Chinese drugstore climbs on US debut

China Nepstar raises $334.1 million after pricing its IPO 20% above the range - the maximum allowed on a US offering.
China Nepstar Chain Drugstore had a solid debut on the New York Stock Exchange on Friday after pricing its initial public offering 20% above the original price range, suggesting that the demand for Chinese growth stocks continues. The final price allowed it to raise $334.1 million, making it the third largest US IPO by a private-sector Chinese company this year.

The debut was keenly watched after Chinese upstream agricultural solutions company Agria Corp tumbled 26.9% on its first day of trading on Wednesday. The market as a whole is also starting to look a bit shakier with NepstarÆs first day of trading coinciding with a third straight day of losses for the Dow Jones index.

ChinaÆs largest drugstore chain gained 27.8% to a high of $20.70 in early trading, but then edged downward for much of the rest of the session. It finished 8% up at $17.50, making it one of only two newcomers to end higher on the night, while four other debutantes fell below their IPO prices. The other five companies were all US-based.

While it wasnÆt one of the more spectacular first days for a Chinese company in the US û recent debuts include a 39.3% gain for AirMedia, a 69.9% gain for Longtop Financial Technologies and a 75% gain for China Digital TV û the company had already priced its IPO well above the $11.50 to $13.50 range at $16.20, using the maximum increase allowed by US regulators.

The high price reflected strong demand during the bookbuild. According to sources, the deal ended up 32 times covered with participation from about 520 institutional investors. The widespread interest was largely due to the fact that Nepstar fit into several types of portfolios, attracting cross-over demand from China growth funds as well as from global retail and healthcare funds. Investors based in the US and Asia accounted for about 45% of the demand each, with European accounts making up the balance.

The company operates 1,791 drugstores in 62 cities in China, selling pharmaceuticals as well as over-the-counter drugs, nutritional supplements, herbal products, personal care products and convenience products. It also offers 1,108 labelled products under its own brand name, which the company says distinguishes it from its key competitors.

The final price values Nepstar at 37.5 times its projected 2008 earnings, which is well above where the comparable sectors are trading. According to one source, Chinese healthcare companies trade at an average 2008 price-to-earnings multiple in the low-30s, Chinese retail companies (non-branded ones like the department stores) in the high-20s and US drugstores in the low-20s.

ôIt really did get a premium valuation driven by its growth story,ö the source says, noting that its growth profile is much stronger than pharmaceutical/drugstore companies in the US or UK such as CVS or Boots.

Independent market research and consulting firm Frost & Sullivan expects spending on pharmaceutical products in China to grow at 23.5% per year 2007 and 2011, reaching Rmb965.2 billion ($126.8 billion) in 2011. This is slightly faster than in 2002 to 2006 when the spending grew at a compound annual growth rate of 19.7%.

That said, Nepstar posted a loss of Rmb3 billion ($394 million) in 2006, which was down from Rmb28.5 billion a year earlier. In the first half this year, it had turned the business around and reported a Rmb34.7 billion net profit ($4.6 billion).

Growth will continue to come primarily from organic expansion in ChinaÆs fast-growing metropolitan areas. This has been the strategy since it was set up in 1995, with the number of directly operated stores growing particularly strongly in recent years from 668 at the end of 2004 to 1,115 a year later and close to 1,800 as of the end of September this year.

According to the prospectus, the company plans to open approximately 21 new stores in the fourth quarter this year and add another 1,050 stores during 2008. These new stores will be mainly in markets where it is already active, including Shenzhen, Tianjin, Ningbo, Guangzhou and Dalian. Observers note that there should also be a lot of opportunity for the company in Beijing and Shanghai, where it has yet to establish a presence.

Indeed, the company says that from 2009 to 2011, it plans to focus its store development programme on expanding in new metropolitan markets where it has no presence so far and where it can leverage its existing regional distribution centres and other infrastructure.
ôWithin our targeted cities, we plan to open stores in clusters in or near large residential communities to become the preferred community drugstore,ö it says.

However, the company doesnÆt rule out acquisitions, which is likely to be one of the key themes in the sector, given how fragmented it is. While a leader in the sector, Nepstar estimates its share of the retail market for pharmaceutical products to be no more than 0.5% in terms of transaction value over the past three years.

The company has earmarked $52 million of the net proceeds from the IPO for new store openings, $27 million to set up two new distribution centres and $11 million to upgrade its information management and inventory control system. However, the remainder û more than two-thirds of the total û may be used for potential acquisitions of retail drugstore chains or independently operated drugstores as well as for general corporate purposes, it said.

The company sold 20.63 million American depositary shares (ADS), or 10% of the company. The ADSs were all backed by new shares with one ADS accounting for two common shares. There is also a 15% greenshoe which could see the total deal size increase to $384.2 million if fully exercised.

The company is majority controlled by chairman Zhang Simin, who will hold 51.9% after the IPO. Goldman Sachs had a 30% stake before the share offering through one of its private equity funds, which has now dropped to 24.2%. Goldman is the sole global coordinator of the IPO, but because of its ownership in the company, Merrill Lynch has been brought in as joint bookrunner.

The largest Chinese IPO in the US this year is online gaming provider Giant Interactive, which raised $887 million a couple of weeks ago, followed by solar wafer manufacturer LDK Solar, which sold $470 million worth of shares in June.

The only other company to end higher among FridayÆs six newcomers was online university American Public Education, which soared 80% to $35.92 from an IPO price of $20.
¬ Haymarket Media Limited. All rights reserved.