China Medical Technologies' Transition is Well Underway

What does a company do when its primary product line begins to saturate the market it operates in? If it is China Medical Technologies (CMED), it is likely to expand in to new markets both geographically, and in relation to products offered.

For some time the company focused on marketing its HIFU (High Intensive Focused Ultrasound) product which is used to treat various tumors. As the system became widely accepted in China, the opportunity to sell more units domestically dwindled. But rather than accept a slowing growth trajectory, management began exploring opportunities to sell their products outside of the mainland. At the same time, an acquisition in early 2007 allowed the company to step into the diagnostic equipment business, effectively re-tooling the company’s path and core business.

Nearly a year after the acquisition, the new FISH product line (Fluorescent In Situ Hybridization) now accounts for a large portion of the company’s revenues. CMED has spent the last several months aggressively building the installed base of machines across the country.

It will not run into the same issues it faced with the therapy systems because the FISH product line uses a significant amount of reagents to perform the tests. These reagents now provide the company with a stable, reliable revenue stream and are a very profitable part of the company’s business. With gross margins at nearly 80% for the consumable products, the company should continue to benefit from the growing number of diagnostic machines being used.

CMED’s primary market is China, but the geographic reach of the company is beginning to expand. With positive announcements in Korea and potential Japan and Russian deployments, the addressable market could quickly ramp higher. While it would likely take several quarters to grow the installed equipment base to a level that generated strong reagent sales, the long-term fundamentals point to some very exciting potential growth initiatives.

At the same time, future acquisitions are expected to be a key part of the company’s growth strategy. Management has proven its ability to seek and purchase new business lines which enable its sales team to leverage their relationships by selling new products to many of the same clients. In January, the company announced the purchase of Beijing BioEkon, which is a small diagnostic company. The purchase brings a new automated diagnostic system into the suite of products offered and should propel reagent sales even further. Additional acquisitions should be expected over the next several quarters.

The stock gave up some of its ground after the last quarterly earnings announcement. Investors were a bit disappointed with revenue growth for the HIFU therapy system, which is becoming less important in the overall growth strategy. On the chart, the stock now sits at a support area that was established last fall. It appears that this is an attractive spot to pick up shares as the stock has stabilized here and the long-term growth level of the company appears to be intact even though that growth is now expected from a new product line.

The company has a March fiscal year end and is expected to report $1.52 for the full 2008 year. Looking toward next year, the consensus estimates are for growth of 50% to $2.28 per share. While these estimates are not guaranteed in any way, it seems very attractive to be able to pick up a company growing at 50% in a stable market for less than 20 times next years earnings. I believe CMED is a name that should be on any growth investor's watch list.

Disclosure: No position.