Till Dec 31, 2014, they serviced 195 clients, ranging from multinational corporations to start-ups, including seven of the top 10 global pharmaceutical companies by sales for 2014. Company's long term clients include global healthcare organisations Bristol-Myers Squibb Co. ("BMS"), Abbott Laboratories (Singapore) Pte. Ltd. ("Abbott") and Baxter International Inc. ("Baxter"). Syngene International Ltd is locally compared to Vimta Labs Ltd, Transgene Biotek Ltd, Saamya Biotech (India) Ltd, Veerhealth Care Ltd, Ashco Niulab Industries, Mavens Biotech Ltd, Piramal Phytocare Ltd, ABL Bio Technologies Ltd, RJ Biotech ltd, Biocon Ltd, Siro Clinpharm, GVK Bio, Clininvent, CliniRX, Ecron Acunova and globally with Quintiles Transnational INC of USA, Parexcel International of USA, Pharmaceutical Product Development LLC of USA, Covance Inc of USA, Medpace of USA, PRA Health Sciences of USA, inVentive health Incorporated of USA, Chiltern International of USA, ICON Plc of USA, Quotient Bioresearch USA, Takara Bio Inc of Japan, Morishita Jintan Co Ltd of Japan, Shin Nippon Biomedical Laboratories Ltd, Japan, EPS Corp of Japan .

Investment Rationale:

SYNGENE INTERNATIONAL LTD is the subsidiary of pharmaceutical major Biocon. It is an internally reputed contract research and manufacturing organization with multidisciplinary skills in chemistry and biology services. It caters to the outsourced research requirements of global pharmaceutical, biotechnology, agrochemical, consumer health, animal health, cosmetic and nutrition companies on a fee-based contractual arrangement. SIL provides a gamut of integrated, end-to-end services to develop novel molecular entities (NMEs) or new drugs. In this process, it works with customers to conduct discovery from target identification to candidate selection , development including pre-clinical and clinical studies, analytical and bio-analytical evaluation, formulation development and stability studies and pilot manufacturing like scale-up, pre-clinical and clinical supplies under one roof. SIL has a client base of 221 overseas customers including large global pharma players like Bristol–Myers Squibb, Abbott and Baxter among others. The company has a team of talented 2,122 scientists including 258 PhDs. It owns a Laboratory and pilot manufacturing facility which is spread over 9,00,000 sq. ft located in Bengaluru. Syngene has state-of-the-art research facilities certified with ISO 9001:2008, ISO 14001:2004, and OHSAS 18001:2007. Its animal facilities are GLP certified by the Indian authorities and AAALAC accredited. Over the last 20 years, Syngene have successfully offered these services to more than 220 clients including start-up companies, large pharma-biotech, agrochemical, chemical, nutrition and animal health companies in the USA, Europe and Asia Pacific including Japan. Syngene has a strong corporate governance framework with a focus on client satisfaction, quality, safety, ethics and integrity. Their ability is to deliver significant value to its customers by leveraging their scientific skills, global mind set and India’s cost competiveness differentiates Syngene as one of the most preferred partners. India has offered a significant cost advantage and skilled personnel. However, as global pharma outsource more R&D functions, outsourcing to India is increasingly seen as a strategic move to garner quality and value, rather than just a tactical decision to lower costs. Contract research organisations (CROs) services span the range of R&D activities from new molecular entity (NME) discovery, development to manufacturing. The growth in the CRO market has historically been driven by growth in R&D spending and increased outsourcing of R&D activities. The global CRO market for discovery services was estimated at US$14.7 billion in 2014 and is expected to reach US$22.7 billion in 2018, reflecting a CAGR of 11.5 %, according to one report. The global CRO market for development services was estimated at US$28.8 billion in 2014 and is expected to reach US$44.6 billion in 2018, reflecting a CAGR (2014-18) of 11.6 %, according to the Frost & Sullivan Report. As an industry, CROs have expanded their service offerings over time to meet growing needs for full-service outsourcing across the full spectrum of R&D and related activities. In practice, however, most CRO service providers Specialise to some degree based on the needs of their clients and the market in which they operate. A significant portion of R&D budgets are spent on outsourcing services domestically and international which are offered by the CRO industry. This was approximately $25 billion in 2015. As of 2015, this figure is expected to grow at 9 % over the next ten to fifteen years. There are over 1,100 CROs in the world, despite continued trends toward consolidation many CROs are being acquired in recent times or others go out of business. It is a very fragmented industry with the top 10 controlling almost 55 % of the market in 2009. Global pharmaceutical players are facing structural issues such as profit pressures arising from impending patent cliff, drying product pipeline and rising R&D costs. Surprisingly, the new product approvals from the USFDA are on the rise. Hence to maintain the cost balance at one end and maintain the new product introduction at the other, these players are inclined to outsource some of the R&D budget to CROs like Syngene. Also, the need for greater flexibility has reduced the willingness of these players to incur large fixed costs associated with large scale R&D programmes. Due to its integrated service offerings coupled with consistent performance and high data integrity ethos, Syngene enjoys high recall value, which is reflected in the fact that eight out of top 10 clients have been engaged with the company for the past five years. The number of clients for company has increased from 111 in FY11 to 221 in FY15. However, the amount of business from 211 customers is only 30 % as of now. This may be due to low amount of outsourcing to Syngene at this stage. The scope of work may increase depending on the service provided by Syngene going forward. The company currently conducts laboratory and manufacturing activities at two primary facilities-Bommansandra, Bengaluru Bommansandra Industrial Area, Bengaluru. Apart from this, it is in the process of establishing a new commercial scale Facility in Mengaluru (SEZ) to manufacture novel small molecules for innovator companies in pharmaceutical, agrochemical and other industrial sectors. Syngene plans to build on the success in integrated services to “follow” their clients’ molecules across discovery, development and manufacturing. Syngene is well-positioned as a one-stop shop for their clients to advance the R&D programmes from the discovery stage through preclinical and clinical trials and, with the new planned manufacturing facilities to support them through the commercialisation process. Strong team and management along with the strong brand recall value a key strength for Syngene and cost effectiveness will help Syngene retain its market share, looking forwards these factors will help the growth of Syngene and most preferred pick from this sector.

