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»08/08/2008 [Independent reports]
Six Key Chinese Healthcare ADRs by: Tom Malthus

As an additional follow-up to my ADR series (see previous articles on energy sector ADRs and financial sector ADRS), I am going to take a look at the Chinese and Hong Kong healthcare sector. There are 6 key Chinese and Hong Kong ADRs within the GICS healthcare sector: Mindray Medical International (MR), Chine Medical Technologies (CMED), Wuxi PharmaTech (WX), Simcere Pharmaceutical (SCR), 3SBio (SSRX), and Tongjitang Chinese Medicines (TCM) Chinese & HK Helathcare Sector ADRs Source: Bloomberg (Closing prices 8/7)

 


The Companies

Mindray Medical International (MR) (Outperform):

Mindray Medical International Limited develops, manufactures, and markets medical devices. The Company offers patient monitoring devices, diagnostic laboratory instruments, and ultrasound imaging systems. (Bloomberg)

MR’s outlook in a nutshell: Unlike the other companies discussed in this piece MR has significant exposure to China and ex-China markets, it is also China’s largest medical device company. The medical devices sector is expected to grow substantially in China over the next several years, and MR is well positioned to take advantage of that growth. MR specializes in patient monitors, diagnostic lab equipment, and anesthesia & ultrasound machines. MR is also in the process of integrating Datascope’s patient monitoring business (DPM) into its own. MR acquired DPM, a U.S. company, earlier in 2008. This acquisition should reap long-term benefits for MR. Nonetheless, it will take 1.5 to 2 years for MR to realize the full synergies of the acquisition, but given the segregation of each companies' client base we see little potential for sales cannibalization. DPM’s sales were mostly centered around hospitals in the US and Europe. Additionally, MR just received FDA approval for DPM’s next generation AS3000 anesthesia delivery system. Domestically, MR has been supported by the Chinese government’s healthcare reform and initiative to purchase medical equipment for rural hospitals; this trend should continue as China further develops rural areas. Further strengthening the case for MR, is its robust pipeline, which includes digital radiography equipment, a digital defibrillator, and various other patient monitoring and chemical analysis equipment. The digital radiography system is essentially an X-Ray machine that shoots a high-res X-ray onto digital film, allowing for simpler analysis and digital storage. I see significant upside for MR given its strong domestic position, and growing international presence. This together with stronger medical device demand in China, a successful integration with DPM, and its innovative product line MR should continue to experience strong growth for the foreseeable future. (Expected Q208 Earnings Report 8/20/08)

Events which could improve outlook:

    * Exceeding 2008’s company guidance of USD560-580mn in revenues and USD132-134mn for income.
    * Successful integration of DPM, with stronger than anticipated synergies (i.e. cross-selling)
    * Stronger domestic and international demand for MR’s product line.

Events which could deteriorate outlook:

    * Higher costs and potential FX risk.
    * Increased competition in both the domestic and foreign markets.
    * Changes in government policy reducing domestic sales or prices.

MR vs. Hang Seng

Source: Bloomberg

China Medical Technologies (CMED) (Outperform):

China Medical Technologies, Inc. is a medical device company that develops, manufactures, and markets products using high intensity focused ultrasound, or HIFU, for the treatment of solid cancers and benign tumors in China. (Bloomberg)

CMED’s outlook in a nutshell: CMED has a unique characteristic when it comes to Chinese healthcare companies; it is the only company in China certified to conduct FISH testing. FISH testing (fluorescence in situ hybridization) is a genetic test that can detect chromosome abnormalities, and can be used prenatally to detect Down’s syndrome and other genetic conditions. Given CMED’s unique position in the market and China’s untapped potential, this segment should help support CMED’s long term growth development. CMED’s other primary segments include ECLIA (electrochemiluminescence immunoassay) and HIFU (high intensity focused ultrasound). These segments should also continue to see growth, but nowhere close to the rate of the FISH business. As CMED is award further approvals by the SFDA they will be permitted to begin advertising FISH and gain access to additional probes to increase its testing scope. Additionally, we have begun to see significant improvements in the company’s margins primarily through an increased emphasis on high margin reagent products, and convincing hospitals to buy low margin equipment, such as microscopes, directly from suppliers. This strategy has led to a non-GAAP margin increase to 79.1% from 72.3% for 1Q08 vs. 1Q07; I anticipate this growth rate will moderate, and remain slightly above current levels. Recently, the company began giving away free ECLIA equipment to new customers, who in turn will end up purchasing high-margin reagent products to operate the machine. In the short-term this could add some pressure onto CMED's bottom-line, but will be more than offset via longer-term reagent sales. All in all, I believe CMED is a great play in the Chinese healthcare industry given its unique position regarding the FISH test, and new strategy emphasizing higher margin products. (1Q08 Earnings Report 8/04/08 Est: 0.52 Act: 0.42)

