An interview with Weikang Bio-Technology Group Co. VP of Finance Ren Hu.
Can you provide some background details of the company?
Weikang Bio-Tech Group is a China-based U.S. listed company on the OTC. Its HQ is in Harbin, in Northeast China. It has 2 operating subsidiaries Heilongjiang WeiKang and Guizhou TianFang, which is a pharmaceutical company acquired in 2008. It has about 72% of the total sales in 2009. Weikang Group is a developer, manufacturer, and distributor of traditional Chinese medicines, western medicines, both prescription and OTC, and health and nutritional supplements. Revenue in 2009 was 47-48 million USD. The business is growing very quickly because it is growing through acquisitions. In '09 to '08, growth was 270% in revenues and 116% in NI [Net Income]. In this business, the margins tend to be very high, both gross margins and net margins. The gross margins are high 50% to 60% with net margins of 30-35%.
The company became public through a reverse merger, and is under-discovered and lacks a following. Not many people know the company which has a very small float of only about 3 million shares. The result is a very low valuation of about 4-5 PE. It has the lowest PE with the fastest growth among its peers in the industry.
Where do you see the company in 5 years? 10 Years?
Three to five years from now it will be a much larger company. It has a great pipeline with a lot of great products to add to its existing portfolio. WKBT currently has 9 SFDA approved new drugs to launch in 2010 and 2011, so the existing portfolio will be expanded by 50-60%. The company also has a lot of cash on the balance sheet, so they are looking for acquisition opportunities.
What type of acquisitions are you looking for?
We are looking for drug companies with product lines supplementary to our drugs and with good distribution networks. This is a very fragmented industry, about 70% of the market is supplied by small to medium sized companies that lack financing and good R&D. Many of these could be our acquisition targets. Organically, we invest a lot in our R&D and constantly have new drugs. In '09 we grew at 270% in terms of sales. In five years the company could potentially reach over 500 million USD in sales.
In China, acquisitions are different than in the U.S., most of the acquisition targets are private companies in China, so it is hard to give a PE. Also, you have to have the government support and connections to make the deal happen. The company we acquired was at a very low price.
What are WKBT’s competitive advantages? What makes these sustainable over long periods of time?
Financing and technology are the two most important considerations for a company in this business. If you are a profitable company, there is a lot of internally-generated cash but not necessarily enough to make the acquisitions we hope to make in the future. We are also a public company with access to the U.S. capital markets. The company has an advantage in this regard. The long term growth of the company is determined by its R&D. The company has over 10 different drugs in the pipeline. The company also wants to guarantee its supply of the raw materials and the quality of its raw materials, sometimes with vertical integration into farming by contracting with local farmers to grow some of the herbal crops. The company has several projects undergoing now.
Can you explain your main competitors a bit more?
A lot of smaller companies that you have never heard of.
As U.S. public companies, we have Biostar Pharmaceuticals (BSPM), Renhuang (RHGP), American Oriental Bioengineering (AOB), China Sky One Medical (OTC:CSKI), Tianyin Pharmaceutical (TPI), China Pharma Holdings (CPHI), Simcere Pharmaceutical (SCR). All of the companies listed have very similar product lines and are in the same industry category.
Are they in the same region?
AOB and RHGP, yes.
If you had a golden bullet to eliminate one of your competitors, who would it be and why?
American Oriental Bioengineering. They are in the nutritional herbal based Chinese Traditional Medicine. A lot of their products overlap with our product lines. They compete on multiple different levels.
Why do your customers choose you over the competition?
Brand names. Rongrun is a well established brand name for good quality and services. In TCM there is brand loyalty. However, initially, it is all about marketing. There are so many different brands, it is based on marketing, promotion, and targeting that a company gain the initial following of its customers. Weikang targets elderly people aged 60 and above, which totals 170 million. We have a lot of promotions, we send customers samples, provide consultations, and have Chinese medicine doctors give customers a free health check up and do follow ups on all the drugs we send to them. When you gain customers through such quality services, they are pretty stable and will stay with the company for a long period of time. The marketing portion is very important. The overall market itself is expanding rapidly, which also helps.
Can you fully explain your segment lines? Do you expect a change in percentages of total sales within your various segments?
