23 February 2015 Sector Report Healthcare Sector Healthcare Sector UP Outsourcing trend on the rise MP OP Valuation summary Company name Stock Market Cap ticker (HK$mn) Quintiles* Q US Covance Inc* CVD US Parexel Int’l* PRXL US Wuxi Pharmatech* WX US Sinopharm 1099 HK Shanghai Pharma 2607 HK Sihuan Pharma 460 HK CMS 867 HK Pioneer Pharma 1345 HK Fudan Zhangjiang 1349 HK Essex Bio 1061 HK Huadong Medicine 000963 CH Hangzhou Tigermed 300347 CH 62,832.2 47,025.2 27,017.2 22,947.3 75,956.8 54,609.0 45,291.5 30,377.5 6,373.3 5,501.1 1,876.2 28,234.4 11,994.0 – EPS Consensus – FY14E FY15E (HK$) (HK$) 2.70 3.09 3.80 4.27 2.17 2.75 1.85 2.11 1.10 1.30 0.93 1.06 0.17 0.21 0.06 0.07 0.23 0.31 0.11 0.13 0.11 0.17 2.16 2.97 0.76 1.09 –––– P/E –––– FY14E FY15E (x) (x) 24.5 21.1 28.0 24.9 29.8 23.1 22.4 19.6 20.0 17.1 14.1 12.4 21.0 17.1 28.4 22.5 16.7 12.5 43.7 37.0 30.6 19.8 30.1 21.9 75.0 52.3 –––– P/B –––– FY14E FY15E (x) (x) n.a. n.a. 3.5 3.1 6.3 5.0 3.5 3.0 2.1 1.9 1.3 1.2 4.1 3.5 6.3 5.3 4.1 3.4 n.a. n.a. 5.9 4.8 7.2 5.8 5.8 6.5 Yield Outsourcing is increasingly adopted by the major pharmaceutical companies as it allows for better flexibility and cost efficiency. (%) 0.0 0.0 0.0 0.0 1.6 1.8 1.4 1.2 3.5 0.0 0.6 1.6 n.a CRO is the most common and well accepted model used by the industry, and CROs in China have been ramping up quickly in recent years. We believe CSO presents notable business potential in China, given the fast expanding market and the fragmented nature of the healthcare industry. Source: Bloomberg, BOCOM Int’l, as of Feb 22, 2015, * EPS consensus are denominated in USD Outsourcing is increasingly adopted by the major pharmaceutical companies, due to: 1) patent cliff; 2) lengthy and costly R&D process; 3) stricter regulatory scrutiny on drug promotions; and 4) the emergence of small-scale biotech companies. CRO (Contract Research Organization) is the most common and widely accepted model used in the industry. The global CRO market grew at a CAGR of 14% during 2007-2013 and we expect this growth momentum to sustain, given: 1) more R&D investments are shifted towards outsourced services; and 2) CROs are broadening its coverage to gradually participate in the entire processing chain, from drug development to product manufacturing. Sector Valuation (A+H) (X) FY15E weighted avg P/E FY16E weighted avg P/E FY15E weighted avg P/B 24.6 20.3 4.3 Source: Company data, BOCOM Int’l Historical P/E Chart Hk_Healthcare 30 +1 STD -1 STD 25 20 15 10 The fragmentation of China’s pharmaceutical industry provides a unique opportunity for CSO market expansion, as we believe: 1) local CROs in China will expand its business scope into the CSO business; 2) key distributors are taking the initiatives to start participating in the CSO market, such as Sinopharm (1099.HK); 3) Shanghai Pharm (2607.HK) has been developing its internal CSO business unit; 4) the unique approach taken by Sihuan Pharma (460.HK) implies business model transformation from the pharmaceutical agent model to the CSO model. Download our reports from Bloomberg: BOCM〈enter〉 Feb-11 Feb-12 Feb-13 Feb-14 Feb-15 Source: Bloomberg 1 – Year Sector Performance Hk_Healthcare Hang Seng Index Source: Bloomberg Milo Liu [email protected] Tel: (852) 2977 9387 Jan-15 Feb-15 Dec-14 Oct-14 Nov-14 Sep-14 Jul-14 Aug-14 Jun-14 Apr-14 150 140 130 120 110 100 90 80 May-14 CSO market in China proved to have similar business trends and opportunities as in the international market. Instead of building in-house sales teams, certain MNCs are collaborating with local CSOs in China on promotion and marketing. Various local pharmaceutical companies with in-house sales representatives also seek to become CSOs for MNCs, in order to enrich their product portfolios. 0 Feb-10 Feb-14 The CSO (Contract Sales Organization) market in China has also been growing rapidly, which grew at a CAGR of 38% in 2008-2013 to RMB13bn. The two largest CSOs in China are China Medical System (867.HK) and Pioneer Pharma (1345.HK), both of which focus on products manufactured by overseas companies. They took up ~28% share of the China CSO market, according to a Frost & Sullivan report. 