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EastPharma Ltd (EAST)

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Monday 16 August, 2010

EastPharma Ltd

Letter to the investors by the Chairman and CEO

Letter to the investors

By the Chairman and CEO


Dear Investors

Thank you for your support for EastPharma.

The purpose of this open letter is to give you a "big picture" view of
EastPharma's current status and its prospects.  It is intended to be an informal
and transparent perspective on your company.

Our main message is that we have successfully transformed Deva Holding, our main
operating subsidiary.  We started with an inefficient, low-margin and
low-market-share, competitor which existed on the lower rungs of the Turkish
generics market. Three years later, through sustained hard work, combined with
two value-creating product acquisitions, our team has created an innovative,
fast-growing leader in branded and branded-generic pharmaceuticals.  We are
proud of our accomplishments, and wanted to share some of the details with you.

I have structured this letter in three parts:

   1. where we came from
   2. where we currently stand, and
   3. where we intend to go from here.

Where we came from:

EastPharma was created as a privately held acquisition vehicle for the takeover
of Deva Holding in early 2007.  About six months after the Deva acquisition we
listed EastPharma on the London Stock Exchange.

The listing itself was highly successful.  For several weeks, EastPharma's
valuation on the LSE was at a significant premium to the underlying valuation of
its holdings in Deva, as traded on the Istanbul Stock Exchange.

As the global financial crisis began, however, the EastPharma share price fell
dramatically - both in absolute terms and relative to the underlying value of
the publicly traded Deva shares. For most of the last three years, EastPharma
has traded at a significant discount to the value of its ownership stake in

After the listing, we resisted investor pressure to make an expensive
acquisition which would have loaded our balance sheet with debt. Instead, we
used our cash to embark on a process of profound transformation - strategic,
operational, organisational - at Deva.  Our objective was to create a great,
innovative, highly profitable,  global pharmaceutical business, based in Turkey.

One of the critical first steps in the transformation was to sell the old
headquarters and main factory building.  Although these assets were valued at
only USD 30m, we ran a highly competitive auction process at the very top of the
world wide real estate boom, and were fortunate to sell them for USD 80m.

Unfortunately, when digging for the foundations of the new factory buildings, we
discovered a number of chemical-filled barrels that had been disposed of by a
previous owner. Although the barrels only contained an organic alcohol, which
was not a toxic substance, we were required to pay a heavy fine. More important,
the Turkish authorities delayed construction by 6 months, which pushed some
critical phases into winter, which resulted in additional delays.

Due to the delays, we used up all of the bridging stock that we had manufactured
to meet market demand while we were transitioning from the old factory to the
new one.  As an interim measure, we had to transfer the majority of our
production one of our other old facilities, Carlo Erba.  This was a significant
regulatory and technological transfer challenge in itself.

Despite the setbacks, in August 2008, we began manufacturing our first products
in the penicillin facility in our new factory at Cerkezkoy.  In September 2008
the first products came out of our new cephalosporin facility at Cerkezkoy.  In
November 2008, we inaugurated our new injectables factory in Kartepe, and in
April 2009, our main production unit in Cerkezkoy was finally ready.  With these
new facilities fully on stream, we had accomplished the first phase of the
transformation process.

Although we had brand new, state-of-the-art facilities, most of the machinery
was old, and had been moved from old facilities.  We still faced product
shortages and stock outs in the market.  Therefore, in 2009, we ordered a whole
range of new machines, to increase our capacity, speed up production, and
improve quality.  Without these new machines, we could not have coped with the
heavy increase in volumes in the first quarter of this year. By the end of
2010, we will have totally new machinery in our penicillin and cephalosporin
units.  With this investment, we will have renewed a big part of our overall
production capacity.

Another significant step in our operational transformation has been preparing
our facilities for inspection and certification by the regulatory authorities in
the most developed countries (e.g., markets in the E.U. and North America).
Although the actual manufacturing standards in our facilities has always been
high, we have been required to improve our written SOPs (Standard Operating
Procedures), and to have all of our operators go through rigorous training in
GMP (Good Manufacturing Practice). So the human element is now most critical as
we prepare for major inspections. The scale of our operation - 250 different
products in more than 600 different dosage forms, 600 workers in our factories -
illustrates how difficult this task is.

By the beginning of 2011, we plan to pass these inspections, and finalize the
operational element of our transformation process.

In addition to the improvements we have made in our operating facilities and
manufacturing processes, we have significantly upgraded the quality of our
staff.  Over the last three years, we have replaced nearly all of the members of
senior management, and a large percentage of the sales forces and production
teams.  We have been fortunate to attract excellent, experienced managers, and
are now viewed as an employer of choice within the Turkish pharmaceutical

On the commercial side of Deva's transformation, in June 2008 we acquired eight
products from Roche, and in-licensed another 8 Roche products.  As part of the
agreement, we took over the related sales force from Roche.  This transaction
has proven to be beneficial for both companies.  For EastPharma, there have been
two major benefits:

-      The acquired and licensed products have provided us with strong cash
flows and a relatively short pay-back period

-      To be chosen by Roche as their commercial partner in Turkey, has greatly
increased the standing and reputation of Deva and EastPharma in the market

I believe we handled the Roche deal extremely well, from the deal negotiations
through to the closing and the operational execution. We were able to transfer
the Roche marketing authorizations (MAs) within a very short time, and were able
to continuously supply the market with products, which given the regulatory
challenges, was not an easy task to handle.

