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Tongjitang Chinese Medicines Company (NYSE: TCM), a company focused on modernized TCM products, has set up a joint venture to acquire Guiyang Liquor Factory, a state-owned company, for 120.6 million RMB ($17.7 million) in cash. Tongjitang, which owns 95% of the joint venture, will pay its share of the consideration in full by February 2010. Though the company is said to be profitable, its revenues in 2008 were only 19 million RMB ($2.8 million).

Guiyang Liquor manufactures and sells 3 brands of Chinese liquors. Tongjitang explains that China liquors can be applied orally or topically to treat bone-related diseases. For that reason, the acquisition is a logical fit for Tongjitang, whose main product, Xianling Gubao, is the leading TCM treatment for osteoporosis in China. Nevertheless, the price seems very high for Guiyang Liquor’s revenues.

Tongjitang listed the following as objectives of the transaction:

• Enter the Chinese traditional medicinal liquor market. Guiyang Liquor is well-known in Guizhou Province, a leading province for producing branded Chinese liquors, which are used to treat bone-related diseases. Tongjitang plans to launch 2-3 Chinese traditional medicinal liquors within the next few years.

• Enhance Tongjitang's orthopedic brand. Tongjitang believes that new Chinese traditional medicinal liquor products, together with Tongjitang's Xianling Gubao, LLF's Heiguteng Capsules, Jingfang's Fengshi Gutong and Jingshu products, will further enhance brand leadership in orthopedic traditional Chinese medicine in both the prescription and OTC markets.

• Strengthen Guiyang Liquor's geographic presence. Tongjitang will expand Guiyang Liquor's existing presence and revenues through Tongjitang's distribution channels.

Tongjitang’s ongoing problem is that sales of Xianling Gubao are trending lower. For the first nine months of 2009, the company’s revenues are down another 2% at 328.9 million RMB ($48.2 million). The company is making acquisitions and introducing new products, but the positive effects of its growth strategy are offset by the decline in Xianling Gubao revenues.

During the first nine months of the year, the company fell to a net loss of 7.9 million RMB ($1.2 million), compared to positive net income of 27.0 million RMB ($4 million) during the year earlier period.

Meanwhile, Tongjitang is eating up the cash it raised in its 2007 IPO. At the end of September, its cash totaled 310.6 million RMB ($45.5 million), down from 473.7 million RMB ($69.7 million) just three months earlier. The latest transaction will take that sum lower by another 115 million RMB. At some point, Tongjitang will have to start generating positive cash flow or raise additional funds from a secondary offering.

Tongjitang ended the day at $3.68 per share. Its 2007 IPO was priced at $10 per share. The company currently has a market capitalization of $117 million.

Disclosure: none.