5 Mar-14 China CRO industry has been ramping up quickly in recent years, registering a CAGR of 25% during 2007-2013, reaching US$2bn. There are ~500 local companies involved in CRO market in China, of which the leading five represent ~15% market share. Healthcare Sector 23 February 2015 Outsourcing is being used as a widely accepted business strategy among the major pharmaceutical companies globally as well as in China. This trend has been basically driven by: 1) patent cliff, estimated to bring in significant lost sales to the pharmaceutical companies; 2) lengthy and costly R&D process for a new drug, which typically requires more than 10 years of development and substantial upfront investment; 3) stricter regulatory scrutiny on drug promotions; and 4) the emergence of small-scale biotech companies. Outsourcing allows pharmaceutical companies to better preserve flexibility and efficiency, reduce costs, turn fixed costs into variable costs, and move assets off the balance sheets. The complexity of the pharmaceutical value chain offers phenomenal outsourcing opportunities in the industry. Figure 1: Estimated sales of off-patented drugs result in patent cliff (US$bn) Spend on off-patented drug 35 28.7 30 25 20 15 14.6 15.3 12.6 10.4 10 7.0 6.2 5 4.2 3.6 3.0 2018E 2019E 2020E 1.3 0 2010 2011 2012 2013E 2014E 2015E 2016E 2017E Source: IMS Health Data, BOCOM Int’l Figure 2: Lengthy process of drug development Source: http://www.yalescientific.org/2013/02/match-manipulate-medicate-old-drugs-targeted-for-new-use/ Download our reports from Bloomberg: BOCM〈enter〉 2 Healthcare Sector 23 February 2015 Contract Research Organization (CRO) is the most common and widely accepted model in the industry. According to Frost and Sullivan, the world’s CRO market was ~US$16bn in 2007 and surged to ~US$35bn in 2013 at a CAGR of 14% during the period. We expect this growth momentum to sustain, driven by: 1) increasing R&D investments (at clinical trial stage) shifted towards outsourced services; and 2) CROs are broadening its coverage to gradually participate in pre-clinical research and post-clinical research. Figure 3: Global CRO market size (US$bn) Global CRO Market Size 19% 40 YoY 14% 30 13% 25 11% 11% 20 15 10 5 0 2007 2008 2009 2010 2011 2012 Outsourcing Penetration 50% 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 17% 16% 35 Figure 4: Global clinical CRO penetration rate 44% 45% 42% 40% 38% 40% 35% 35% 36% 33% 30% 25% 20% 2009 2013 Source: Frost and Sullivan, BOCOM Int’l 2010 2011 2012 2013 2014E 2015E Source: Frost and Sullivan, BOCOM Int’l China CRO industry has been ramping up quickly in recent years, growing at a CAGR of 25% during 2007-2013 to US$2bn and occupying ~7% of global market share in 2013. There are several globally renowned CRO companies, including Quintiles (Q.US), Covance (CVD.US) and Parexel (PRXL.US), which have entered the Chinese market through proprietorship, corporation or acquisition, setting the industry standard in early years. There are also active local CROs, such as Wuxi Pharmatech (WX.US), Venture Pharma (8225.HK), ShangPharma, Asymchem and Hangzhou Tigermed (300347.CH). They are the leading local CRO companies in China, together representing ~15% of China CRO market share. Figure 5: China CRO market size (US$bn) China CRO Market Size YoY 4.5 40% 34% 4.0 31% 35% 31% 3.5 30% 24% 3.0 25% 2.5 2.0 18% 16% 16% 17% 15% 15% 17% 20% 15% 1.5 1.0 10% 0.5 5% 0.0 0% 2007 2008 2009 2010 2011 2012 2013 2014E 2015E 2016E 2017E Source: Genetic Engineering & Biotechnology News http://www.genengnews.com/gen-articles/china-and-india-in-global-drug-r-d-outsourcing/4596/ Download our reports from Bloomberg: BOCM〈enter〉 3 Healthcare Sector 23 February 2015 Contract Sales Organization (CSO) has been emerging over the last two decades. Multinational Pharmaceutical Companies (MNCs) generally outsource their drugs sales when the drugs are mature and the patents expire, or in the