American Oriental Bioengineering: Ancient Secrets Meet Modern Medicine

| About: American Oriental (AOBI)

Not so long ago, the mention of biotech immediately conjured up thoughts of multibillion-dollar powerhouses like Amgen Inc. (Nasdaq: AMGN), Genentech Inc. (NYSE: DNA) and Biogen Idec Inc. (NYSE: BIIB). But like any sector, change in biotech is inevitable, particularly as makers of cheaper generic and herb-based drugs seek to cut into Big Pharma's market share.

Steeped in the 5000-year-old practice of Traditional Chinese Medicine [TCM], Chinese drugmakers and biotech companies combine age-old herbal remedies with high-tech Western medical science—drawing on millenniums of trial and error and the latest advances in technology—to create new drugs for domestic and international markets.

Up-and-comer American Oriental Bioengineering, Inc. (NYSE: AOB), a China- and New York-based maker of pharmaceutical and nutraceutical products, is suddenly squarely on the radar of investors. The company develops, manufactures and markets pills, vitamin drinks, patches, gels and powders to treat everything from arthritis to impotence. The pharmaceutical segment creates plant-based prescription and over-the-counter drugs (for pharmacies, clinics and hospitals), while the smaller nutraceutical segment (accounting for 20 percent of company revenues) focuses on developing unregulated natural medications often found in health-food stores, supermarkets and alternative medicine clinics.

Analysts, all of whom kicked off coverage with bullish outlooks, have maintained their ratings: on July 9, Piper Jaffray initiated coverage with an "outperform"; analyst Elliot Wilbur with CIBC World Markets issued a July 13 initial "sector outperform" rating; and on Aug. 9, analyst Julie Chen of Brean Murray reiterated her "buy" rating and raised her target price from $14 to $16, while analysts at Lazard Capital maintained their "buy" rating and also raised their estimate.

Second-quarter earnings, reported on Aug. 9, showed the company's profit rose 67% to $9.67 million, or $0.15 a share, from $5.83 million, or $0.09 a share, last year. Revenue increased 48.7% to $33.9 million from $22.8 million in the same period in 2006 (Revenues from pharma products were $26 million, while nutraceuticals brought in $8 million.) Company executives anticipate third-quarter revenues of approximately $42 million, a 55% increase compared with third quarter 2006 revenues of $27.1 million. Analysts, who expect continued growth, have raised EPS estimates for both 2007 and 2008.

American Oriental has been aggressively snapping up rivals (four in the past five years, with a fifth on the horizon), allowing it to quickly grow its business. In June, American Oriental bought Changchun Xinan Pharmaceutical Group for $30 million and will soon close a $40 million deal to acquire competitor Guangxi Boke Pharmaceutical Co. Ltd., which will allow the company to double its current offering of about 20 products.

"The China pharmaceutical market is very large with approximately $28 billion in sales in 2005 and, importantly, over 20 percent of this market is in Traditional Chinese Medicine products" Wilfred Chow, senior vice president of finance, said at the UBS Global Life Sciences Conference in New York on Thursday. "TCM has been a very important part of the health-care system in China for thousands of years and today many of these proven remedies have been modernized with formulations and manufacturing processes similar to those used in the Western pharmaceuticals."

"Our market is not only large but also growing very rapidly. With 1.3 billion people aging and improving their standard of living, health care is our top priority. By 2010, we forecast that China is going to be the fifth largest pharmaceutical market in the world," Chow said.

Chow explained that the PRC government is committed to improving the health-care system in China and named the modernization of TCM as one of its key objectives.

TCM will remain a mainstream in China health care given the population's preference for green products and the relative affordability of these products compared to Western medicines,” he said. “We think the market will continue to grow rapidly.

Chow added:
Because of the platform we have built, we believe that we are well positioned to be a leader in the large and growing market of modernized Traditional Chinese Medicine and nutraceutical products in China.

China's General Administration for Quality Supervision, Inspection and Quarantine is taking active steps to clean up its recent problems with food and drug safety issues, which may leave investors more confident in Chinese-made products. A recent PricewaterhouseCoopers report pointed toward Asia as the emerging center for biopharma.

According to the report, titled "Gearing up for a Global Gravity Shift: Growth, Risk and Learning in the Asia Pharmaceutical Market," multinational corporations will be forced to move their operations to the region (from the United States and Europe) to find less expensive places to manufacture drugs, while Asia-Pacific biopharmaceutical companies will increasingly consolidate to penetrate international markets.

For its part, American Oriental has solid financials, a top-notch management team, a robust pipeline of popular products, and a commitment to expanding their market within and outside of China—good reason to believe the company will continue to make waves on Wall Street.

The stock closed at $11.43 on Thursday. Shares have traded between $5.67 and $14.19 in the past 52 weeks. Analysts' consensus median target price is $14.50. CEO Shujun Liu holds more than 40% of the company's stock.

Note: American Oriental Bioengineering is in the portfolio of Growth Report, an independent investment advisory published by Business Financial Publishing LLC, the owner of American Oriental Bioengineering was added to the Growth Report selection of stocks on Nov. 29, 2006, at a price of $10.15 per share.

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