China Medical Technologies: Fishing For Success

When China Medical (CMED) announced the acquisition of FISH (Fluorescent in situ Hybridization) technology less than a year ago, investors yawned due to a lack of visibility and the stock took a temporary retreat. At the time CMED was sitting on a pile of cash and the question of what to do with it was on the mind of many investors, so to use it for acquiring intellectual property instead of swallowing a competitor with revenues/earnings was not well liked. Even a long term believer in CMED like myself was a tad skeptical on what was so special about FISH technology to merit a cost in excess of $130mm. That was then.

Since the integration of FISH began, investors have started to see what attracted CMED management in the first place:

• It perfectly compliments their ECLIA product line and creates an unparalleled advanced IVD (In-vitro Diagnostics) portfolio in China and other emerging Asian countries.
• The FISH probes follow the razor blade model that CMED applies to maintain high gross margins across its revenue (>60%). The current probe menu consists of 15 reagents across prenatal and cancer categories on their R&D label.
• FISH will be earnings accretive this year on anticipated revenues of $20mm
• High margin probes (70% gross margin) represented 20% of FISH revenues in Q2, and this number will grow rapidly over the coming years.
• In excess of 250 units should be delivered in 2007, demonstrating CMED's strong relationships with Chinese hospital networks and healthy demand for this previously untapped market.

* To learn more about FISH, you can visit the Wikipedia link for a comprehensive overview of the science or a direct link to China Medical's website.

Since the integration of FISH has occurred so smoothly, investors can now begin to give some credence to CMED's CEO, Xiaodong Wu, prediction that FISH can deliver $200mm in revenues by 2012. This is quite a bold target considering that CMED as a whole is only expected to be around $115mm in total annual revenues by their year end '07 (end of q1 '08). If Mr. Wu can indeed deliver $200mm per year of FISH revenues at net margins of 50%, this part of the business alone could be well worth more than all of CMED today ($1.2b). Not a bad use of their cash after all. This ofcourse would exclude their HIFU business which captures 70% of China market share and is about to record its first international sales after the recently announced FDA approval in Korea, and also exlcudes their ECLIA business with a portfolio now up to 70 reagents with high margin revenues growing at an 80% clip year over year. This is some heavy discounting that retail investors can take advantage of.

A big growth trigger for FISH comes from the approval of its probes by the China SFDA. Without SFDA approval, CMED can only sell R& D probes which drastically limits the revenue stream. The SFDA in China has been very slow as of late, but CMED management expects to have FISH probes approved by the end of Q3 this year. Only after the probe portfolio is matured will we see the true potential of FISH, but with the China government focusing more on healthcare, it doesn't take a genius to point out that CMED is still in its infancy as a medical device company.

Despite its shares hitting an all time high on Thursday, CMED still looks significantly undervalued given the proven success of its management over the past two years and the various growth drivers that exist today. I won't even get into the potential that will emerge via their heavy focus on R&D and unannounced market opportunities (think HPV in China). CMED typically does most of its sales volume in Q3 and Q4 which are its upcoming quarters, so I recommend to accumulate shares for the first half of '08 which should provide a good cushion in a very unpredictable US market.

While many Chinese equities are surrounded by high expectations and huge speculation, China Medical is still very much undiscovered as demonstrated by the relatively small amount of analyst coverage and limited following. Trading at an '08 PE of 24 and still in its infancy stage, CMED has too many growth outlets to be hidden for much longer and I expect big things in 2008 as the macro conditions in China continue to improve for medical device companies.

Comments

[tomad:]

What about CMED partner in Europe –EDAP?

2008 Jan 06 08:44 AM