Detailed Rationale

CRISIL Ratings has reaffirmed its ratings on the bank facilities and debt instruments of Aragen Life Sciences Private Limited (Aragen Life) at ‘CRISIL AA-/Stable/CRISIL A1+’.

 

Aragen Life benefits from the diversified clientele, medium-to-long term contracts with customers and continued client addition, which supports revenue as well as widens the clientele. Improving cost-competitiveness vis-a-vis Chinese players and increased focus of global pharmaceutical (pharma) players on outsourcing research and development (R&D) beyond China has led to sustained healthy revenue growth of around 20% in the past two fiscals. Furthermore, continued healthy demand in the Discovery Services and Biologics segment (DBS; overseas operations) and capacity addition across businesses should help Aragen Life achieve healthy double-digit growth in revenue over the medium term.

 

Operating profitability improved to around 25% in fiscal 2020 from 20.4% in fiscal 2019, mainly on account of increased contribution from the high-margin DBS business and high capacity utilisation at the Visakhapatnam facility, which undertakes drug development. Operating margin is likely to remain healthy with scale-up of operations in high-margin business segments and economies of scale.

 

The financial risk profile has strengthened over time, driven by healthy cash generation and prudent use of debt. Gearing was at a comfortable 0.48 time as on March 31, 2020, and other credit metrics were healthy as well. While Aragen Life is expected to step up capital spending to Rs 250 crore annually in the next few years and is on the lookout for mid-sized acquisitions, it is expected to maintain prudent credit metrics. Liquidity was adequate, with cash and equivalents of Rs 196 crore as on March 31, 2020.

 

Thus far, Aragen Life has remained largely ring-fenced from the rest of the GVK group and has not provided any temporary or permanent financial support to GVK group companies. CRISIL Ratings is given to understand that the status quo will be maintained by Aragen Life given the presence of Mr Davinder Singh Brar and his family, with equal stake, and the presence of the private equity partner, Chrys Capital, with a significant minority stake. CRISIL Ratings has also noted that in case of another company of the GVK group, the regulatory authorities are investigating the company and its directors, including Mr Sanjay Reddy and a few of his family members, alleging financial irregularities. CRISIL Ratings has been informed that this development has had no impact on the operations of Aragen Life and will continue to monitor this.

 

CRISIL Ratings also understands that Chrys Capital is looking to exit Aragen Life by the end of fiscal 2021, as its investment tenure is coming to an end and is likely to be replaced by another investor.

 

The ratings continue to reflect Aragen Life’s established market position in the contract research industry, based predominantly on full-time equivalent (FTE) and fee-based contracts, healthy financial risk profile and liquidity. These strengths are partially offset by susceptibility to regulatory changes and increasing competition, and high geographic concentration risk.

Analytical Approach

For arriving at the ratings, CRISIL Ratings has combined the business and financial risk profiles of Aragen Life and its wholly owned overseas subsidiaries, Aragen Bioscience Inc (Aragen) and GVK Biosciences BV Netherlands. The entities, together referred to as Aragen Life herein, have the same management, financial linkages and similar businesses.

 

Please refer Annexure - List of entities consolidated, which captures the list of entities considered and their analytical treatment of consolidation.

Key Rating Drivers & Detailed Description

Strengths

• Established position in the contract research industry: Aragen Life is one of the largest contract research organisations (CROs) in India, with a large clientele that includes several global pharma players. It offers integrated services across the drug discovery and development value chain, and provides research services in medicinal chemistry and biology to innovator pharma companies. The company's established market position is reflected in its large clientele of over 450 companies. Drug discovery services is the major revenue contributor, accounting for around 50% of the company’s revenue in fiscal 2020. This division synthesises compounds, and the company, with its strong track record, has continually obtained new projects under the division. Revenue contribution from the Discovery services segment increased to 26% in fiscal 2020 from 14% in fiscal 2019.