The largest segment is Chinese traditional medicine – about 80% is TCM products. In terms of medicine, our preventive medicine is the largest percentage of sales. Supplements that are good for your liver, good for your heart, and other internal system etc. Western medicines are primarily over the counter. Some are classified as prescription medicines that we sell to the hospitals and doctors who use on their patients. Most OTC medicines we sell to pharmacies, and local food and drug stores. They are mostly preventive and health-enhancing medicines. WeiKang is in 5 provinces and 1 city (Beijing). TianFang is distributing its products through over 60 distributors all over the country. We usually collect payments when we deliver the goods, which gives us almost no accounts receivable. Many Chinese companies have huge accounts receivable. With Weikang it is always payment on delivery which makes a very small accounts receivable balance.
What is the growth like in the industry?
China is currently the fifth largest pharmaceutical market in the world. It is expected that it would be the 2nd largest by 2020, and the largest by 2050.
In this industry TCM is about 2/3 of the total medicine market in China, but we also have western medicines and drugs. Overall, the market is growing very fast for several reasons. The economy is growing and people have more disposable income. The health awareness is increasing; the proportion of income spent on preventive medicine is increasing very quickly. Very high health care costs is also a reason for increased expenditure in preventive health care. Housing expenditures have recently grown very fast, but medicine is the second fastest growing expenditure category in China. So the overall market is growing very fast, we estimate in minimum 25-30% in annual growth in bottom line.
Do you expect to raise additional capital through the equity markets?
Currently we don’t need external money to expand our operations, as we have 18 million in cash. We also have more upwards capacity, and are only running at 1/3 of our capacity in WeiKang, and our other subsidiary TianFang is at ½ [capacity]. Our total capacity is about 107 million USD. Therefore, in the near future we do not have a need for capital expenditures. The cash is mainly for future acquisitions, and R&D of course. In the long run, we do want to raise additional capital on good terms. We have submitted a NASDAQ listing application. The plan would be to become a NASDAQ-listed company first and then go and raise money on good terms.
What is the capex required to maintain the business on a yearly basis?
It really depends, one consistent expenditure the company is making is on R&D. Currently R&D spending is 10% of sales. R&D is project-based, some months there is no R&D, like in the first quarter for example. At the start of the second quarter, we started a large project. In Q2'10 you will see huge R&D expenditures. We expect R&D to be as high as 1/3 of our net income in new product development. So while there is not necessarily capital expenditures on a yearly basis, we do make large investments in R&D.
Who are your customers? Can I meet or speak with them?
We have many different types of customers, primarily individual customers. Our biggest target customer is elderly people, and there are 170-190 million people in China in this age group. Of course we have younger age group customers too. Other customers are clinics and hospitals where doctors can use our products. New rural clinical medical centers are also customers. There will be 124 billion USD government investment in rural medical health care system in China. As a result, many new rural medical centers were established, around 30,000 township hospitals, and 700,000 villages clinics. When they build those medical centers, they need a supply of equipment and a supply of medicine. Our distributors sell our products to these new centers. A lot of these sales also go to retail pharmacies, drug stores, and nutritional food stores.
We can identify any of these customers and arrange for you to speak with them when you are in China.
Can you explain the SFDA approval process? Do you have any literature detailing the process?
It takes a long time, generally 1-2 years, or even 3 years in the case of western medicine. Basically when you develop a new drug, you submit all the documentation and testing results to the SFDA. They conduct their own test to replicate your results. That is the process that takes a lot of time and if they reach similar results they will approve the drug to be on the market. This takes quite a long time.
How long will it take to ramp up to full capacity? What will be total sales at this point?
It should happen pretty fast, we are growing at about 30% without acquisitions, this comes from the pipeline and the new drug growth. So in 2-3 years we should be able to reach full capacity at these plants, without further acquiring new capacity
How high is insider ownership?
If you had to invest in a U.S.-listed publicly traded Chinese company other than your own, what would it be?
Over the years my investment style has evolved into derivatives only. Most of my positions are in options.
Why do you think companies list in U.S. instead of China?
The U.S. is by far the largest capital market with deep liquidity and mature regulatory systems.
There is a lot of fraud in U.S. listed Chinese companies, how would you look to find fraud in these Chinese companies?
Look at the auditors.
Disclosure: Long WKBT