Events which could improve outlook:

    * Further SFDA approvals for new FISH probes.
    * Continued growth in company margins.
    * Reaching or exceeding expectations of 500 hospitals with FISH capabilities by the end of 2008.

Events which could deteriorate outlook:

    * Increased competition.
    * Lower than anticipated FISH sales.
    * Changes in government policy adversely affecting the sector.

CMED vs. Hang Seng

Source: Bloomberg

Wuxi PharmaTech (WX) (Neutral):

WuXi PharmaTech Cayman Inc. provides pharmaceutical and biotechnology research and development outsourcing. The Company's services include discovery chemistry, service biology, analytical, pharmaceutical development, and manufacturing. (Bloomberg)

WX’s outlook in a nutshell: While the CRO business should remain robust in China, WX's recent acquisition of AppTech, a biologics manufacturing company raises some concerns. WX is a market leader in China’s CRO industry, and I anticipate this portion of WX’s business to continue experiencing strong growth over the next several years. In fact, on June 24th 2008 WX announced they have entered into a memorandum of understanding to create a 50-50 joint venture for contract research with Covance. The joint venture will be located at WX’s Suzhou facility; specific financial terms are expected to be released once the deal is complete. This deal should help boost WX’s CRO segment’s long term growth potential. However, WX’s USD169mn acquisition of U.S. based Apptech will likely add significant cost pressure, and lead to higher earnings variance due to the volatility of biologics manufacturing. All in all, given the recent Apptech acquisition and the potential for increased costs and compressed margins we do not see much upside potential for WX. (Expected Q208 Earnings Report 8/13/08 Post-market)

Events which could improve outlook:

    * Strong demand for biologics manufacturing.
    * Significantly higher CRO business in China.
    * Streamlined integration of Apptech combined with successful cross-selling initiative.

Events which could deteriorate outlook:

    * Increased costs from Apptech acquisition.
    * Decrease in biologics demand.
    * Slow-down in CRO business

WX vs. Hang Seng

Source: Bloomberg

Simcere Pharmaceutical (SCR) (Neutral):

Simcere Pharmaceutical Group manufactures and supplies branded generic pharmaceuticals to the China market. The Company's products include antibiotics, anti-cancer medications and anti-stroke medications. (Bloomberg)

SCR’s outlook in a nutshell: SCR and the Chinese generic drug industry in general face strong competition. SCR’s sales suffered in Q208 due to shifting its legacy Yidasheng sales model to agent sales from direct sales, which led to a reduction in price. This shift was undertaken to increase competitiveness in the market as other companies begin releasing rival drugs. Nonetheless, SCR has at least one first-to-market generic expecting approval during 2H08, which could help bolster sales. I anticipate SCR will continue experiencing sales growth in its generic markets, yet this is likely to be offset by lower prices from increased competition. We can already see an example of this in the switch from Yidasheng's direct sales model. Furthermore, a SCR rival has released a drug rival drug to Yidasheng that is selling slightly below Yidasheng’s current price. Increased sales volumes to small and medium sized hospitals and pharmacies should help make-up for some of the decline in prices, but not ar levels I believe strong enough to support significant upside for the company. SCR also mentioned on its 2Q08 earnings call that it is considering acquisitions given its strong cash base. All in all, despite the fact that we believe SCR’s sales volume will continue to expand, it will likely be somewhat off-set by lower prices due to increased competition. (2Q08 Earnings Report 8/05/08 Est: 1.44 Act: 1.48)

Events which could improve outlook:

    * Stronger than anticipated drug sales.
    * Competitors bringing rival drugs onto market slower than expected
    * Approval and eventual ability to market drugs in SCR’s pipeline including Biapenem, Palonosetron, Iguratimod, and Levamisole.
    * Any significant acquisition that could improve SCR’s bottom line.

