CMP = Rs 207
Price target: Rs 375
Key points:
- According to a few media reports, Solrex Pharmaceuticals has acquired an 8.06% stake in Orchid Chemicals (Orchid) from the open market. The stake has been acquired at an average price of Rs 165-170 per share. As per media speculation, Solrex Pharmaceuticals belongs to the Ranbaxy group. If the media speculation is to be believed and the Ranbaxy group manages to take over Orchid at a cheap price of Rs 165-170 per share, it would come as a huge benefit for the group. The company will gain from acquiring a fundamentally strong business with a complementary product portfolio and that too at extremely cheap valuations.
- Pursuant to the ~40% plunge in the share price of Orchid on March 17, 2008 due to relentless selling by the troubled Bear Stearns and the subsequent margin call trigger for the promoters, the promoter holding in Orchid had reduced from 24% to 17%. The low promoter holding coupled with the sharp fall in the share price made Orchid an attractive takeover target.
- Tfair value of Orchid works out to Rs 375 per share, which means that the Ranbaxy group's purchase price would work out to a 120% discount to the fair value of the company and a 93% discount to the 52-week high price of Rs 328. In fact, the acquisition price would be at par with Orchid's estimated FY2008 book value of Rs 167.6 per share.
- Orchid's business model is fundamentally strong with a strong presence in the USA and expansion plans underway in Europe. However, the stock has been plagued by several concerns including a relatively low promoter holding and an over-leveraged balance sheet. I feel that the potential takeover of Orchid by the Ranbaxy group or even the holding of a minority stake by the Ranbaxy group in Orchid will ensure long-term growth for Orchid, as the latter would be in stronger and more credible hands.
- At the current market price of Rs 207, Orchid is discounting its FY2008E earnings by 11.9x and its FY2009E earnings by 8.8x. The valuations at these levels seem absolutely compelling when viewed in context of the strong growth potential that awaits the company.
- I retain strong positive stance on the stock and maintain Buy recommendation with a price target of Rs 375.
