Biomedical materials producer Shanghai Haohai Biological Technology wraps up pre-marketing on Tuesday for a $250 million to $350 million initial public offering, which looks set to benefit from the liquidity fuelled rally that has been pushing the valuations of Hong Kong listed stocks closer to their Mainland counterparts.
The deal has been on an accelerated schedule after commencing investor education last Wednesday and appears to have hit a sweet spot in the market. The Hang Seng China Enterprises Index is up 16.1% since the middle of March and the Shanghai Composite Index up 27.4% since the beginning of the year.
Hong Kong-listed small cap stocks have been a particular focus for investors, although the whole market has rallied since the end of last month when the Chinese government allowed domestic mutual funds to participate in the Shanghai-Hong Kong Stock Connect scheme. The southbound quota was fully utilised on both Wednesday and Thursday of last week as qualified investors attempted to jump ahead of an expected inflow of funds that may close the valuation gap between the A and H share markets.
Credit Suisse produced a research report on Thursday, which calculated that A-shares are currently averaging 20 times forward earnings, while H shares remain at 10 times, below their historical average. However, the bank also argued that small cap valuations on the mainland appear to be in bubble territory, with Shenzhen listed stocks averaging 60 times forward earnings and Shanghai-listed ones 93 times.
Valuation
One of Shanghai Haohai's main comparables, Grandhope Biotech, is trading at 177 times forward earnings and is up 72.4% since January 5. Likewise, Hong Kong-listed Bloomage Biotech is up 68.4% since the beginning of March and is now trading at 23.9 times forecast 2015 earnings.
However, global comparables such as Anika Therapeutics are also trading at relatively high multiples. The Nasdaq-listed company is currently trading at 28.86 times projected 2015 earnings.
In terms of net profits, Anika Therapeutics is about the same size as Shanghai Haohai, which is being marketed on a fair value range of 24 to 32 times forecast 2015 earnings of Rmb270 million ($43.5 million). Sole sponsor UBS also forecasts that 2016 earnings will rise to Rmb360 million ($58 million), a 33.3% year-on-year increase.
The company plans to issue 25% of its enlarged share capital pre-greenshoe, equating to a market capitalization of $1.044 billion to $1.392 billion based on the fair value range. The flotation will comprise of primary shares with proceeds being used to expand capacity.
Formal bookbuilding will open on April 15, with pricing set for April 23 and listing on April 30. Sources close to the deal say that a portion of the offering will be placed with cornerstone investors, but allocations are being scaled back.
This is partly to encourage secondary market performance, but also because there are likely to be retail clawbacks if the current frenzy holds strong.
Policy-driven sector
China-related healthcare stocks have been an investor favourite for some time, benefiting from the country's GDP growth as well as its ageing population. Healthcare companies have recorded consistently strong profit growth although the sector is far more policy-driven than other sectors, which track the rise of a consumer society.
One of the sector's chief risks is the pricing pressure the government has exerted on all pharma companies. That said, Beijing has also introduced a number of initiatives which favour domestic pharma companies at the expense of global giants.
For example, in August 2014 the central government's National Health & Planning Commission said it wanted the country's class III public hospitals to use domestically produced medical devices. They also stood to benefit from the fact that these large public hospitals often negotiate on behalf of neighbouring smaller ones as well.
Shanghai Haohai distributes its products to 1,700 class III hospitals and 3,000 class II hospitals, representing 90% and 40% of their respective totals.
Since 2008, it has been able to steadily eat into the market share of its chief foreign competitor in the orthopedics sector, its largest revenue source. From 2008 to 2013, its market share in intra-articular viscosupplements rose from 15.2% to 29.4%, while China's leading supplier, Bausch & Lomb, saw its share fall from 47.7% to 29.6% over the same period.
In the 2013 financial year, Shanghai Haohai derived 46% of its revenues from the orthopedics sector particularly osteoarthritis, where its products are used to protect joints from further damage. Most of the company's products rely on sodium hyaluronate, which is used for medical and cosmetic procedures either as an injection or gel. Bloomage Biotech, for instance, uses sodium hyaluronate for dermatological products in plastic surgery.
One of Shanghai Haohai's chief selling points is its dominance in China where it had a leading 50% market share in the anti-adhesives sector by revenue in 2013. This sector accounted for 31.1% of its revenues that year.
The company is also the largest manufacturer of opthalmic viscoelastic devices, its third major revenue source. It accounts for 39.6% market share of the devices, which are used in cataract surgery - a procedure forecast for robust growth in coming years.
Shanghai Haohai's most recent financial figures show that net profits hit Rmb141.5 million ($22.8 million) in 2013, up 31.6% from the previous year and equating to a net profit margin of 35.3%. For the first six months of 2014, the company reported net profits of Rmb81.6 million ($13.15 million) and a net profit margin of 35.1%.
The company previously applied to list on the Shenzhen Growth Enterprise Market in 2012 alongside other medical materials companies like Grandhope. However, the regulator rejected the application on the grounds that its raw material was being sourced from one supplier, which was also a major competitor.
One question for investors will be the extent to which that situation has been remedied. In its prospectus the company says that it has expanded its production of sodium hyaluronate from 1,350kg in 2011 to 2,500kg by 2014.
Investors will also be keen to hear about the company's future product pipeline. R&D spending averages about 5.9% of revenues.