Remember market conditions? The blanket excuse that is trotted out whenever any company fails to find investors in an IPO? Well, market conditions are a little dicey at the moment, but China Nepstar (NPD) nevertheless managed to price its IPO at $16.20, which was 30% above the proposed range of $11.50 to $13.50. Prospects trump market conditions, again.
In very early trading, China Nepstar moved another $2.80 higher to $19 per share.
China Nepstar is the largest pharmaceutical drugstore chain in China. The company offered 20.625 million ADSs (each ADS is worth two ordinary shares) in the IPO, so the offering raised a healthy $334 million for Nepstar. Immediately after the IPO, the company will have the equivalent of 103.125 million ADSs outstanding, giving Nepstar a market capitalization of $1.67 billion.
By most measures, China Nepstar was already pricey, even at the lower asking price. But this is China, and even if worldwide stock markets are losing confidence, China still seems the land of unlimited opportunity.
At $16.20 per ADS, the IPO values the company at 7.3 times 2006 revenues (which were $228 million). There is no P/E ratio because the company booked a very small loss in 2006. This year is shaping up a little better, with revenues in the first six months ahead of last year by about 18% at $124 million. That’s enough for a profit of $4.5 million or 3 cents per share, fully diluted. Annualized, the PE ratio would be a daunting multiple of 270.
China Nepstar has disclosed its plans for a portion of the money, as follows:
• $52 million for new stores
• $27 million for two distribution centers
• $11 million for upgrades to the information management and inventory control system.
The remainder is for the all-purpose general corporate needs – and, more interestingly, acquisitions. As Nepstar points out in its prospectus, existing local law in the big cities of Beijing and Shanghai prohibits the building of new pharmacies within a specified distance from an existing pharmacy. To grow in these cities, therefore, Nepstar is obliged to buy existing chains to increase its penetration and spread its overhead across more outlets.
At the moment, the company is not currently engaged in talks with any possible targets. The $200 million or so that Nepstar will have left over after its spending projects will buy a lot of pharmacies. Existing shareholders paid an average of just 36 cents for each ADS, so the step-up to the IPO price is considerable. In 2004, Goldman Sachs (GS) (or more precisely, five institutional investors affiliated with Goldman Sachs) made a $25 million investment in Nepstar, for which they received 50 million Series A redeemable convertible preferred shares. These will convert into 50 million ordinary shares or 25 million ADSs. For $25 million, the investors now own $405 million worth of stock, a 16.2X return over three years. Not surprisingly, Goldman also ran the IPO, and the results show the company did a very good job.
With its 1791 retail outlets in 62 cities, Nepstar is the largest pharmacy chain in China, even though it controls less than 0.5% of the total transaction value of all such stores. Each outlet produced an average of only $158,000 in revenue during 2006, giving an insight into business in China and the value of the dollar versus the yuan. Between 2004 and 2006 Nepstar produced a CAGR of 43.4%, and it has increased its outlets by a factor of 2.5 during the past three years.
In short, China Nepstar is not a value investment. As the IPO shows, even in times of above-average uncertainty, a company that offers the opportunity for huge growth can compel investors to pay up for a chance to participate in China’s retail pharmaceutical market.