territories where they have yet to establish their own sales teams. For example, in 2008, MSD cut 1,200 sales personnel and outsourced sales of Cozaar and Hyzza to InVentiv Health. MNCs have been continuously cutting their in-house sales teams over the recent years, owing to: 1) cost-saving pressure due to patent cliff; and 2) stricter regulatory scrutiny on drug promotions. Some small R&D-focused biotech companies with no in-house sales teams also prefer to use CSOs for product launches. The global CSO market is smaller than the CRO market, given: 1) it has only been around for two decades, relatively new compared with CRO market; and 2) different countries deploy slightly different approaches which require more flexibility and nimbleness in coping with market regulations, in our view. Figure 6: Global CSO market size (US$bn) Figure 7: Global CSO market share Global CSO Market Size 6.0 YoY 15% 5.0 13% 13% 11% 16% 14% 12% 14% United Drug 17% 12% 4.0 3.0 InVentiv 14% 18% 16% 8% Publicis Touchpoint 10% PDI. Inc. 4% 10% 8% 2.0 6% 4% 1.0 2% 0% 0.0 Quintiles 29% Others 26% 2007 2008 2009 2010 2011 2012 2013 2014 Source: Capgemini Consulting http://www.capgemini-consulting.com/blog/accelerating-life-sciences-transf ormation/2013/05/disrupting-the-traditional-commercial-model Source: Sutherland Global Services http://issuu.com/sutherlandresearch/docs/contract_sales_organizations_mar ket CSO market in China proved to have similar business trends and opportunities as in the international market. Instead of building their in-house teams from scratch, several MNCs are collaborating with local CSOs in China. Various local pharmaceutical companies, which have their in-house sales representatives, also seek to become CSOs of MNCs, in order to enrich their product portfolios. For example, Pioneer Pharma (1345.HK) is the CSO partner of Alcon for ophthalmic remedies, while Essex Bio (1061.HK) is the CSO partner of Pfizer for ophthalmic remedies. Moreover, there are a few examples of R&D-focused companies with CSO business. For example, NT Pharma (1011.HK) formed CSO partnerships with Sanofi Pasteur and Fudan-Zhangjiang (1349.HK), primarily for the vaccines and Libod (Doxorubicin Liposome Injections) products, respectively. The CSO market in China has been growing rapidly at a CAGR of 38% during 2008-2013 to RMB13bn. The two largest CSOs in China are China Medical System (867.HK) and Pioneer Pharma (1345.HK), both of which focus on products manufactured by overseas companies. The CSO market in China is more fragmented than global CSO market, as the leading five companies only represent ~44% market share in the CSO market in 2012, according to Frost & Sullivan, versus 74% by the top 5 global CSO companies. Download our reports from Bloomberg: BOCM〈enter〉 China CSO market size has been outgrowing the CRO market since 2012, attribute to: 1) a lack of R&D capability in drug development; 2) high demand due to large population; and 3) the global CRO that began in early 1970s when China was under-developed. 4 Healthcare Sector 23 February 2015 Figure 8: China pharmaceutical CSO market size (RMBbn) Market Size 40 YoY 70% 62% 35 60% 30 25 20 50% 38% 38% 27% 31% 31% 32% 32% 30% 15 Figure 9: Market share of CSOs in China Rxmidas 4% NT Pharm 5% Eddingpharm 8% Others 56% 40% 30% Pioneer Pharma 9% 20% 10 5 10% 0 0% 2008 2009 2010 2011 2012 2013E 2014E 2015E 2016E 2017E Source: Frost & Sullivan (2012), BOCOM Int’l China Medical System 18% Source: Frost & Sullivan (2012), BOCOM Int’l The fragmented nature of China’s pharmaceutical industry provides a unique opportunity for CSO market expansion. China currently has 4,500 pharmaceutical companies, of which only 15% have established in-house sales teams, and the rest rely heavily on agents. There are currently ~500,000 sales reps in China, and less than 20% of them are employed as in-house sales reps, with the rest self-employed or employed by agents. These agents are generally in small scale and loosely controlled by the manufacturers, and they work on a buy-and-sell basis