Kanghui Holdings: A Bright and Shining Star in the IPO Market

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Kanghui Holdings (NYSE: KH) is a leading domestic developer, manufacturer and marketer of orthopedic implant products in China. They sell two primary lines of proprietary orthopedic implant products, trauma and spine, with more than 30 product series covering a wide array of orthopedic implants and associated instruments. Trauma products include nails, plates and screws used in bone fracture surgery. It also makes meshes and interbody cages, as well as fixation systems for spines.

According to Frost & Sullivan, the global orthopedic implant market is set to grow from US$12.9 billion in 2006 to US$27.7 billion by 2015, representing a CAGR of 8.1%. The Asia Pacific region is expected to become the most important geographic region for growth in the global orthopedic implant market in the coming years, and the rapid growth in the China and India markets is a principal factor for this overall growth. China’s orthopedic implant market grew from RMB4.4 billion in 2007 to RMB6.1 billion in 2009, representing a CAGR of 18.4%, and is expected to grow to RMB16.6 billion in 2015, representing a CAGR of 18.1% from 2009. Furthermore, China’s orthopedic implant market is estimated to move from the third largest in 2010 to the second largest in 2015, surpassing Japan.

With rapid domestic economic growth and rising per capita disposable income in China, medical treatment and products are becoming increasingly affordable. Notably, according to Frost & Sullivan, China’s per capita healthcare expenditure in 2007 was only US $112, compared to the United States’ per capita healthcare expenditure of US $7290. China’s overall healthcare expenditure represented only 4.8% of its GDP in 2007, compared to 16.0% of the GDP in the United States. Recently, the Chinese government unveiled a RMB 850 billion (approximately US $125 billion) three-year spending plan to improve the healthcare infrastructure and expand insurance coverage in China.

By 2011, healthcare reform is expected to enable more than 90% of Chinese citizens to obtain basic medical insurance. The reform will continue to expand the accessibility and affordability of Kanghui Holdings’s products beyond the top tier cities in China.

The domestic orthopedic implant market is also driven by the aging population. Elderly patients have an increased susceptibility to many conditions that require orthopedic surgery. For example, fractures by osteoporosis and degenerative diseases, more commonly seen in the elderly, are the primary reasons for patients to undergo trauma or spine surgeries using products developed by KH. The United Nations projects over 400 million, or nearly 35% of the Chinese population, are expected to be over 60 years old, while nearly 70 million people over 50 years old in China now have osteoporosis conditions in the year 2006. The growing and aging population and increased need for orthopedic care will drive the revenue growth of KH in the years ahead.

It is remarkable that the orthopedic implantation rates in China is 100 times lower relative to the rates in the United States. The low implantation rate in China leaves significant room for additional growth in the Chinese orthopedic implant market in the future.

On July 31, 2008, Kanghui Holdings acquired Beijing Libeier for the sum of RMB 182.7 million. This acquisition complemented Kanghui’s existing network of distributors, brought 83 new distributors and contributed to the net revenues. In China, health care manufacturers sell products to third-party distributors, who in turn sell those products directly to hospitals or through sub-distributors. As of June 30, 2010, KH had built a strong domestic network of 237 distributors for their products covering 30 of the 31 provinces, municipalities and autonomous regions in China. Kanghui Holdings (KH) has a global network of 27 distributors in 24 countries across Asia, Europe, South America and Africa. Moreover, Zero2IPO, the most prestigious integrated service provider in the field of VC and PE, selected Kanghui Holdings as No. 1 in the “Zero2IPO-Venture 50 Awards” in 2008. In 2009, Forbes released the “Potential of Enterprises in China 2009 Forbes List” and Kanghui Holdings was ranked No. 4 among 200 rapidly growing SMEs in China.

In the Chinese market, KH’s direct competitors include Shandong Weigao Group, Medical Polymer Company Limited (Weigao) and other leading international orthopedic implant manufacturers, such as Johnson & Johnson (NYSE:JNJ) and Medtronic (NYSE:MDT). Weigao (8199.HK) is listed in the Hong Kong Stock Market with a much higher P/E of ~50.

To compete with global companies, Kanghui Holdings has strong research and development capabilities that focuses on developing new proprietary products. Since 2008, nine new products (four trauma products and five spine products) have been released and seven more are expected to be released by the end of 2011. KH has also received government incentives and subsidies from time to time. The company has received numerous awards from central, state, and local governments, including more than RMB 100 million from the Innovation Fund of the National Ministry of Science and Technology in China. In addition to internal efforts, KH collaborates with the Institute of Metal Research of the Chinese Academy of Sciences to perform strategic research and product developments. A post-doctoral research program was also established at KH’s research and development center and graduates from top universities in China were recruited.

The company showed strong financial results for the quarter ended June 30, 2010.

· Net revenue increased by 29.4% to RMB58.1 million (US$8.6 million) in the second quarter of 2010 from RMB44.9 million in the second quarter of 2009.

· Gross profit increased by 25.6% to RMB38.8 million (US$5.6 million) in the second quarter of 2010 from RMB30.9 million in the second quarter of 2009.

· Net income was RMB27.7 million (US$4.1 million) in the second quarter of 2010, representing 47.7% of our net revenue, compared to RMB20.9 million in the second quarter of 2009, representing 46.5% of our net revenue.

· Net revenues grew from RMB139.6 million in 2008 to RMB184.3 million (USD $27.0 million) in 2009 at a CAGR of 32%. Net income grew from RMB60 million in 2008 to RMB75.0 million (US $11.0 million) in 2009 at a CAGR of 25%.

The company has launched its IPO and offered 5,340,000 ADSs on August 11, 2010. Each ADS represents six of its ordinary shares, so its P/E should be calculated ~13 compared to the industry average of 20. The joint bookrunners for KH are Morgan Stanley (MS) and Piper Jaffray (PJC). Once the reticent period ends, more analysts will begin to add coverage for this stock, and that will be an optimistic sign for KH. I believe KH will continue to generate value for shareholders due to the increasing portion of the people in China, who can afford high-quality orthopedic implants and the growing emphasis on health coverage from the Chinese government.

Disclosure: Long KH