Rating Rationale
September 30, 2020 | Mumbai
GVK Biosciences Private Limited
Long-term rating upgraded to 'CRISIL AA-/Stable'; short-term rating reaffirmed
 
Rating Action
Total Bank Loan Facilities Rated Rs.378.5 Crore (Enhanced from Rs.332 Crore)
Long Term Rating CRISIL AA-/Stable (Upgraded from 'CRISIL A+/Positive')
Short Term Rating CRISIL A1+ (Reaffirmed)
 
Rs.75 Crore Non Convertible Debentures CRISIL AA-/Stable (Upgraded from 'CRISIL A+/Positive')
Rs.50 Crore Commercial Paper CRISIL A1+(Reaffirmed)
1 crore = 10 million
Refer to annexure for Details of Instruments & Bank Facilities
Detailed Rationale

CRISIL has upgraded its rating on the long-term bank facilities and non-convertible debentures of GVK Biosciences Private Limited (GVK Bio) to 'CRISIL AA-/Stable' from 'CRISIL A+/Positive'. The rating on the short-term bank facilities and commercial paper has been reaffirmed at 'CRISIL A1+'.
 
The rating revision reflects steady improvement in GVK Bio's business risk profile driven by healthy demand from global pharmaceutical (pharma) players for contract research, healthy profitability, and the company's strengthening financial risk profile.
 
GVK Bio benefits from diversified clientele, medium-to-long term contracts with customers and continued client addition, which helps support revenue as well as widens the customer base. Improving cost-competitiveness vis-a-vis Chinese players and increased focus of global 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 GVK Bio 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 GVK Bio is expected to step up capital spending to Rs 250 crore annually in the next few years and is also on the lookout for mid-sized acquisitions, it is expected to maintain prudent credit metrics. Liquidity was adequate with cash and equivalent of Rs 196 crore as on March 31, 2020.
 
GVK Bio has thus far 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 is given to understand that the status quo will be maintained by GVK Bio, given the presence of Mr Davinder Singh Brar and his family, with equal stake, and also the presence of the private equity partner, Chyrs Capital, with significant minority stake. CRISIL 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 few of his family members, alleging financial irregularities. CRISIL has been informed that this development has had no impact on the operations of GVK Bio; CRISIL will continue to monitor the same.
 
CRISIL also understands that Chrys Capital is looking to exit GVK Bio 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 GVK Bio'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 has combined the business and financial risk profiles of GVK Bio, and its wholly owned overseas subsidiaries, Aragen Bioscience Inc (Aragen) and GVK Biosciences BV Netherlands. The entities, together referred to herein as GVK Bio, 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: GVK Bio 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 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 customer base, the company has reduced customer concentration risk, with the share of top 10 customers in revenue almost halving in the past 4-5 years.
 
* Healthy operating profitability: Strong operating efficiency capabilities, cost reduction initiatives, and high share of the profitable drug discovery business has enabled GVK to report healthy operating profitability margins in excess of 20-24% since fiscal 2017, barring 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 is likely to lead steady profitability over the medium term.
 
* Healthy and improving financial risk profile: The financial risk profile has strengthened over time, because of healthy cash generation and prudent use of debt. Gearing was at a comfortable 0.48 time as on March 31, 2020, while interest coverage was over 13 times (around 9 times in fiscal 2019). While GVK Bio is expected to step up capital spending to Rs 250 crore annually in the next few years and is also 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 crores relating to tax claims which are being contested; a negative verdict requiring large pay out 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 GVK Bio. Additionally, the company faces competition from CROs based in China, 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:
GVK Bio derived around 66% and 18% of its revenue from the US and Europe, respectively, in fiscal 2020, 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 surpluses, which stood at close to Rs.200 crores 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. The 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 believes GVK Bio'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 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.

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

Note on complexity levels of the rated instrument:
CRISIL complexity levels are assigned to various types of financial instruments and are included (where applicable) in the Annexure -- Details of Instrument in this Rating Rationale. For more details on the CRISIL complexity levels, please visit www.crisil.com/complexity-levels.
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 90.80 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-23 44.70 NA CRISIL AA-/Stable
NA Term Loan NA NA 31-Mar-24 50.00 NA CRISIL AA-/Stable
NA Term loans NA NA 31-Mar-26 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 31.00 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
Annexure - Rating History for last 3 Years
  Current 2020 (History) 2019  2018  2017  Start of 2017
Instrument Type Outstanding Amount Rating Date Rating Date Rating Date Rating Date Rating Rating
Commercial Paper  ST  50.00  CRISIL A1+      09-09-19  CRISIL A1+    --    --  -- 
Non Convertible Debentures  LT  0.00
30-09-20  		CRISIL AA-/Stable      09-09-19  CRISIL A+/Positive    --    --  -- 
Fund-based Bank Facilities  LT/ST  331.50  CRISIL AA-/Stable      09-09-19  CRISIL A+/Positive  21-06-18  CRISIL A+/Stable  13-07-17  CRISIL A+/Stable/ CRISIL A1+  CRISIL A+/Stable/ CRISIL A1+ 
Non Fund-based Bank Facilities  LT/ST  47.00  CRISIL A1+      09-09-19  CRISIL A1+  21-06-18  CRISIL A1+      CRISIL A1+ 
All amounts are in Rs.Cr.
Annexure - Details of various bank facilities
Current facilities Previous facilities
Facility Amount (Rs.Crore) Rating Facility Amount (Rs.Crore) Rating
External Commercial Borrowings 44.7 CRISIL AA-/Stable External Commercial Borrowings 55 CRISIL A+/Positive
Letter of Credit@ 47 CRISIL A1+ Foreign Currency Term Loan 2.13 CRISIL A+/Positive
Proposed Long Term Bank Loan Facility 31 CRISIL AA-/Stable Letter of Credit@ 47 CRISIL A1+
Term Loan 125 CRISIL AA-/Stable Proposed Long Term Bank Loan Facility 47.07 CRISIL A+/Positive
Working Capital Facility* 90.80 CRISIL AA-/Stable Term Loan 50 CRISIL A+/Positive
Working Capital Facility 40 CRISIL AA-/Stable Working Capital Facility* 90.80 CRISIL A+/Positive
-- 0 -- Working Capital Facility 40 CRISIL A+/Positive
Total 378.5 -- Total 332 --
*Fully interchangeable with letter of credit/buyers' credit/bank guarantee
@Interchangeable with buyers' credit/bank guarantee
Links to related criteria
CRISILs Approach to Financial Ratios
CRISILs Bank Loan Ratings - process, scale and default recognition
Rating criteria for manufaturing and service sector companies
CRISILs Criteria for Consolidation
CRISILs Criteria for rating short term debt

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