in certain regions. We believe the unique approach of Sihuan Pharma (460.HK) to manage its agents (composed of ~20,000 sales reps) is a good example, indicating business transformation from the pharmaceutical agent model to the CSO model. The difference between agent and CSO is that agent is responsible for sales while CSO brings integrated solutions to the pharmaceutical company, including product positioning, hospital penetration, technical support, product management and most importantly, certain risk-taking (such as price erosion from the tendering) for the pharmaceutical companies. We expect local CROs in China will expand its business scope into the CSO business. The world’s largest CRO Quintiles has already expanded the scope of business into CSO in China, providing integrated end-to-end solutions to the pharmaceutical companies in different stages. Some domestic CROs also added CSO services to the business model, such as CareWay, which believes the flexible business model could secure long-term strategic collaborations with the pharmaceutical companies. More local CROs will likely follow suit, eventually becoming comprehensive providers of a broad range of drug development and other support services for the healthcare industry. Domestic pharmaceutical distributors are also taking the initiative to start participating in the CSO market. Sinopharm (1099.HK) signed a cooperation agreement with AstraZeneca for the marketing and distribution of Betaloc in Jun 2014. We consider the cooperation a milestone for Sinopharm to expand into the CSO business. In Oct 2014, Sinopharm and Pfizer launched the “County Hospital Program” to improve the medical capabilities of county hospitals, and help these hospitals to set up standardized Stoke Centers and Chest Pain Centers (CPC) in order to enhance their influence as a step of preparation for future drug marketing initiatives. We expect Sinopharm to become a major CSO partner of Pfizer in the future, and the new business model may be considered an extension of its business to the upper stream of the supply value chain. Download our reports from Bloomberg: BOCM〈enter〉 5 Healthcare Sector 23 February 2015 Other pharmaceutical distributors are also developing CSO businesses. For example, Huadong Medicine (000963.CH) is the CSO partner for several local and overseas biopharmaceutical manufacturers, such as Octapharma for human serum albumin (HSA), and LG Life Sciences for Hyaluronic Acid (HA). Shanghai Pharma (2607.HK) is also developing its internal CSO business unit. Shanghai Pharma has over 20 subsidiaries covering the entire value chain from manufacturing, distribution to retail, and has become one of the largest CSOs of Pfizer in China for products such as Prevenar, an invasive disease prevention drug for infants. They recently introduced “integration of manufacturing and distribution strategy” to boost internal synergies, allocating more sales force from the distribution and retail subsidiaries to the manufacturing subsidiaries. We consider this a great example of internalizing the CSO model, and we will not be surprised to see other pharmaceutical companies follow suit. We believe CSOs present notable business potential in China, and we believe: 1) local CROs in China will expand its business scope into the CSO business; 2) key distributors are taking the initiatives to start participating in the CSO market, such as Sinopharm (1099.HK); 3) Shanghai Pharm (2607.HK) has been developing its internal CSO business unit; 4) the unique approach taken by Sihuan Pharma (460.HK) implies business model transformation from the pharmaceutical agent model to the CSO model. Figure 10: Valuation of listed peers Name 中文名 Stock Code Mkt Cap Currency (HK$mn) International peers Quintiles Transnational Covance Inc Parexel International Wuxi Pharmatech Simple average Weighted average Domestic peers Sinopharm Shanghai Pharma Sihuan Pharma China Medical System China Pioneer Pharma Fudan Zhangjiang Essex Bio Huadong Medicine Hangzhou Tigermed Simple average