Strides Arcolab Ltd: Pay-out Decision

Case background
Pharma industry worth $34 Billion

Agila specialties acquired by Mylan Inc. for $1.725 Billion

Deal was valued at 18.7x Agilas EBIDTA

Proposed dividend payout of $650-700 million 5,050 %

dividend rate and dividend payout ratio of 85%
Rationale of Sale of Agila
Deal was valued 18.7x EBIDTA
Deal size more than the market value of Strides and also higher than Mylans
1.3 billion dollars revenue from Asia-Pacific region
Agila had a broad product portfolio of more than 300 filings approved globally
Comparable deals:

Novartis acquired Ebewe Pharma $1.2 B, 4.7 times sales

Mylan acquired Bioniche Pharma, $550 M, 4.2 times revenue

Abbott Laboratories acquired Piramal Healthcare- $3.72 B, 8.7 times sales

The CEO of the company wanted to focus on Biotech company and legacy
business of strides
Stride wanted to reduce its leverage and use proceeds of sale to resolve its
debts.
Options before Kumar
1) Zero Dividend Pay-out
In line with Strides image of a company looking to grow
aggressively

2) 15-20 percent Dividend Pay-out

In line with Strides past dividend pay-outs
Free cash could be used to retire debt, but also for future
expansion plans

3)Residual Dividend Pay-out Policy

Fiduciary responsibility to reward the investors
Zero Dividend Policy
PROS
There will be no transaction cost
or tax borne by either customer
or company
Company is well prepared to
take up any investment
opportunity that might arrive in
future without having to go for
debt
Company can invest in risk free
bonds and still provide nominal
returns to the customers
CONS
The company has been regularly paying
out dividends in the past years and
abruptly not paying dividend will foster
negative sentiments among investors
The company has very little investment
opportunity (approx. 100 million)
compared to funds available (approx. 1
billion) so investors would pressurize the
company to return back the money if they
cant use it
Investors invested in injectible business
and should get back the money generated
from it and should be given the option to
invest in other business at their own will
Payout Dividend as Per Company Trend
PROS
Continuation of healthy trend of
paying out nearly 15% dividend
which means less opposition by
investors
Investors have the option to earn
nominal profit through dividend and
see the future growth of the company
without having much negative impact
on share price
Company is well prepared to take up
any investment opportunity that
might arrive in future without having
to go for debt
CONS
Due to low investment opportunities
available, there is no immediate visible
future growth for the company so
investors would want to invest in better
opportunities
It is not the core competency of the
company to maintain huge cash balance
and without proper plans to utilize it, they
are more likely to generate lower returns
for the shareholders
Since the funds are a part of equity and
income generation from projects is low so
with large sum of money as equity, ROE
will be low which would decrease the
market price of shares
Pay Complete Sum as Dividend
PROS
Handsome one time return
CONS
for shareholders
Taxation i.e. Dividend
Equal return for all
payout tax on company
shareholders based on their
equity holding Increase cost of capital in
future in case of debt as D/E
ROE will increase as equity
ratio will increase due to low
will decrease keeping equity
returns constant
Buyback Shares using Complete Sum
PROS
No taxation either on
company on shareholder
Gives choice to the investor
to stay invested for new
business or not
RoE and EPS will increase
thereby raising market price
of the share
CONS
2 year blocking period on
taking new investment from
equity market even in case of
new investment opportunity
Increase cost of capital in future
in case of debt as D/E ratio will
increase due to low equity
Unequal distribution of money
as not all investors will be able
to sell back the shares
Factors for Dividend Decision
Investment Opportunities
Stability in Earnings
Alternative Sources of Capital
Degree of Financial Leverage
Signaling Incentives
Clientele Effect
Factors for Dividend Policy
Tax-preference Theory
Investors preferred low dividend payouts
Bird-in-Hand Fallacy
Investors prefer high payouts
Clientele Effect
Investors bought the stock keeping in mind dividend
pay-out trend
Signaling effects
Investors tend to buy stocks in firms that had dividend
policies that match their preference for high, low or no
dividends.
Change in the Capital Structure
Strides decided to reduce debt from Mylan proceedings. As it had
experienced previous deals, net debt was reduced from $591.61 billion to
$298.62 billion
Year Debt to EBITDA Interest Coverage
2012 5.76 2.72
2013 2.53 3.45

Pharmaceuticals business did not require more CAPEX and Biologics business can
be financed from Mylan proceedings
So, it made sense to pay off the debt than to keep the cash in hand and pay
interest on debt. Also, Repo rate was increased by 525 basis points in recent times
and lending rates remained high, making debt expensive
The Indian Pharmaceutical sector has been debt heavy and international credit
rating agencies were downgrading Indias sovereign ratings making ECBs difficult.
Impact of Dividend Pay-out

Rating agencies will assign a higher rating to Strides because of lower DE ratio of
0.26 and higher interest coverage

Analysts will be sceptical about the valuation as negligible debt will increase
WACC which might lower Equity value

Bondholders will be disappointed because of the pre mature redemption

given that interest rates in India has gone up in recent times

Managers could get more payout as interest expense will be lower and
companys assets will be free from covenants resulting in freedom of decision
making
Shareholders will be at advantage because of lower risk and higher distributable
profits but they will also be concerned as de leveraging will amount to higher
WACC and lower equity value
What Happened to Strides Arcolabs Dividend
Decision?
Dividend Pay-out Trend of Strides
Impact of Dividend Pay-out on Share
Price