In this series of articles I will attempt to highlight a few selected cases of both the bright, and less bright spots that I have found compelling (either on the short or long side) across the Chinese healthcare sector. I will generally pick 1 long and 1 short per article. This week I focus on CO (short) and OTCPK:CBMG (long)
First- The Case For China Healthcare Growth
The seminal McKinsey paper from last year outlined 3 themes which shape China's growing healthcare market:
(1) the continuation of economic and demographic trends
(2) further health-care reform, and
(3) the policies articulated in the government's 12th five-year plan.
Notably, Health-care expenditures have more than doubled-from $156 billion in 2006 to $357 billion in 2011- and are now ~5% of Chinese GDP. Incomes and disposable incomes are increasing- the urban middle-class population is projected to increase from 29% of urban households in 2005 to 75% in 2020, and the upper-class group from 1% to 7%. Finally, many diseases remain under-diagnosed and under-treated as one might expect in a country of this size.
Healthcare Players in China
Many large and mid-cap healthcare companies have a significant Asia footprint, including Pfizer (PFE), Lilly (LLY) , Thermo Fisher (TMO), Life Technologies (LIFE), Waters (WAT), Mettler (MTD) and others.
Some of the top pure play players by market cap include Mindray Medical (MR) at $4.5b , WuXi Pharmatech WX ($2b), as well as China Biologic (CBPO) ($800m), Simcere Pharmaceutical (SCR) ($500m), and Sinovac Biotech (SVA) ($300m).
I will focus on some mid/small cap players with compelling risk-rewards that are misunderstood by the market- either on the long or short side- with compelling risk/rewards.
First, on the cautious side: China Cord
China Cord is a provider of cord blood storage services in China, similar to PerkinElmer's (PKI) service here in the US. It has 3 operating cord blood banks, in Beijing, Guandgond, and Zhejiang. The company recently reported weak Q1/14 earnings, with top and bottom line below consensus, and it reduced forward guidance (new subscribers) for FY'14, while maintaining EPS targets.
I believe that after last year's Year of the Dragon, new subscriber growth will be fairly muted this year and will create an overhang for the stock, despite the ability (or lack thereof) to control costs, as the stock trades heavily on growth prospects. In the 1Q alone, new subscribers of 15,260 were short of 17,500 consensus, and the target was lowered to 65k for the year, vs. 69-72k previously.
The recent resignation of one of its board of directors (Jeremy Yee, exec director and member of comp committee) caused the stock to dip 11% on that day. Yee is already the current CEO of Cordlife (OTCPK:CORFF), which is one of CO's biggest strategic partners. One week later, Cordlife raised $33m by selling at $1.25 per share, with only a 5% discount from the last closing price. The timing of both of these events suggest that CO will be facing a more cash-flush formidable competitor going forward.
On a revenue basis, its market cap of $300m on only $90m in revenues is a healthy 3.3x P/sales for a company only growing at 6% y/y (they did $85m in top line in FY13) and, in my view, far below the growth rate for hardly a mature market. I suspect PerkinElmer is taking share with their dominant service already in the US being ported over to major hospitals in China, starting in Beijing. PKI has been very vocal about the upside from the China opportunity and as such that is another overhang.
Based on the cloud of uncertainty over the corporate governance broadly, the loss of a strategic partner on the board, and the rich valuation for such low growth prospects (using EPS of $0.22 for FY14, the stock is trading at 17x forward earnings…or a P/E/G on the top line of almost 3x), I would assign a more conservative valuation of ~2.5x top line, or a 14-15x P/E. IN this scenario, my target falls to a market cap of ~$225mm, or roughly 20% below current levels.
On the interesting side, Cellular Biomedicine (OTCPK:CBMG)
Certainly comparing CO and Cellular Biomedicine is apples and oranges- one is a somewhat well understood and liquid broad Chinese-service company, while the other is a more illiquid, microcap company, albeit with a very promising technology platform. My intention is not to highlight as a pair trade, but just to throw out ideas that I find compelling throughout the series.
With that preamble, CBMG is developing a pipeline of cell-based therapeutic products, and is the 1st mover in China to apply autologous and allogeneic cells as medical technologies.
CBMG should take advantage of several advantages of the Chinese drug market, including expedited clinical pathways (particularly for cell-based therapies), including lower time and cost to market. The Company has acquired, transferred, commercialized and advanced research and human treatment experience in progenitor cells and cancer cell technology.
The Company is developing biomedicine based on tissue-derived progenitor cells, embryonic stem [ES] cells and cancer-specific dendritic cells. It considers these cell types as viable options for cell-based therapies to apply to a variety of medical indications.
What attracted me to the story was the combination of a Western-educated and pedigreed management team, the promise of 1st mover advantage in a wide open market with a wide open technology (stem cells), and a compelling pathway to cash generation.
First, for a small cap company, it has what I regard as a fairly well pedigreed US management team with extensive connections (it appears) in US and China- including backgrounds from RPI, Harvard, Stanford, Affymetrix, Microsoft, and others. Notably, it also has paid up for a top auditor (BDO), international tax adviser (E&Y) and appears to be committed to running a Western-style financial book.
Second, the catalyst pathway/ platform. The company is focusing its lead product on Knee Osteorthritis (KOA) which has 50mm prevalence in China. Its intra-articular injections of haMPC (mesenchymal progenitor cells) has an anti-inflammatory property that can down regulate immune response and can regenerate damaged joint tissues. The product would be the first of its kind in China, but very similar to those launched in Spain/Netherlands (TiGenix' Chondro) and South Korea (Mediposts' Cartistem), which are both allogeneic adipose derived or umbilical cord derived stem cells….and both products have had positive uptake. Will look for phase II data in '14.
Behind this, CBMG is developing therapy for hepatic cellular carcinoma [HCC] which has an incidence of 300k a year…. And 45% of worldwide HCC patients are in China. Similarly here, the company is conducing a ph-I trial for its TC-DC therapy, in which liver cancer stem cells are loaded in to trigger an effective immune cascade response.
As far as financials, the stock is at $5.40, which is a market cap of $33mm, and trades only 1,000 shares a day ($6,000 notional), extremely thin. Even 6.2m shares outstanding has a very small float. The company raised cash recently at $6.70 and has a few million in cash via check financing filings.
I do not believe that the company is covered by sell side, so my DCF approach is to take an adjusted peak year sales estimate of $200mm in 2017 based on the addressable markets, and comparable product sales to date and the expected timing, (could ultimately be conservative) and discount back by 25% to arrive at a present market value of ~$75mm, which is roughly double today's levels. Given the initial promise of the data, coupled with the first mover advantage, this could ultimately prove to be conservative.
With the stock this small and illiquid, I think the chief downside risk is simply that- it is nearly impossible at current levels to amass a significant position in the open market without moving the stock. Nevertheless, it's one to keep on the radar and look to be opportunistic as catalysts present.