Outlook and Valuation:

Syngene International Ltd. is a subsidiary of Biocon, an India's largest and Asia's leading biotechnology company with a strategic focus on biopharmaceuticals and research services. Syngene was incorporated in 1993 and is headquartered in Bengaluru, India. The company has now become one of the leading India-based Contract Research Organisations (CRO), offering a suite of integrated, end-to-end discovery and development services for Novel Molecular Entities (NMEs) across various industries including biotechnology, pharmaceutical, agrochemicals, consumer health, animal health, cosmetic and nutrition companies. Syngene has the world class infrastructure. Their laboratory and manufacturing facilities are of high standards as required by the regulatory compliance and are consistent with the requirements of the large global clients. This provides the sustainable competitive advantage to Syngene. Their research facilities and systems are certified with ISO standards. The pre-clinical research facilities are certified with Good Laboratory Practices (“GLP”) certificates and accredited by Association for Assessment and Accreditation of Laboratory Animal Care (“AAALAC”). The clinical facilities are GLP compliant, National Accreditation Board for Testing and Calibration Laboratories (“NABL”), College of American Pathologists (“CAP”) and Central Drugs Standard Control Organisation (“CDSCO”) accredited and have undergone multiple FDA audits. In 2014, they successfully completed an FDA pre-approval inspection of one of their manufacturing facilities. In 2010 and 2013, they also successfully completed EMA audits of their bioanalytical and clinical facilities. Contract Research And Manufacturing Services (CRAMS) organizations provide outsourced services to support discovery and development for R&D driven organisations across various industries like biotechnology, pharmaceuticals, biopharmaceuticals, nutraceuticals, animal health, agro-chemicals, cosmetics and electronics. CRAMS service providers will typically compete in various segments of Discovery, Development and Manufacturing. Global R&D expenditure for the pharmaceutical industry in 2014 was approximately $139 billion, of which $105 billion could have potentially been outsourced. The outsourcing market for discovery, pre‐clinical and clinical segment was stood at around US$43.5 billion by 2014 and is expected to grow at CAGR of 11.5 % to US$67.2 billion by 2018. Geographically, North America and Europe together accounts for around 75 % of the total global outsourcing business. Syngene intends to evolve itself from a CRO based to a Contract Research and Manufacturing Services (“CRAMS”) based organisation with commercial-scale manufacturing capabilities. This can help Syngene to leverage their existing relationships with clients and provide them with forward integration on the discovery and development continuum. Syngene currently manufactures developmental batches of small and large molecules to support clinical trials for multiple clients. In the area of small molecules, it has multiple client-programmes that are in late-stage clinical development. Syngene recently entered into three long-term contracts with two existing clients for commercial manufacturing of their novel small molecules. Currently, one of these molecules is under late stage development, while the other two are at various stages of clinical development. In addition to these contracts, Syngene is also working on attracting new clients for commercial manufacturing opportunities, which will be the key growth driver for the company. Global CRAMS market grew by 15-16 % CAGR over 2010-2015, while Indian CRAMS market during the same period increased by 25-30 % CAGR. Going forward, the Indian CRAMS industry is expected to increase approximately to US$18 billion in 2018 from about US$7.6-7.8 billion in 2013, registering 18-20 % CAGR. The growth would be mostly led by increase in strategic alliances and expanding footprints to major geographies through strategic partnership. The growth rate for Indian CRAMS players slowed down to 5-8 % CAGR during 2009-2011. The industry underwent tough times on account of inventory rationalization and reduction in Research and Development (R&D) budget by multinational pharma companies in the face of global slowdown. Amid slowdown, CRAMS players also faced rising cost pressures, especially with new products not being launched in the market. The cost of developing new drugs is estimated to have reached approximately US$5 billion. However, the growth rate gradually picked up to low double digits in subsequent years. Going forward, it is expected that there could be