Events which could deteriorate outlook:

    * Continued pricing pressure from competitors.
    * Lower than anticipated drug sales.
    * Rejection of drugs in SCR’s pipeline.
    * Any government regulation regulating drug costs.

SCR vs. Hang Seng

Source: Bloomberg

3SBio (SSRX) (Outperform):

3SBio, Inc. is a biotechnology company. The Company researches treatments in the areas of nephrology, oncology, supportive cancer care, inflammation, and infectious diseases. (Bloomberg)

SSRX’s outlook in a nutshell: SSRX is a growing company in a growth industry in China. SSRX’s two main products are EPIAO and TPIAO, which experienced record sales increases of 42% and 104% in 1Q08, respectively. EPIAO is an EPO drug, which helps stimulate the body’s red blood cell production that can be prescribed to patients with anemia, or who are undergoing chemo-therapy. According to the company, in Europe roughly 17% of chemo-patients are using EPO drugs, while in China the ratio currently stands at 2%, implying large growth potential for the drug. TPIAO is a THPO treatment, which increases the body’s production of platelets; this drug can also be prescribed to oncology patients. Looking ahead SSRX has an apparently strong pipeline, with its high dosage EPIAO treatment and second generation IL-2 treatment both finishing Phase III trials. SSRX expects to file with the SFDA regarding both these drugs during 2H08. By the end of 2008, SSRX also expects to file with the SFDA to permit using its TPIAO drug as a treatment for ITP, a bleeding disorder. Management expects to continue investing heavily into the company's core business, increasing sales force and expanding capacity. Despite higher costs seen in 1Q, we foresee SSRX continuing to penetrate China’s oncology market while maintaining stable margins. All in all given SSRX’s growth and future pipeline, I believe SSRX is a good play in the Chinese healthcare industry. SSRX is a growth company with a management team who seem to be making wise investment decisions for the company’s future. SSRX also has the right to buy-back company shares through March of 2009. Lastly, I expect the company could upwardly revise its 2008 guidance during its Q208 earnings call, this of course depending on 2Q results. (Expected Q208 Earnings Report 8/12/08 Post-market)

Events which could improve outlook:

    * Improved 2008 company guidance.
    * Stronger than anticipated EPIAO & TPIAO sales.
    * Approval of new treatments by the SFDA.

Events which could deteriorate outlook:

    * Strong competition from other market players, which could reduce market share or add pricing pressures.
    * Any pipe-line drugs failing to get approval from the SFDA.
    * Higher than anticipated costs reducing margins.

SSRX vs. Hang Seng

Source: Bloomberg

Tongjitang Chinese Medicine (TCM) (Neutral):

Tongjitang Chinese Medicines Co. is a pharmaceutical company. The Company develops, manufactures and markets modernized traditional Chinese medicines. (Bloomberg)

TCM’s outlook in a nutshell: I am hesitant on TCM’s outlook for several reasons 1) nearly 80% of TCM’s revenue comes from its Xianling Gubao product alone, which is used to treat osteoporosis; 2) the traditional Chinese medicine industry is extremely competitive; & 3) canceling its privatization due to what was reported as a deteriorations in the credit market. All in all, if it were not for this equities recent sell-off after the cancellation announcement I would have rated them ‘underperform’, but given the sell-off and challenges the company still faces I don’t see much upside or downside for TCM.

Events which could improve outlook:

    * Higher than expected earnings.
    * Re-initiating privatization.
    * Creating a more robust product base.

Events which could deteriorate outlook:

    * Slower than anticipated sales of Xianling Gubao.
    * Earnings below expectations.



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