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Concord Medical Services (NYSE:CCM), a leading Chinese operator of radiotherapy and diagnostic imaging centers in China, went IPO last Friday at a price of $11. The stock closed the first day of trading at $9.5, down 13.6%.

Concord operates the largest network of radiotherapy and diagnostic imaging centers in China, with 83 centers in 36 cities across the country. Typically, it enters into long term contracts with hospitals to lease and manage these centers. The business is highly profitable, with gross margin over 70% and net margin above 40%. The industry outlook appears to be quite positive as well. The relatively underdeveloped medical infrastructure in China resulted in significant unmet demand for medical services, particularly in the cancer diagnosis and treatment area. Concord Medical has been expanding at a fast speed in the last two years, more than doubling the number of centers operated from 34 by the end of 2007 to 83 in September 2009, through both organic growth and acquisitions.

It is hard to find comparable companies for Concord Medical. NightHawk Radiology Holdings (NHWK) is somewhat similar. For the record, Nighthawk IPOed at $17 in 2007 and ended up $4.54 at close of December 14th. Even though Concord Medical operates with high operating margin, its asset turnover is very low, thus the resulting ROE is not at all great. So the big question is how attractive the business model is and how should investors understand it.

Fortunately, one company that Concord acquired in 2008, China Medstar, was a public company listed on London AIM market (market for international smaller growth companies). It operated a very similar business as Concord. A review of the history of Medstar as a public company helps shed some light on Concord’s business.

Here is the quote from Concord Medical's prospectus:

To complement our organic growth, we have also selectively acquired businesses to expand our network. In July 2008, we acquired China Medstar Pte. Ltd., or China Medstar, a company then publicly listed on the Alternative Investment Market of the London Stock Exchange, or the AIM, for approximately £17.1 million or approximately RMB238.7 million (US$35.0 million). At the time of the acquisition, China Medstar jointly managed 23 centers with its hospital partners across 14 cities in China.

Medstar went into public on London Stock Exchange late 2006. At the beginning of 2007, Medstar had 16 centers and was planning to open another 19 during the year, but it underachieved by adding only one center. Plagued with other delinquent account issue with a big customer, Medstar saw its stock price fell over 80 pence in June 2007 to 32 pence in May 2008, half of its book value, before Concord announced the acquisition of it for $35M, or 62 pence per share. The book value of Medstar at the time of acquisition was $33M.

The short history of China Medstar highlighted several potential risks for Concord:

  1. Due to the capital intensive nature of the business, sufficient funding is the key to expansion. Post IPO, Concord has a cash balance of $161M. It appears to be in a much better position than Medstar in 2007.
  2. A/R credit risk. Concord’s A/R balance currently stands as high as $17M, while it generated $30M revenue for the first 9 month of 2009. The AR days is as long as 160 days. This could be a substantial risk if any delinquency happens.
  3. Healthcare sector risk. Policy tightening in the sector may slow down contract signing and center expansion.
  4. Management execution risk.

Concord also plans to enter the hospital business using about half of the IPO proceeds, by opening two specialty cancer hospitals. The hospitals should have a lower margin than the radiotherapy and diagnostic imaging centers, but the AR days will be much shorter. It also remains to be seen if the management can run the hospitals successfully.

With a stock price of $8.7, Concord is currently trading at about 25x 2009 earnings, which is not cheap, given the above risks mentioned. Although I like Concord’s business, many questions remain. I prefer to have them answered before buying into this broken IPO.

Disclosure: No position

Source: History of China Medstar Sheds Light on Concord Medical Services