Is Hovid’s takeover valuation too low?
Ho Chung Teng 
On Oct 9, 2017, Fajar Astoria Sdn Bhd and Hovid’s chairman and MD David Ho Sue San initiated a takeover of the pharmaceutical manufacturer, valuing the company at around RM311.93 mil

Hovid Bhd, a pharmaceutical manufacturer that is the target of a takeover effort, has had fund managers and some shareholders miffed about its valuation. According to them, the offer price of 38 sen per share and 20 sen per warrant, though considered fair and reasonable, has not taken into consideration the future earnings potential of the company.

As a result, one fund manager says the offer price has severely undermined the future earnings potential of Hovid. Some shareholders are also claiming that they have yet to receive any dividends as they have agreed to plough back its earnings to grow the company. Hence, the takeover attempt has had many of them feeling unhappy.

“Operating activities cash flow generated by the company in the past few years, which should have been awarded to shareholders as dividends, were instead ploughed back into the business to grow future income,” explains Spiral Thinker Alliance founder and head of research David Poh.

Poh says the offer price does not take into consideration Hovid’s future earning capacity

“This (expansion) is the right thing to do, but taking it private for a song and squeezing out minority shareholders who initially agreed to this expansion using almost all the generated operating cash flow is definitely something that the investing community frowns upon,” Poh tells FocusM.

On Nov 22, the acceptance deadline for the takeover was extended once again to Dec 7 and the threshold acceptance level from shareholders reduced to 75% from the previous 90%.

On Oct 9, Hovid made a Bursa announcement that it had received a conditional takeover offer for the remaining shares that it did not own from Fajar Astoria Sdn Bhd and Hovid’s managing director, David Ho Sue San. Fajar Astoria is a private vehicle setup by TAEL Two Partners Ltd, a private equity firm based in Singapore. The offerers plan to delist Hovid from Bursa.

At the time of the offer, Ho held 33.72% of Hovid shares and another 43.57% of its warrants. Initially, the offerors jointly wanted at least a 90% acceptance from Hovid’s shareholders by Nov 20. The deadline was later extended to Dec 4. 


Valuation of Hovid

At 38 sen per share, based on 820.88 mil shares outstanding, the offerors are valuing Hovid at about RM311.93 mil. However, Spiral Thinker’s Poh values Hovid at more than RM500 mil. Poh bases his valuation on the net cash flow expected to occur over the life of the business discounted at appropriate interest or discount rate. 

“In this regard, when valuing Hovid, a prudent investor should take into account of Hovid’s capacity expansion programme, potential new product to be released as well as new markets, etc., to estimate the potential growth on the potential earnings and cash flows,” Poh says.

His view is echoed by an investment banker. He says  that investment banks will usually determine a company’s takeover worth based on its historical financial results, along with analysts’ past target price on the company.

As of Nov 15, Hovid market capitalisation is at RM295.52 mil.

Despite Poh’s positive view, an independent report issued by AmInvestment Bank Bhd says the price is logical based on the company’s latest results and current financial standing. It says the weak outlook for Hovid was mainly due to its declining earnings performance. For FY16, Hovid’s net profit declined to RM18.15 mil, from RM20.88 mil in FY15. For FY17 ended June 30, 2017, Hovid reported a net loss of RM1.12 mil.

Hovid’s dull share price performance is also to be blamed. The counter has been on a downward trajectory since hitting a five-year high of 56.5 sen per share on April 20, 2015. Hovid closed at 32 sen on Oct 9, 2017, prior to the announcement of the takeover.

Hovid’s share plummeted to a 52-week low of 24 sen on Jan 10, after Hovid’s manufacturing licences were revoked by the Ministry of Health’s Pharmaceutical Services Division. This was the result of an audit conducted by the National Pharmaceutical Regulatory Department, which found that the company’s manufacturing practices were not in compliance with Current Good Manufacturing Practice (cGMP).

Having incurred losses in the second half of FY17, the company is slowly returning to the black. For Q1FY18, ended Sept 30, Hovid reported a net profit of RM2.13 mil, against a net loss of RM6.35 mil in the previous corresponding quarter.

The company says in its latest quarter results that its production for all plants are operating on 24-hour shifts to deliver the back-orders received during the period the licences were revoked.

“Barring any unforeseen circumstances, the outlook for the group is expected to be satisfactory given that the group is expanding its tablet and capsule production facility, which will be commissioned towards the end of 2017, and actively securing new overseas markets and registration of new products,” Hovid adds.

Poh notes that Hovid is fortunate to have been able to sustain sales when its licences were revoked. “Looking at the bright side, it was fortunate that Hovid was able to sustain sales using its existing inventory during the suspension period,” says Poh.


New plant to begin operations in 2018

Fund managers tell FocusM that in 2014, Hovid embarked on an expansion plan that involves the construction of new plant and installation of new production facilities for its Chemor plant located in Ipoh.

Once completed, potential earnings could begin flowing into the company in 2018. According to Poh, the new plant is aimed at boosting tabletting and capsuling capacity by 70%.

Hovid’s annual reports, between 2012 and 2017, also state that the company has allocated a total of RM104 mil in capital expenditure, which is to be utilised for, among other things, the new plant, warehousing and a research and development centre. The company’s new research and development centre in Bayan Lepas, Penang is reported to cost RM15 mil. The company also recently completed the building of its centralised distribution warehouse in Ipoh.

All this are part of the expansion plan which shareholders say has not been taken into consideration when valuing the company for the takeover. 

Hovid, when contacted, did not respond to FocusM’s queries.

In addition, one fund manager points out that the generic pharmaceutical market is also expected to expand in the near future, mainly due to patent cliff, whereby major overseas patents are said to expire. Further, there is the growing support for generic drugs from the government, with new complex generic drugs set to enter the market.

According to London-based GlobalData, the Malaysian pharmaceutical industry is estimated to be worth US$2.3 bil (RM9.5 bil) in 2015, and the industry is projected to grow at a compound annual growth rate (CAGR) of 9.5% to US$3.6 bil by 2020.

The analyst expects the industry to continue its upward trajectory, as the government is looking to source for more generic drugs in an attempt to better utilise its healthcare expenditure. He adds that the government is the largest purchaser of pharmaceuticals in Malaysia.


Positive catalyst going forward

With a number of blockbuster drugs’ patents expiring in the near future, Hovid is expected to benefit. Once this happens, generic drugs can be produced and sold at a much cheaper price.

According Spiral Thinker, Hovid has recently registered a number of generic drugs, including pregabalin (a drug for treating epilepsy and neuropathic pain which costs US$7 per tablet), meropenem (a broad-spectrum antibiotic priced at US$25 per 500mg) and Eretaf (a generic Tadalafil, for treating erectile dysfunction).

In addition, Hovid is undertaking a collaboration with US-based Ohio University to produce Tocovid (vitamin E). Trials with the US Food and Drug Administration are expected to be completed by 2018.

A local investment bank analyst says local generic companies will still have opportunities, mainly due to the emergence of patent cliff. “For the years to come, the expiry of patents of many blockbuster drugs developed by foreign companies will present opportunities for local generic drug manufacturers,” the analyst says.

The analyst says the pharmaceutical sector is a defensive and growing industry. This comes as the sector thrives on a growing and ageing population, growing affluence and the rising prevalence of non-communicable diseases (chronic disease).

Over the past decade, Malaysia’s pharmaceutical industry grew at a CAGR of between 8% and 10%, largely on the back of imports of patented and generic drugs. “Malaysia is still heavily reliant on imports with about 70% of pharmaceutical needs imported,” the analyst says.

This article first appeared in Focus Malaysia Issue 260.