gradual improvement with expected CAGR 18-20 % on the back of recovery signs witnessed in US markets. Further, global pharma companies are slated to enhance their allocations towards R&D in order to increase their drug pipeline. Increase in fresh orders and new assignments will aid in revival of CRAMS business. India has offered a significant cost advantage and skilled personnel. However, as global pharma outsources more R&D functions, outsourcing to India is increasingly seen as a strategic move to garner quality and value, rather than just a tactical decision to lower costs. Syngene’s expansion plans are well on track to boost the next leg of growth. Syngene plans to spend around $200 million over the next three to four years for setting up a new facility and expansion of existing facility. It has commenced the process of establishing a new commercial facility in Mangaluru to manufacture novel small molecules for innovator companies. It has also expanded its current small molecule manufacturing facilities in Bengaluru to meet the interim manufacturing needs of its clients. Additionally, it is in the process of expanding its large molecule manufacturing Capabilities by establishing a new unit in Bengaluru. Syngene derives 95 % of the revenues from exports. In terms of classification on contractual basis, it derives 36 % of the revenues from long term dedicated contracts with a Contractual commitment of five years and more. The company offers a dedicated, customised and ring-fenced infrastructure in line with client’s requirements. These dedicated centres are generally multi-disciplinary, full time engagements that support the R&D requirements of our clients. The remaining 64 % come from full time equipment (FTE) and fee for service (FFS) contracts. In FTE contracts, the company does billing based on the number of scientists deployed. In this case there is an agreement with the clients for a minimum utilisation of a specified number of scientists dedicated to their work. The scope of services and deliverables under FTE contracts generally evolves over time. The FTE contracts are generally renewable annually. FFS contracts are short-term in nature. In FFS contracts, the agreement is for fixed price for agreed services within a defined scope. Syngene International has financial stability and steady operational cash flows to enable the extension of platforms in line with the present and future needs of clientele. Further, long-term collaborations with certain clients lead to predictable and stable cash flows. The company has strong balance sheet, well adequate to support their new molecular entity (NME) development with dedicated investments in terms of both capabilities and capacities. Syngene’s leverage free balance sheet with sustainable cash flows the net debt/equity (net D/E) has reduced to nil in FY15 from 0.6x in FY11. Also, in the past five years it has generated cumulative free cash flow of Rs. 200 crore post incurring capex on capacity expansions, technological up gradations and maintenance. The major capex incurred in past three years was to develop a dedicated facility for its clients abbott and Baxter. Over the next three years, the company is planning around US$200 million capex towards capacity augmentation in its laboratory services, developmental services and GMP drug substance manufacturing. Company has very sound fundamentals, with 4 year revenue CAGR of 28 %, between FY11- FY15 and PAT CAGR of 59 %. During FY15, revenue grew 23 % YoY, to Rs. 860 crore, 95 % of which came via exports, while EBITDA margin was healthy at 34 %, leading to an EBITDA of Rs. 293 crore, up 32 % YoY. Since the company enjoys many tax concessions in form of SEZ unit and additional depreciation on plant and machinery, income tax rates are very low, and stood at just 14 % for FY15. Thus, net profit of Rs. 175 crore was earned in FY15, translating into net margin and EPS of 20.3 % and Rs. 8.75 respectively. At the current market price of Rs. 405.30, the stock is trading at 38.89 x for FY16E and at 31.05 x for FY17E. Company can pst Earnings per share (EPS) of Rs. 10.42 for FY16E & for FY17E it could be seen at Rs. 13.05. It is expected that the company will keep its growth story intact in the coming quarters also and can be a good pick from this CRO sector.

KEY FINANCIALS	FY15	FY16E	FY17E	FY18E
SALES (₹ Crs)	859.90	1,025.10	1,222.20	1,531.10
NET PROFIT (₹ Cr)	175.00	208.50	261.10	332.60
EPS (₹)	8.75	10.42	13.05	16.63
PE (x)	40.00	33.60	26.80	21.00
P/BV (x)	8.30	7.10	6.00	5.00
EV/EBITDA (x)	16.70	21.61	18.11	14.39
ROE (%)	20.70	21.00	22.20	23.60
ROCE (%)	19.50	20.80	22.50	24.40

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