 

• Low-risk business model, predominantly based on FTE and fee-based contracts: The company follows a low-risk business model, which involves billing on an FTE basis. Contracts are typically renewable annually, resulting in stable revenue. The company has a large clientele and has retained around 70% of its clients over the past several years. It has long-term relationships with clients, resulting in multiple assignments and higher revenue contribution. The business model, involving FTE and fee-based contracts, has led to substantial and stable revenue. Also, through diversification of its clientele, the company has reduced customer concentration risk, with the share of the top 10 customers in revenue almost halving in the past 4-5 years.

 

• Healthy operating profitability: Strong operating efficiency, cost reduction initiatives and high share of the profitable drug discovery business have enabled Aragen Life to report healthy operating profitability margin in excess of 20-24% since fiscal 2017, barring the impact of restructuring at its US subsidiary and volatile active pharma ingredient (API) prices in fiscal 2019. Streamlining of operations and better utilisation of capacities are likely to lead to steady profitability over the medium term.

 

• Healthy and improving financial risk profile: The financial risk profile strengthened over time because of healthy cash generation and prudent use of debt. Gearing was a comfortable 0.48 time as on March 31, 2020, while interest coverage was over 13 times (around 9 times in fiscal 2019). While Aragen Life is expected to step up capital spending to Rs 250 crore annually in the next few years and is on the lookout for mid-sized bolt-on acquisitions, it is likely to maintain prudent credit metrics; gearing is not expected to exceed 1 time on a sustained basis. The company also has sizeable contingent liabilities of over Rs 100 crore relating to tax claims that are being contested; a negative verdict requiring large payout by the company will remain a monitorable.

 

Weaknesses

• Susceptibility to regulatory changes and increasing competition:

The contract research industry is highly fragmented on account of low entry barriers. Several large global pharma players are outsourcing contract research activities to India. Hence, more CROs may enter the fray, increasing competition and constraining pricing flexibility of established players such as Aragen Life. Additionally, the company faces competition from CROs based in China and Eastern Europe, among others, which may have a broader portfolio of services. Nevertheless, the company benefits from its wide range of service offerings and strong clientele. The company is also exposed to stringent regulatory requirements.

 

• High geographical concentration risk

In fiscal 2020, Aragen Life derived around 66% and 18% of its revenue from the US and Europe, respectively, exposing it to region-specific regulatory and political developments. Going forward, the majority of revenue is expected to come from the US, in line with the current trend. However, upfront and milestone-based payments from customers should mitigate this risk to some extent. Revenue is also susceptible to regulatory and political developments in countries in which its customers are located. As the company derives 92% of its revenue from the overseas market as in fiscal 2020, its revenue and operating margin remain susceptible to any adverse foreign exchange (forex) movements. However, the company hedges its forex exposure as per its hedging policies, mitigating the risk to an extent.

Liquidity: Strong

Liquidity is supported by healthy cash generation, over Rs 150 crore per annum, and moderate utilisation of fund-based bank limit of Rs 130 crore, averaging 53% over the 12 months through May 2020. The company has also steadily built up its cash surplus, which stood at close to Rs 200 crore at March 31, 2020. Cash accrual will comfortably cover debt obligation of Rs 16 crore and Rs 34 crore in fiscals 2021 and 2022, respectively. Dividend payout has been moderate at 25-40% of net profit over the past few years and is expected to remain at 25-30% over the medium term.

Outlook Stable

CRISIL Ratings believes Aragen Life’s business risk profile will further improve over the medium term, driven by its established business model and healthy business performance. The financial risk profile will continue to strengthen, while liquidity will remain healthy.

