Dilip Shanghvi, chairman of Sun Pharmaceutical Industries Ltd., poses during an interview at the company’s headquarters in Mumbai. (Photographer: Kuni Takahashi/Bloomberg)

The Nexus Between Sun Pharma, Aditya Medisales And Dilip Shanghvi

In December a whistleblower letter and a brokerage sales note cast several doubts about disclosure and corporate governance standards at Sun Pharmaceutical Industries Ltd. Among those is the relationship between its Promoter and Managing Director Dilip Shanghvi and one of the company’s key distributors – Aditya Medisales Ltd. A BloombergQuint investigation shows this relationship went back several years and ought to have been disclosed much earlier than it has been.

Sun Pharma is India’s largest drugmaker with consolidated sales of Rs 26,490 crore in financial year 2017-18. Most of its drugs in India are distributed by privately held Aditya Medisales. No small business this – AML did a revenue of Rs 8,005 crore in FY18, though like it is for most distribution companies that work on a slim margin, profit was minuscule at Rs 29.17 crore.

In its FY18 annual report, Sun Pharma disclosed that AML is a related party, owned 59.27 percent by Shanghvi.

But it isn’t that Shanghvi acquired the company that year or suddenly came into possession of it. He has indirectly owned it prior to that as well, probably since 2006. Yet Aditya Medisales was not disclosed as a related party of Sun Pharma till 11 years later.

How did Sun Pharma get away with this?

Also read: Mr Shanghvi, Your Secret Cost Sun Pharma’s Investors Rs 11,000 Crore In Two Days

Hiding Behind A Technicality?

Well, Sun Pharma said in a statement to BloombergQuint that “the transactions with AML are reported as related party transactions in FY18 but not in previous years since AML was not required to be classified as a related party prior to FY18. AML became a related party in FY18 due to consolidation of its shareholding amongst fewer entities as compared to the past”.

But BloombergQuint’s investigation shows that for many years before FY18, AML was a related party at least in spirit if not according to the letter of the law. And it escaped the latter thanks to complex ownership structures.

Aditya Medisales was incorporated as a private limited company in October 1990 and since FY07 (detailed shareholding was not available at exchange prior to that) has been owned by entities many of whom are also listed as the Shanghvi family promoter entities of Sun Pharma.

For instance, stock exchange filings pertaining to FY07, the first year in which shareholding details are available, and FY17, the year before AML was finally categorised as a related party, show common entities.

The Nexus Between Sun Pharma, Aditya Medisales And Dilip Shanghvi
The Nexus Between Sun Pharma, Aditya Medisales And Dilip Shanghvi

A scrutiny of AML’s shareholding revealed that many of its shareholders are in turn owned by other companies and so on, making the ownership trail difficult to unravel for all the 10 years prior to FY18.

But a BloombergQuint study of AML’s shareholders for the years FY15 to FY17 shows that Dilip Shanghvi, through various privately held entities, owned at least 50.9 percent of the distributor. In fact, in FY17, consolidation among some of those entities led Shanghvi Finance Pvt. Ltd.—a company wholly owned by Dilip and Vibha Shanghvi—to list AML as a step-down subsidiary in its filings with the Registrar of Companies.

Ownership structure of some Aditya Medisales shareholders that traces back to Dilip Shanghvi.
Ownership structure of some Aditya Medisales shareholders that traces back to Dilip Shanghvi.

This complex, indirect structure of ownership is what likely gave Sun Pharma an opportunity to avoid classifying AML as a related party till FY18, despite the two having a common controlling shareholder.

In FY18, the AML ownership structure was further consolidated.

  • 21 companies of the Shanghvi family, including those which held stake in AML, were to be merged into Shanghvi Finance.
  • This group consolidation of promoter companies led Shanghvi Finance to hold a direct majority stake—59.27 percent—in Aditya Medisales.

Thus, it was only in FY18 that AML was listed as a related party of Sun Pharma.

Till then, despite its relationship with Shanghvi and his family, AML escaped all company law provisions applying to related-party transactions.

Starting April 1, 2014, related-party transactions, such as those between Sun Pharma and AML, would have required board approval and a shareholder vote in which the related party could not participate.

Had these provisions applied, shareholders would have had the chance to vote on certain peculiar financial arrangements between Sun Pharma and AML. Arrangements that BloombergQuint discovered while sifting through filings by both companies.

AML Operations

AML is the largest distributor of Sun Pharma’s drugs and formulations in the domestic market.

The company has warehouses and godowns spread across the country and 32 C&F locations to support its business operations, said Brickworks Ratings in an April 2015 report.

But AML’s operational costs don’t seem to be commensurate with the scale of its operations, as per data reviewed by BloombergQuint.

Despite the many warehouses and godowns it operates, AML spent just Rs 2.22 crore on payroll and Rs 14 lakh on power in FY18. This seems too low for a distribution company with Rs 8,000 crore in sales, close to Sun Pharma’s standalone sales, requiring high-end storage facilities for drugs and formulations.

The Nexus Between Sun Pharma, Aditya Medisales And Dilip Shanghvi

AML and Sun Pharma didn’t respond to BloombergQuint’s emailed query seeking clarity on these operational costs.

Advances To Private Promoter Entities

Despite its low operational costs, AML has taken unsecured loans worth Rs 600 crore as on March 2018. The company did not respond to BloombergQuint’s queries regarding use of funds.

By the way, AML is listed among the many entities that Sun Pharma extended unsecured loans to in FY18. But no specific amounts are available, and the company did not respond to queries for details.

A Distributor With Treasury Operations?

AML has been investing receivables and short-term loans in treasury operations.

According to BloombergQuint’s calculations, in FY18, AML’s collection cycle from customers was 19 days and its payable cycle to Sun Pharma was 42 days.

BloombergQuint also reviewed data for 14 years and computed that on an average, the company received payments from wholesalers in 20 days and paid Sun Pharma every 70 days.

This gap allowed AML to invest the temporary surplus cash in inter-corporate short-term deposits. As part of the treasury operations, it also seems to have further lent some of the unsecured loans it received.

The Nexus Between Sun Pharma, Aditya Medisales And Dilip Shanghvi
The Nexus Between Sun Pharma, Aditya Medisales And Dilip Shanghvi
The Nexus Between Sun Pharma, Aditya Medisales And Dilip Shanghvi

It is not uncommon for promoters to privately own several companies that may be suppliers, vendors or distributors for their flagship, listed company. This has been a common way for promoters to extract value from the supply chain for their personal benefit and is the main reason why the new company law in 2014 introduced stricter disclosure and approval provisions for related party transactions. Despite that Sun Pharma seems to have used technicalities to avoid listing AML as a related party all the way till 2018. This issue is one among many that has created a corporate governance storm for the company.

In its statement to BloombergQuint, the company said it is reviewing the relationship with AML. “Sun Pharma’s relationship with AML is on an arm’s-length basis. As investors have expressed concerns regarding this arrangement, we are in the process of evaluating various options for undertaking domestic formulation business.”

Also read: SEBI Examining Whistleblower Complaint Against Sun Pharma, Says Chairman Tyagi