Western drugmakers are stepping up the hunt for emerging market tigers in India.

British-based GlaxoSmithKline has emerged as frontrunner for a phased buy-in to Dr Reddy's Laboratories, India's second-largest drugmaker, people familiar with the situation said.

A transaction could spark a fresh wave of foreign deals in India's drugs sector, after the troubled purchase of Ranbaxy by Daiichi Sankyo last year.

While nothing is finalized, one possibility is that Glaxo will take a 20 percent stake in Dr Reddy's Holdings, a family vehicle that in turn owns 23.2 percent of the drugmaker.

This would give Glaxo a stake of just under 5 percent, worth around $165 million. But the British company could also get right of first refusal on the family's remaining holding, the sources said.

Officials at both companies declined to comment.

Industry analysts said such a deal would fit well with Glaxo's strategy, spearheaded by Abbas Hussain, of building up its presence in key emerging markets.

It would mirror the 16 percent stake bought in May in Africa's biggest generic drug maker, Aspen Pharmacare, in an asset-transfer deal worth some $470 million.

While not alone in stalking Dr Reddy's, Glaxo is thought to have the edge, helped by an existing alliance that gives it access to many of Dr Reddy's products.

Dr Reddy's will be able to explore various growth opportunities after Glaxo comes on board with a stake, said Bino Pathiparampil, an analyst with Indian brokerage IIFL.

In the past, Western drugmakers have viewed Indian generics companies with deep suspicion. But attitudes are changing fast as slowing markets at home and a cliff of patent expiries has forced Big Pharma to explore new business models.

These days, every company is trying to increase its exposure to fast-growing emerging markets where a swelling middle class wants the assurance of safe, branded -- but unpatented -- drugs to treat the ailments that come with rising prosperity.

SWEET SPOT

India represents a sweet spot, given its growing domestic market and the ability of its sophisticated drug industry to supply other expanding low- and middle-income markets.

You get access to a much lower yet relatively sophisticated cost base, which then helps you in terms of going into wider emerging markets with much more competitive pricing, said Keith Schlagbauer, head of healthcare consulting at business research firm Frost & Sullivan.

Glaxo is not alone. Sanofi-Aventis took control of unlisted Indian vaccines maker Shantha Biotechnics in July and Pfizer clinched licensing deals with Aurobindo Pharma and Claris Lifesciences in May.

We're talking to everybody about emerging markets now ... even people who don't have an emerging markets strategy are trying to find out why everybody else does, said one senior banker.

Other companies that could be in the frame for a foreign deal include Wockhardt and Piramal, although one source said recent speculation of an imminent deal for Piramal was wide of the mark.

Deal-making for Western drug companies in India is not plain sailing, however. Daiichi got its fingers badly burned by a U.S. import ban on some Ranbaxy products, highlighting the risky nature of some parts of the generics business.

Agreeing valuations is also problematic.

Doing deals with family controlled companies is tricky at best, the London-based banker said.

There's always some cousin who doesn't want to sell ... and another who thinks the price isn't good enough, and another who thinks they shouldn't sell at all, they should give him the company to run.

(Additional reporting by Sumeet Chatterjee in Bangalore, Editing by Sitaraman Shankar)

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