Given the explosive growth in small-cap companies’ market capitalization in recent times, we are observing several radical calls like ‘Small-cap companies are in a bubble’ or “This is the start of the new capex cycle”, or “This is India’s decade”.
However instead of fixating on the share prices of these companies, if we just focus on their:
~ business models
~ Key transformational decisions in the past
~ What lies ahead
We will not only appreciate their entrepreneurial story even more..after all compounding sales & profits at a rate greater than 12-15% when the economy itself grows at only 6-7% on average is nothing short of mind-blowing!
But this will also help us humanize the entrepreneurs instead of reducing them to mere numbers:) & focus on the quality of their strategies & decision making which can be used by investors & business community as mental models while investing in other companies or even utilizing it in one’s own business!
With that being said, let’s jump right into the 1st story of the “Journey of A Multibagger” series – Gujarat Themis Biosyn.
Looking at the price chart, one immediate thought that pops up is… I wish I had invested in March 2020, after all, the stock went up by 10X in a matter of 3 years!
But instead of focusing on that front, let us understand ~ ‘The journey of this multi-bagger
About the Company
The company is in the business of supplying API intermediates namely Rifamycin S and Rifamycin O to its customers for the production of finished medicine.
The business is currently managed by Themis Medicare (another listed company that has a stake of 23.2%) while the majority shareholder is Pharmaceutical Business Group which increased its stake from 24.6% to 51% (following the buyout of another JV partner)
Coming to the Products portfolio:
Rifamycin S is an intermediate for manufacturing a drug called Rifampicin which is used for the treatment of bacterial diseases like Tuberculosis & leprosy. This business is primarily Tender-based hence revenues are highly dependent on Govt. tenders.
Rifampin O is an intermediate for manufacturing the drug Rifaximin which is used for the treatment of diarrhea, irritable bowel syndrome, and hepatic encephalopathy.
It is one of the only indigenous producers of these drugs owing to a complex production process followed by the company called – ‘Fermentation’.
One might wonder why these intermediates are not produced by the Pharma companies themselves.
After all, Fermentation is not a new chemistry & dozens of companies have tried their hands in the past. However, owing to an inability to make products more economically & efficiently, several producers went under when China started to dump the products into the Indian market.
Thus, mastering this chemistry is tough & complex, especially at a viable level, therefore Pharma companies prefer to not make this by themselves.
Additionally, This involves high capex (for Eg. the company’s current capacity has a replacement value upwards of 200 Crs!) & Long gestation period wherein regulatory approvals itself take at least 2 years.
This is the reason why, the company has strong competitive advantages in the Indian market where the major competition comes from Chinese imports which have sequentially reduced owing to higher power & freight costs.
However, the elephant in the room still remains..what clicked that transformed it from 100 Cr to a 1000 Crs company?
The Key trigger: Pivot in Business Model from Contract manufacturing (Job work) to Market sales model
One Immediate observation: Something changed drastically in the business post-FY20!
Let’s understand what happened~ basically, the company was engaged in contracts with only two companies ~Lupin & Optrix Laboratories where the company used to make products for them based on contractual orders & charge a fixed margin over & above the cost incurred on the production. One might realize that if only 2 companies contribute to your entire revenues, the contractual agreements will be in favor of the buyer! Because of this over-dependence on them (which mind you still exists), the margins over & above the costs for the contracts were very low which lead to relatively low profit margins for the company.
This is when the company decided to pivot in FY19-20, wherein the company will charge the market price for its products from the customer. Now, since the market prices were higher, the company’s realizations suddenly shot up~leading to an extra-ordinary margin profile which is visible from the increase from 18-21% (being fixed margins charged under previous contracts) to upwards of 50% (owing to higher realizations)
While this sounds like an easy decision to take or bet on in hindsight, this is where we can learn from the pain & risk-taking abilities of the entrepreneur. But what risks you ask?
Well, firstly under Contract manufacturing, the inventory requirements are very low as production takes place according to the orders received, while the margins are also fixed, which ensures the company a ‘Stable-Profitable-Less Capital intensive earnings stream’.
However, after this pivot, the company had to not only maintain a very high inventory to meet the demand whenever it arises coupled with a more lenient credit period to the customers ultimately leading to higher capital being employed. Plus, under this model, margins are highly susceptible to the current market prices of the same drug, therefore profitability becomes less certain in comparison to the previous model where margins were fixed.
It is this ‘valiant decision’ (along with several other recent developements) that changed the company’s & its shareholders fortune.
What Lies Ahead: Transformation from a one-trick pony to an API Powerhouse
As one might have observed, the company although boasts of a strong returns & margin profile, manufactures only 2 products, which not only leads to higher dependence on these two products but limits future growth opportunities.
The management was quick enough to address that through a forward integration strategy, the company is foraying into the production of finished formulations through an ambitious INR.200 Crs CapEx for creating R&D & production facilities.
The company currently has 6 products in the R&D phase & expects this to scale-up post September once the R&D plant is capitalized.
This is not only expected to create high growth post-FY24 but also reduce the risk of high concentration on the current two products.
Further, the slow growth reported in Rifa-S for FY23 (owing to a slowdown in Tenders) is expected to be arrested in the coming year owing to the new WHO regulations regarding the preference for 3HP rifapentine-based treatment as compared to the current prevailing Rifampicin-based treatment. This is a major development for the business as Rifa-S will be required as an intermediate for the new drug where the dosage required is high, & the conversion ratio of Rifa-S to Rifapentine is low, which will lead to higher volumes.
The company is not seeing any major import dumping or the resulting pricing pressure from China which is another positive development.
Closing Thoughts
In this blog, we learned the strategy of pivot in the Business model & its potential impact on the company’s fortune. You must have observed that we didn’t talk about any potential targets of the company’s future stock price or our projected numbers for the business, but did you wonder why?
Well, the only objective of our blog series “The Journey of a Multi-bagger” is to focus on the historical transformational decisions taken by Entrepreneurs which led to asymmetric returns for their shareholders & learn from their challenges.
We sincerely hope that the resulting mental models will help our readers in taking future investments or business decisions & at the same time celebrate our country’s ‘Phenomenal Entrepreneurs’.. after all they are the true pilots of the Plane (i.e.Business) which we have onboarded as passengers (i.e.Shareholders) & it is only because of their efforts & hard work, that we are able to reach our ultimate destination (i.e.compounding our wealth).
P.S. If you like our research, you may wish to be a part of our MissioN SMILE community here.
