Windlas Biotech: IPO analysis

Windlas Biotech is a contract development and manufacturing organisation (CDMO) involved in providing various services, such as product development as well as manufacturing and licensing of generic drugs, including complex generics, for pharma companies. While generic drugs refer to off-patent medicines with the same chemical substances, complex generics refer to generic medicines that require high-end manufacturing expertise.

The company's CDMO business primarily caters to the domestic market and contributes 85 per cent to the total revenue. Windlas generates its remaining revenue through the sale of generics in the domestic market and exports to semi-regulated markets. In FY21, the company catered to 204 customers through its four facilities in Dehradun. Of these four facilities, three are compliant with the standards of the World Health Organization.

Domestic formulations (the process of making medicine in the final form) CDMO value stood at approximately Rs 20,000 crore in FY20 and is expected to grow by 13-15 per cent in the next five years on the back of several factors, including an increase in asset-light pharmaceutical companies, growing cost awareness and manufacturing efficiency. Further, the industry is expected to consolidate, owing to increasing compliance costs and changing government regulations. All these are likely to pave the way for top organised players, such as Windlas, to grow.

Through this Rs 401.5 crore IPO, comprising Rs 236.5 crore of an offer for sale and Rs 165 crore of fresh issue, the existing PE firm Tano Capital is completely selling its 22 per cent stake in the company. Out of this Rs 165 crore of fresh-issue proceeds, Rs 50 crore will be used for setting up the injectables dosage business at one of the facilities, while around Rs 67.5 crore will be used for meeting working-capital needs and repaying debt. Going forward, the company plans to leverage growth opportunities in the injectables business (medicines that can be injected), while ramping up its CDMO business. Since the company claims that it has no listed peers in the domestic CDMO business, we have compared it with listed companies operating in the foreign CDMO space who tend to have higher margins.

Strengths

• The company manufactures complex generics for domestic pharma companies. These processes are highly technical in nature. In FY21, around 68 per cent of its revenue came from these complex generics.
• Windlas is focused on chronic therapies (60 per cent of FY21 revenue). The chronic therapeutic category refers to the drugs used for the treatment of chronic diseases like diabetes. Going forward, this category is expected to witness more growth than other categories.
• Mostly, the company maintains long-term relationships with its customers, with the contract duration ranging from two to five years.

Risks/weaknesses

• The Rs 20,000 crore domestic CDMO/CMO market is highly competitive, with the presence of several unorganised and organised players. The company's market share is only around 1.5 per cent.
• The company deals with big pharma companies and doesn't really command strong pricing power, as depicted in its low profit margins (5-7 per cent). Small-scale operations (FY21 revenue of Rs 431 crore), coupled with low margins, implies a lack of competitive advantage.
• In January 2020, the USFDA placed an import ban on one of the company's facilities. Besides, none of its other facilities are USFDA compliant. However, the company does not export to the US and doesn't intend to focus on that market in the next few years.
• It has high customer concentration with the top 10 customers and the top customer accounting for 58 per cent and 11 per cent, respectively, of the FY21 revenue.
• In a bid to make medicines more affordable, the Indian government has recently brought about price controls. Such regulations can hurt the company's margins.

IPO questions

The company/business

1. Are the company's earnings before tax more than Rs 50 crore in the last twelve months?
No, the company's profit before tax (post exceptional items) in FY21 stood at Rs 21.7 crore.

2. Will the company be able to scale up its business?
Yes. As of March 2021, the company was operating at low capacity utilisation across its product categories, 39.2 per cent, 4.4 per cent and 39.5 per cent for tablets/capsules, pouch/ sachet and liquid bottles, respectively. Hence, if the company intends to ramp up its business in the existing categories, it won't require any medium-term expansion. Additionally, it is setting up an injectables dosage business at one of its facilities. Industry tailwinds in the CDMO business, its foray into injectables and the use of IPO proceeds towards working-capital needs should help the company scale up its business.

3. Does the company have recognisable brand/s, truly valued by its customers?
Not applicable. Around 85 per cent of its revenues come from contract manufacturing and services business under which the company is involved in developing products and manufacturing complex generics for domestic pharmaceutical companies. Since the company doesn't sell products under its own brand name, the concept of brand recognition isn't relevant.

4. Does the company have high repeat customer usage?
Yes. Under the CDMO business, the company enters into contracts ranging between two and five years with its customers. It has had long-term relationships with its various customers and in FY21, the top 10 customers accounted for 57.9 per cent of the total revenue.

5. Does the company have a credible moat?
No. The domestic CDMO market is a fairly crowded market, with the presence of several organised and unorganised players. As of FY20, the company had a market share of just 1.5 per cent. Additionally, although it enters into contracts of around two-five years, customer stickiness isn't assured as the company manufacturers only generic medicines. Also, its facilities aren't USFDA compliant, which is the toughest of all regulatory compliances. The PBT margin of just around 8-10 per cent (Divis Lab: 33.7 per cent) depicts that the company doesn't command a credible moat.

6. Is the company sufficiently robust to major regulatory or geopolitical risks?
No. Pharma companies such as Windlas Biotech are subject to inspections by various regulatory bodies like the USFDA and others. In fact, the USFDA imposed an import ban on one of the company's plants in January 2020.

