Sun Pharmaceutical Industries (Sun Pharma unrated) announced that it had entered a definitive agreement to acquire 100% of Ranbaxy Laboratories (Ranbaxy unrated) in a cashless, all-stock transaction.

For Daiichi Sankyo Company (Daiichi Sankyo A1 stable), the transaction means that it will acquire a final 9% stake in Sun Pharma, replacing its current 63.4% stake in Ranbaxy.

Ranbaxy shareholders will receive 0.8 shares in post-acquisition Sun Pharma for every single Ranbaxy share, implying a total equity value for Ranbaxy of about USD 3.2 billion.

The transaction is credit positive for Daiichi Sankyo because it will restore its ability to execute its long-term strategy of driving growth through its Indian generics business. Previously, leveraging Ranbaxy's operations to serve global markets, especially those in the US, was key to Daiichi Sankyo's long-term generics strategy. However, Ranbaxy lost all its ability to export to the US after the Food and Drugs Administration (FDA) banned imports from all four of its Indian facilities.

As a result of this ban and a penalty payment of USD 500 million provisioned in December 2011, Ranbaxy's contribution to Daiichi Sankyo's profitability, on a consolidated basis, has declined substantially in recent years.

The transaction is also credit positive for Daiichi Sankyo because it will acquire a share-although smaller than its share in Ranbaxy -in a far more profitable company-Sun Pharma. Accordingly, we expect a positive impact on the revenue and profits that Daiichi Sankyo earns from its stake in the Indian generics manufacturer.

We do not see any negative impact of this transaction on Daiichi Sankyo's balance sheet. We calculate the market value of Daiichi Sankyo's 9% stake in the new post-transaction company at USD 2 billion. This calculated value substantially exceeds the written-down book value of its stake in Ranbaxy. Therefore, additional event-driven write-downs-leading to a weakening of Daiichi Sankyo's balance sheet are unlikely. The company paid JPY488 billion in November 2008 for its 63.9% stake in Ranbaxy. However, Daiichi Sankyo took a special write-down of JPY351 billion on its investment in FYE3/2009.

We expect Daiichi Sankyo's leverage metric to improve-following the transaction-owing to the shift of its Indian generic investments from a consolidated to a non-consolidated basis.

While this expected outcome is due to the deconsolidation of Ranbaxy debt on Daiichi Sankyo's balance sheet following the transaction, the economic/business risk for Daiichi Sankyo will also decline. The task of resolving Ranbaxy's problems will effectively pass to Sun Pharma after the acquisition.

According to the transaction's details, Sun Pharma will assume USD 800 million of Ranbaxy's debt, roughly 20% of Daiichi Sankyo's reported consolidated debt at end-2013.

Shares of Sun Pharmaceutical Industries gained Rs 39.6, or 6.74%, to trade at Rs 626.85. The total volume of shares traded was 927,207 at the BSE (1.31 p.m., Wednesday).