We also integrated the Roche sales force well, and melded two very different
cultures into a new Deva culture. All of the Roche products have performed well,
to the great satisfaction of both EastPharma and Roche.

Last but not least, during the worst period of the international finance crisis,
we had to finance a big amount of Roche bridging stock as well as increased
working capital requirements.  This was very challenging, but our management
team resolved the issue without resorting to solutions, which would have greatly
diluted our equity investors. We struggled through a period of very tight credit
in Turkey.  If loans were available, interest rates were 30% in Turkish Lira as
well as in USD. Today, the situation has normalized and we pay rates of 7% in
Turkish Lira, 3% in USD and 2% in Euros.

Where we are now:

Thanks to our success with the Roche products, we were able to strike another
"end of cycle products" deal last week, this time with BMS. Again, we expect
this transaction to be highly beneficial for Deva and EastPharma, as it will
enhance our product offering with a good number of new products, many of which
will have a steady demand with little competition.

As far as our market position in the Turkish market is concerned, I am very
pleased to report that we increased our market share from around 1.8% when we
acquired Deva Holding to 3% last year.  Our share has grown further, to 4% in
this current year.  As evidence of our dramatic growth, Deva was recently ranked
fifth out of the top 500 Turkish industrial companies for increases in revenues
in 2009.

In late 2009, in an effort to reduce government spending, the Turkish Ministry
of Health decreased pharmaceutical prices significantly across the board.
Although Deva's prices per unit were reduced, on average, by 15%, we fully
compensated for this revenue loss by increasing market share and expanding our

With the successful Roche and BMS transactions, we have achieved one of our most
important strategic objectives: consolidation of market share in the Turkish
market. We are proud to have achieved this without making unnecessarily
expensive acquisitions of entire companies, but rather through highly selective
acquisitions of specific products.

Where we want to go:

We feel we are well positioned to grow EastPharma's revenues and profits
significantly for the next several years.

Our strategy for the Turkish market is to take additional market share by
introducing a steady stream of innovative new products.  In many cases, we will
have exclusive or semi-exclusive rights to these products in Turkey.

Mid last year, we created a new R+D center, and greatly increased the number of
researchers at our company.  The purpose of this move was to accelerate the
introduction of new products.  Prior to our takeover in 2007, Deva launched only
1 to 2 new products per year.  Our target is to launch at least 10 new products
every year, and we are already close to achieving this pace of innovation.

Outside of Turkey, we have ramped up our efforts to export products to
semi-regulated markets.  We have met with some early successes, and we expect
significant revenues and profits from this initiative within the next year.

Our bigger objective is to expand our sales into developed markets. As explained
above, we are focused on passing major GMP inspections in our facilities in the
next several months.  Once we clear this challenging hurdle, our broader export
strategy will begin to generate revenues.

Regarding our valuation, we can say that our listing on London Stock Exchange
has been a mixed blessing. On one hand, we were able to raise large amounts of
capital under very favorable conditions. And before the global finance crisis
hit, the listing was highly successful.

Now, however, liquidity is very poor, and the market capitalization is
persistently very low.  EastPharma  trades at a discount of approximately 80% to
the underlying valuation of Deva publicly traded shares in the Turkish market.
Unfortunately, there is no quick or easy solution to eliminate this discount.
In the long term, however, we believe that this discount will disappear, because
there is no fundamental economic reason for it to exist.

To conclude, I would like to point out that, even though EastPharma's price
performance on the London Stock Exchange has been disappointing, it is not an
indication of the underlying company's performance.  If Deva were not doing
well, the Deva share price should also be depressed.

I would also like to point out that our ongoing efforts to build Deva are very
much going according to plan.  Since we took over Deva, a little more than 3
years ago, we have almost doubled the sales, have totally renewed all production
facilities and completely upgraded the entire management team. We have
integrated the Roche products successfully and we have come through the
financial crisis with a strong balance sheet.

There have been significant pricing pressures in our main market, due to
government efforts to reduce pharma spending, competition for Turkish market
share, and erosion of European pharmaceutical prices which are used for Turkey's
reference price system. Volume growth for the market as a whole, and for Deva in
particular, is currently compensating for these pricing pressures.

Today, our company is strong, with a very healthy balance sheet and satisfactory
cash flow. All areas of the company, from R+D to production and marketing have
been restructured and strengthened.  The Turkish pharmaceutical market continues
to be very strong in volume terms and the fundamentals are promising. Your
management team is committed to improve the company day by day and I am
confident that the patient investor will be rewarded in the future.

Sincerely yours,

Philipp Haas


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Source: EastPharma Ltd via Thomson Reuters ONE


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