7. Is the business of the company immune from easy replication by new players?
No. The company is primarily involved in contract manufacturing for drug formulations. Although the company deals in complex generics products, which formed around 68.5 per cent of the total product portfolio in FY21, an R&D expense of just 0.8-1.2 per cent of the total revenue and the presence of several players signify that the business is not immune from easy replication by new players.

8. Is the company's product able to withstand being easily substituted or outdated?
Yes. In recent years, the outsourcing of medicine manufacturing has gained popularity on the back of a growing demand for generic medicines and biologics, the focus on reducing time to market, the capital-intensive nature of the pharma business and complex manufacturing requirements. Although the company needs to continuously update its manufacturing process knowledge, the CDMO business is likely to gain more prominence in the coming years.

9. Are the customers of the company devoid of significant bargaining power?
No. In FY21, the company serviced 204 customers, however, the top 10 customers accounted for 57.9 per cent of the revenue, while the top customer accounted for 11 per cent. The presence of a huge number of CDMO players, along with high customer concentration, gives significant bargaining power to customers.

10. Are the suppliers of the company devoid of significant bargaining power?
No. The company purchases APIs and other materials from third-party suppliers domestically. The company doesn't enter into any long-term contracts with suppliers and prices are negotiated for each purchase order, thereby giving substantial bargaining power to suppliers.

11. Is the level of competition the company faces relatively low?
No. Domestic contract manufacturing is a highly fragmented and competitive industry, with the presence of a large number of organised and unorganised players. The company commands a market share of just 1.5 per cent.

Management

12. Do any of the founders of the company still hold at least a 5 per cent stake in the company? Or do promoters totally hold more than a 25 per cent stake in the company?
Yes. The promoter will continue to hold nearly 60 per cent of the company after the IPO.

13. Do the top three managers have more than 15 years of combined leadership at the company?
Yes. Mr Ashok Windlass, its whole-time director, has been associated with the company for the past two decades. Managing Director Mr Hitesh Windlass has been associated with the company for the past 13 years.

14. Is the management trustworthy? Is it transparent in its disclosures, which are consistent with SEBIguidelines?
Yes, we have no reasons to believe otherwise.

15. Is the company free of litigation in court or with the regulator that casts doubts on the intention of the management?
No. While most of the litigation related to the company seems well within the scope of regular business, there is one specific case that seems, prima-facie, the result of an intentional act of the company. The company is facing criminal charges for selling products at prices higher than the ones set by the regulator (the National Pharmaceutical Pricing Authority). However, the company has acknowledged that it wouldn't be commercially viable to sell the products within the government-mandated cap. This is, in effect, a confession of wrongdoing.

16. Is the company's accounting policy stable?
Yes, we have no reasons to believe otherwise.

17. Is the company free of promoter pledging of its shares?
Yes, the promoters have not pledged any part of their shareholding.

Financials

18. Did the company generate the current and three-year average return on equity of more than 15 per cent and return on capital of more than 18 per cent?
No. While the current return on equity is around 18 per cent, the three-year average return on equity has been 11.7 per cent. Similarly, while the current ROCE is 20.2 per cent, the three-year average ROCE has been 16 per cent.

19. Was the company's operating cash flow positive during the previous three years?
Yes, the company's cash flow from operations was positive in the previous three financial years.

20. Did the company increase its revenue by 10 per cent CAGR in the last three years?
No, the company's revenue increased by only 7 per cent CAGR in the last three years.

21. Is the company's net debt-to-equity ratio less than 1 or is its interest-coverage ratio more than 2?
Yes, the company has a negligible amount of net debt (around Rs 20 lakh) and its interest-coverage ratio was around 42 times as of FY21.

22. Is the company free from reliance on huge working capital for day-to-day affairs?
Yes. The working-capital days for FY21 was for around 70 days and the management estimates that going forward, the days are likely to remain the same. This is in line with other pharmaceutical companies and hence, the company should be free from huge working-capital needs.

23. Can the company run its business without relying on external funding in the next three years?
Yes. The current capacity utilisation across facilities is around 38 per cent or less. Besides, the company is raising sufficient capital from the IPO to meet its expansion plans and working-capital needs. Hence, it should not rely on external funding for the next few years.

24. Have the company's short-term borrowings remained stable or declined (not increased by greater than 15 per cent)?
No. The company's short-term borrowings increased by 40 per cent in FY21 and around 23 per cent in FY20.

25. Is the company free from meaningful contingent liabilities?
Yes, the company did not have any contingent liabilities.

The stock/valuations

26. Does the stock offer an operating-earnings yield of more than 8 per cent on its enterprise value?
No, the company's stock will offer an operating-earnings yield of 5.4 per cent on its enterprise value.

27. Is the stock's price-to-earnings less than its peers' median level?
No, the stock's price-to-earnings ratio of 64.4 is more than its peers' median level of 60.

28. Is the stock's price-to-book value less than its peers' average level?
Yes, the stock's price-to-book value of 2.8 is less than its peers' average level of 8.5.

Disclaimer: The authors may be an applicant in this Initial Public Offering.