Rating Sensitivity Factors

Upward Factors

• Sustained healthy double-digit growth in revenue, with operating profitability maintained in mid-20% range
• Further strengthening of the financial risk profile and healthy liquidity surplus

 

Downward Factors

• Moderation of revenue and profitability due to intense competition or impact of any adverse regulatory action; for instance, operating profitability margins declining below 18-20% on sustained basis
• Higher-than-expected capital spending or debt-funded capital expenditure, leading to moderation in credit metrics – for instance, gearing remaining above 1 time and Debt to EBITDA above 2 times on a sustained basis
• Significant change in shareholding among promoters or large fund outflow to promoters or promoter companies by way of dividend, capital reduction, share buy-back or any other manner, leading to moderation in liquidity
• Material regulatory action against promoters, impacting operations
• Negative verdict in case of tax exemptions of over Rs.100 crore being contested, lowering liquidity

About the Company

GVK Bio, incorporated in 2000, is an integrated contract research and development organisation(CRDO) , which provides drug discovery and development services to pharma companies. It provides end-to-end and integrated services across the value chain, from drug discovery to commercial manufacturing. The company provides services such as patent services, medicinal chemistry services, scale-up technologies, formulation and analytical services, process research development (PRD), and custom chemical synthesis (CCS). It also manufactures APIs and API intermediates. It has over 500 clients, including 17 of the top 20 global pharma companies. The company has more than 2,200 employees, with facilities in Hyderabad, Bengaluru, and Visakhapatnam, and in Morgan Hill, California.

 

Its wholly owned subsidiary, Aragen, is a privately held, US-based, pre-clinical CRO specialising in high-value biologics services. Another wholly owned subsidiary, Inogent, was merged with GVK Bio pursuant to a scheme that received all approvals in May 2018; the merger became effective from April 1, 2017.

 

As on March 31, 2020, Mr Brar and his family members and Mr Reddy and his family members directly and indirectly held 41.01% shares each in the company; 16.77% was held by Destiny Investments Ltd (Chrys Capital) and the remaining was held by GVK Bio Employee Welfare Trust. In December 2020, the name was changed from GVK Biosciences Ltd to Aragen Life.

Key Financial Indicators

Particulars	Unit	2020	2019
Revenue	Rs crore	951	795
Profit After Tax (PAT)	Rs crore	99	61
PAT Margin	%	10.5	7.7
Adjusted debt / adjusted networth	Times	0.48	0.31
Adjusted interest coverage	Times	13.24	8.65

 

Any other information: Not applicable

Annexure - Details of Instrument(s)

ISIN	Name of Instrument	Date of Allotment	Coupon Rate (%)	Maturity Date	Issue Size (Rs.Cr)	Complexity Level	Rating Assigned with Outlook
NA	Working Capital Facility*	NA	NA	NA	111.80	NA	CRISIL AA-/Stable
NA	Working Capital Facility	NA	NA	NA	40.00	NA	CRISIL AA-/Stable
NA	Letter of credit@	NA	NA	NA	47.00	NA	CRISIL A1+
NA	External Commercial Borrowing	NA	NA	31-Oct-2023	44.70	NA	CRISIL AA-/Stable
NA	Term Loan	NA	NA	31-Mar-2024	50.00	NA	CRISIL AA-/Stable
NA	Term loan	NA	NA	31-Mar-2026	75.00	NA	CRISIL AA-/Stable
NA	NCDs^	NA	NA	NA	75.00	Simple	CRISIL AA-/Stable
NA	Commercial Paper^	NA	NA	NA	50.00	Simple	CRISIL A1+
NA	Proposed Long-Term Bank Loan Facility	NA	NA	NA	10.00	NA	CRISIL AA-/Stable

* Fully interchangeable with letter of credit/buyers’ credit/bank guarantee

@ Fully interchangeable with buyers' credit/bank guarantee

^Placement awaited

Annexure – List of entities consolidated

Names of Entities Consolidated	Extent of Consolidation	Rationale for Consolidation
Aragen Bioscience Inc	Wholly owned subsidiary	Fully consolidated
GVK Biosciences B V Netherlands	Wholly owned subsidiary	Fully consolidated