Weighted average –––––––P/E––––––– –––––––P/B––––––– –Gross Margin (%)– Operating Margin (%) 13A 14E 15E 13A 14E 15E 13A 14E 15E 13A 14E 15E 昆泰跨国控股公司 科文斯股份有限公司 百瑞精鼎国际公司 药明康德有限公司 Q US CVD US PRXL US WX US 62,832.2 47,025.2 27,017.2 22,947.3 USD USD USD USD 33.0 32.4 37.9 25.1 33.6 38.7 24.5 28.0 29.8 22.4 26.2 26.1 21.1 24.9 23.1 19.6 22.2 22.3 n.a. 3.2 4.8 3.7 4.0 4.3 n.a. 3.5 6.3 3.5 4.4 2.6 n.a. 3.1 5.0 3.0 3.7 2.2 26.2 27.4 26.4 36.6 35.2 30.6 33.5 38.7 35.4 30.9 34.7 38.6 9.1 8.4 6.8 18.2 13.9 11.4 10.1 19.3 14.4 12.3 10.9 19.6 国药控股股份有限公司 上海医药 四环医药 康哲药业 中国先锋医药 复旦张江 亿胜生物科技 华东医药 泰格医药 1099 HK 2607 HK 460 HK 867 HK 1345 HK 1349 HK 1061 HK 000963 CH 300347 CH 75,956.8 54,609.0 45,291.5 30,377.5 6,373.3 5,501.1 1,876.2 28,234.4 11,994.0 HKD HKD HKD HKD HKD HKD HKD CNY CNY 24.3 15.5 25.8 37.1 16.0 47.8 33.7 38.5 72.3 34.6 30.9 20.0 14.1 21.0 28.4 16.7 43.7 30.6 30.1 75.0 31.1 24.1 17.1 12.4 17.1 22.5 12.5 37.0 19.8 21.9 52.3 23.6 19.2 2.0 1.5 3.6 4.9 3.0 8.4 4.6 7.8 9.1 5.0 4.1 2.1 1.3 4.1 6.3 4.1 n.a. 5.9 7.2 5.8 4.6 3.5 1.9 1.2 3.5 5.3 3.4 n.a. 4.8 5.8 6.5 4.0 3.1 8.0 12.8 78.2 54.5 30.4 92.1 89.6 19.9 44.8 8.1 12.3 79.3 54.4 32.8 n.a. 79.7 21.1 46.9 8.1 12.0 79.1 54.6 34.9 n.a. 78.6 21.6 46.1 3.6 3.4 30.9 32.6 21.3 26.1 21.1 6.2 26.6 3.9 3.6 38.3 30.0 22.3 n.a. 15.6 6.1 28.8 3.9 3.6 38.7 30.0 23.9 n.a. 17.2 6.5 26.5 Source: Bloomberg, BOCOM Int’l, as of Feb 22, 2015 Download our reports from Bloomberg: BOCM〈enter〉 6 Healthcare Sector 23 February 2015 BOCOM International 11/F, Man Yee Building, 68 Des Voeux Road, Central, Hong Kong Main: + 852 3710 3328 Fax: + 852 3798 0133 Rating System Company Rating www.bocomgroup.com Sector Rating Buy: Expect more than 20% upside in 12 months LT Buy: Expect more than 20% upside but longer than 12 months Neutral: Expect low volatility Sell: Expect more than 20% downside in 12 months Outperform (“OP”): Expect more than 10% upside in 12 months Market perform (“MP”): Expect low volatility Underperform (“UP”): Expect more than 10% downside in 12 months Research Team Head of Research @bocomgroup.com Raymond CHENG, CFA, CPA, CA (852) 2977 9393 raymond.cheng (852) 2977 9384 hao.hong Strategy @bocomgroup.com Economics Hao HONG, CFA Banks/Network Financials Qingli YANG Miaoxian LI (86) 10 8800 9788 - 8043 miaoxian.li Oil & Gas/ Gas Utilities (852) 2977 9212 yangqingli Fei WU (852) 2977 9392 fei.wu Shanshan LI, CFA (86) 10 8800 9788 - 8058 lishanshan Tony LIU (852) 2977 9390 xutong.liu Li WAN, CFA (86) 10 8800 9788 - 8051 Wanli Consumer Discretionary Property Phoebe WONG (852) 2977 9391 phoebe.wong Anita CHU (852) 2977 9205 anita.chu Summer WANG (852) 2977 9221 summer.wang Shawn WU (852) 2977 9386 shawn.wu (852) 2977 9387 milo.liu Jerry LI (852) 2977 9389 liwenbing Jennifer ZHANG (852) 2977 9250 yufan.zhang Yuan MA, PhD (86) 10 8800 9788 - 8039 yuan.ma Connie GU, CPA (86) 10 8800 9788 - 8045 conniegu (852) 2977 9243 jovi.li Consumer Staples (852) 2977 9235 alfred.lau Luella GUO (852) 2977 9211 luella.guo (86) 21 6065 3606 louis.sun (852) 2977 9209 lizhiwu (852) 2977 9216 miles.xie Geoffrey CHENG, CFA (852) 2977 9380 geoffrey.cheng Fay ZHOU (852) 2977 9381 fay.zhou (86) 21 6065 3675 wei.yao Renewable Energy Healthcare Louis SUN Telecom & Small/ Mid-Caps Milo LIU Insurance & Brokerage Zhiwu LI Technology Internet Miles XIE Transportation & Industrial Metals & Mining Jovi LI Alfred LAU, CFA, FRM Automobile Download our reports from Bloomberg: BOCM〈enter〉 Wei YAO 7 Healthcare Sector 23 February 2015 Analyst Certification The authors of this report, hereby declare that: (i) all of the views expressed in this report accurately reflect their personal views about any and all of the subject securities or issuers; and (ii) no part of any of their compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed in this report; (iii) no insider information/ non-public price-sensitive information in relation to the subject securities or issuers which may influence the recommendations were being received by the authors. 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