10 Dec 2018 19:10 IST

Sun Pharma: Bogged down by allegations and speculation

Accusations of insider trading and spike in loans, among other issues, plague the company

The Sun Pharma stock plummeted more than 16 per cent this week, following a slew of allegations by a brokerage firm and a whistleblower complaint to the Securities and Exchange of India (SEBI). Investors were spooked at the thought that SEBI may reopen investigations into the insider trading case against the company and its promoters, settled through the consent mechanism last year.

In a conference call hosted by Sun Pharma to address these issues, the management highlighted that while most information about the company is already available in the public domain, some issues are not related to the company or are factually incorrect, and others are very old (over 10 years).

The management further claimed that most of the issues reported had already been disclosed in compliance with relevant laws at the time, and it is unfair to view them retrospectively. As said, over the years, the regulatory framework, expectations of transparency and corporate governance have changed significantly. Applying today’s standards and revisiting old management decisions will create an unreasonable burden.

However, the explanation given on two issues — loans and advances worth ₹2,242 crore given to employees and others and, domestic formulation sales routed through promoter distribution entity Aditya Medisales Ltd — seem unsatisfactory. The management has stated that it will evaluate an alternative after consulting investors.

The key allegations and the response by the management are given below.

Insider trading case

The whistleblower alleged that promoters of Sun Pharma made money through insider trading. The company management denied the allegation, saying it has not been involved in any insider trading norm violations relating to the Ranbaxy deal. However, there was a minor technical issue relating to a procedural aspect of trading window closure due to the intervening holidays. The board meeting for approving the Ranbaxy acquisition was held on a Sunday and, hence, the lawyers advised that there is no need to announce a trading window closure as the stock market is anyway closed on the weekend.

SEBI later ruled that the company should have announced a window closure. This case was settled with the regulator, with no admission of guilt, in accordance with the provisions of applicable laws, and the matter was closed.

Domestic business routed through related party

The management explained that its domestic formulations business is routed via Aditya Medisales, which became a related party in FY18 due to shareholding consolidation. It wasn’t a related party prior to that. According to the management, this was a structure created from a tax efficiency viewpoint.

As investors have expressed concerns regarding this arrangement, the management is open to changing the distribution arrangement with Aditya Medisales. The options include Sun Pharma taking over the distribution business or acquiring Aditya Medisales at a cost. Any change in the domestic distribution structure could lead to an increase in its tax rate.

Allegation against audit firm Valia and Timbadia

It is alleged that one of the partners of an audit firm of Sun Pharma — Valia & Timbadia — was investigated in a stock price rigging case. The Sun Pharma management responded by saying that the issue is 20 years old and that neither the partners of the firm nor the firm itself were party to the investigation.

The firm audits some of the smaller subsidiaries of the company (which accounted for 0.6 per cent of the group’s consolidated revenue in 2017-18). The company did not engage large global audit firms due to the small size of the subsidiaries. Sun Pharma may look to hire new audit firms to improve investor confidence.

Jermyn Capital managed its FCCB transactions

Another allegation is that Jermyn Capital, a small investment banking firm, was given the mandate for FCCB issuance in 2004. Further, a SEBI order in 2006 showed that there were links between Jermyn Capital and Ketan Parekh, and his associate Dharmesh Doshi. The company management clarified that the lead book manager was JP Morgan Chase, while Jermyn was a co-book runner for overseas borrowings.

Lakshdeep Investments not a promoter entity

Lakshdeep Investments & Finance, a company owned by Sudhir Valia, a shareholder and brother-in-law of Dilip Shanghvi, who exercises control over the company, is not classified as a promoter company of Sun Pharma.

The management has said that Lakshdeep Investments was classified as a non-promoter entity on legal advice received years ago. Even if Lakshdeep Investments is classified as a promoter, there will be no change in promoter shareholding. Sun Pharma is looking to seek revised legal opinion on the matter.

Spike in loans and advances in FY18

This accusation is that the loans and advances given to non-related parties by Sun Pharma rose sharply to ₹2,242 crore in FY18, compared to ₹69.8 crore a year ago.

The company said that it was a structured transaction, related to the pharmaceutical business. The loan was given in the normal course of business, at arms-length basis, at market interest rates and market terms and conditions. The management has not shared more details, citing business sensitivity. The company said it can unwind this transaction earlier than planned, if required.

Outlook

With the 16 per cent correction in the stock price, the stock trades at about 19 times its estimated 2019-20 earnings, which is 5-10 per cent lower than its large-cap peers such as Dr Reddy’s, Lupin and Cipla.

After a prolonged under-performance in 2015-17 due to structural headwinds in the key markets and regulatory overdrive in its key facilities, Sun Pharma seems set for a rebound, with revival in earnings in the recent quarters.

Though there is no clarity on the corporate governance issue, it will adversely impact the company if the insider trading case is reopened by SEBI. However, Sun Pharma’s long-term revenue and earnings prospects look robust considering its earnings growth expectations and improvement in the speciality business.

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