Tongjitang Chinese Medicine: Earnings Up, But Counterfeits Hurt Sales

Tongjitang Chinese Medicines Company (TCM) had the unfortunate responsibility of informing investors that, once again, its revenues for the quarter were lower than the year-earlier period. Trying to put a good face on the news, Tongjitang led its announcement by saying that Q2 revenues were up 13% from Q1, a hopeful sign. Still, the unavoidable fact remains that its Q2 sales, which came in at $17.4 million, were down 15% from 2007’s second quarter.

On a GAAP basis, Tongjitang recorded net income of $1.1 million and net income per ADS of 3 cents. Adding in option-related compensation charges of $1.3 million, Tongjitang’s net income was $2.5 million. The latter number represents a 67% decline from the year-earlier net income of $7.5 million.

Tongjitang Chinese Medicine’s problem remains that competitors are selling counterfeit versions of its flagship product, the TCM osteoporosis treatment Xianling Gubao [XLGB]. Revenues from the product were down 26% from the year-earlier quarter at $11.9 million. Last year, XLGB provided 78% of Tongjitang’s revenues. This year, it contributed just 68%. It is healthy for Tongjitang to diversity its offerings and lessen its dependence upon a single product. Unfortunately, Tongjitang does not have other products to take up the slack. Other Tongjitang core products were lower by 21%.

The company’s recent Guizhou LLF acquisition improved the situation slightly: Guizhou LLF added 8.5% of the revenues for the quarter ($1.5 million). Tongjitang paid $5.6 million to purchase Guizhou Long-Life Pharmaceutical Company and its 10 marketed TCM products in September 2007.

In March 2008, Tongjitang announced that it had reached an agreement to buy Qinghai Pulante Pharmaceutical Co. for $3.5 million. Pulante is a TCM pharmaceutical company that uses Tibetan formulations. Its lead product is Chongcao Qingfei Capsules, an OTC medication indicated for respiratory diseases, including Chronic Obstructive Pulmonary Disease, which afflicts smokers.

Just before Tongjitang released its Q1 financial report, Mr. Xiaochun Wang, the company’s Chairman and CEO, together with one director, offered to buy all the outstanding shares of Tongjitang for $10.20 per ADS, which was slightly higher than the $10 price at which the company priced its IPO one year ago. That offer was rejected and the stock price has plummeted in the aftermath. Tongjitang Chinese Medicines currently sells for $4.13.

At the end of the second quarter, Tongjitang had $106.6 million in cash, a drop of $9.6 million over the preceding three months. The company has a market capitalization of $140 million, implying the market assigns a value of $33.4 million to Tongjitang’s ongoing business.

The company said in its release that the following developments will improve Tongjitang’s performance in the future:

• 2008 revenue is expected to total approximately 535 million RMB ($78 million)
• Gross margins will be in the mid-60% range
• New acquisitions will enhance Tongjitang’s offerings
• The sales and marketing network will expand into new pharmacies and hospitals
• New products will emerge from the pipeline, which currently is developing 11 new products.

Unless Tongjitang is being coy about its plans, there isn’t much in this list that will help matters in the near term. Tongjitang has the capital to make a significant acquisition – or even a series of smaller ones. It needs to do something to bolster its sagging revenues, and it needs to do more than attempt to staunch the counterfeiting of its lead compound.

Disclosure: None.