Simcere breaks negative trend for Chinese listings in the US

The pharmaceutical company trades up 5.5% after pricing its $226.5 million IPO at the top of the range.
Simcere Pharmaceutical Group has broken the recent trend of a negative first day performance for Chinese companies listing in the US, rising 5.5% on its New York Stock Exchange trading debut on Friday.

The company, which manufactures and distributes mainly branded generic pharmaceuticals but has also made a move into innovative drugs, received a good response to its initial public offering, allowing it to fix the price at the top of the $12.50 to $14.50 range.

This resulted in a total deal size of $226.6 million, which ranks Simcere as the largest Chinese pharmaceutical sector IPO û in any market. Goldman Sachs was sole bookrunner for the offering, which also saw a number of existing shareholders take the opportunity to cash in part of their holdings.

The price gained as much as 11.9% intraday before settling at $15.30. The performance would have come as a relief for investors who have watched three of the past four Chinese companies fall on their trading debut. For two of them the sell-off came even though the IPOs were well oversubscribed, suggesting investors hadnÆt been in it for long term. The third one saw modest demand from the beginning and was forced to price the deal 33% below the bottom of its original price range.

The worsening appetite for Chinese stocks have taken a toll on most Mainland companies listed in the US, including those that had previously been pushed to very lofty valuations, but the newcomers have been among the hardest hit. And from SimcereÆs perspective, it obviously didnÆt help that two of the recent new listings were also in the drug-making business.

Tongjitang Chinese Medicines, which was the most recent addition to the list, dropped 2.5% on its first trading day in mid-March after pricing its $98.7 million IPO at $10, compared with an initial price range of $15 to $17 and a revised range of $12-$14. Since the debut the integrated specialty pharmaceutical company which focuses on modernised traditional Chinese medicine, has hovered around the IPO price and the most recent close was at $9.85.

Bio-pharmaceutical company 3SBio, whose main product is a hormone that stimulates the production of red blood cells to reduce the need for blood transfusions, fell 7.2% on its first day in early February and is currently trading 36% below its IPO price. The latter was fixed at $16, above the indicative range of $12 to $14, allowing the company to raise $123 million.

Meanwhile, Xinhua Finance lost 14.2% when it came to market a week before Tongjitang and is now down a total of 23% since listing. A producer and distributor of broadcasting content primarily for TV and radio that derives the bulk of its revenues from advertising, Xinhua raised $300 million after pricing its IPO in the middle of the $12 to $14 range.

ôOne of the challenges was to overcome the fact that sentiment for Chinese companies had become scarred because of the performance of other IPOs,ö says one observer commenting on the Simcere transaction. ôUS investors were initially the most sceptical of the three major regions, but by the time they got a chance to meet the management, the sentiment changed dramatically and in the end the US participation in the deal was actually quite strong.ö

According to sources, about 70% of the Simcere deal went to the US with the reminder split fairly evenly between Europe and Asia. Some 200 investors came into the book, which was said to have been ôvery well subscribedö even though the stock was priced at a premium to both the US and Indian manufacturers of generic drugs.

At the IPO price, Simcere was valued at 26 times its projected earnings for 2007, which compares with about 19 times for the US companies and about 20 for the Indians. On a 2008 basis, SimcereÆs valuation falls to 17.5 times, while the US manufacturers trade at a P/E multiple of around 14.5 and the Indian companies fetch a multiple of about 16.4.

The higher valuation was seen warranted partly because of the higher growth prospects in the Chinese market, with analysts anticipating SimcereÆs net profit compound annual growth rate at just above 40% in 2006-2008. And with Simcere also having broken into the market for innovative drugs with its anti-cancer medication Endu (also known as Endostar), the company can no longer be regarded just as a generic drugs manufacturer.

ôIt is not exactly a bio-pharmaceutical company, but it does have an element of that to support its growth,ö the observer says, adding that the company is devoting a bigger share of its revenues to research with the aim of adding more innovative products to its portfolio in the future.

According to the listing prospectus, the company plans to spend about $52 million of the $162.9 million in net proceeds from the IPO on research, including $35 million to fund pre-clinical studies and trials in China together with international pharmaceutical and biotechnology companies to develop innovative drugs for the Chinese market. Another $13 million will go towards Phase IV clinical trials for Endu with the hope of being able to use this drug for other types of cancer as well. At present, Endu is used only to treat lung cancer.

The company will also use $30 million to repay outstanding short-term bank loans.

Simcere offered 25% of the company, or 15.625 million American Depositary Receipts, of which 12.5 million are new. The remaining 3.125 million ADS were sold by a group of directors and executives through a jointly held company named New Good Management, which held 69% before the IPO. The other seller was Assure Ahead Investments, which is made up of a group of international investors, including Goldman Sachs, which owns 11%. Assure Ahead owned the remaining 31% of the company pre-listing.

There is a 15% greenshoe which will be all secondary shares could see the total proceeds increase to $260.5 million. Each ADS represents two ordinary shares.

Chinese generic drug makers are not at the same advanced stages as their counterparts in India where the number of products per company is much higher. The Chinese companies also tend to focus on the domestic market, while the Indian companies make generic drugs for the international market.

According to the prospectus, the domestic Chinese market offers great growth potential, however, due to increasing disposable income and higher spending on pharmaceuticals, an ageing population, and better cost efficiency because of lower R&D and clinical trial costs. The China National Center for Biotechnology Development estimates the cost of bringing a new pharmaceutical product can be as little as $5.9 million in China, compared with an estimated $800 million in western countries.

The Chinese government has also been supporting the growth in this industry through a series of initiatives, which includes encouraging foreign ownership and shutting down companies that manufacture counterfeit drugs. Meanwhile, ChinaÆs pharmaceutical industry is still highly fragmented, which provides an opportunity for consolidation.

International study and database company Freedonia Group estimates that total spending on pharmaceuticals will grow at a CAGR of 13.6% between 2005 and 2010, which is significantly higher than the 5-8% expected to be achieved in the rest of the world.

Simcere started operations as a generic drug maker in 1995 and has built up a strong distribution platform that it now uses to sell both generic drugs and drugs that it has developed on its own (often referred to as innovative pharmaceuticals). It currently sells 38 products, but has approvals from the ChinaÆs State Food and Drug Administration to manufacture and sell over 100 other products.

Aside from Endu, which prevents the growth of blood vessels in tumours, its top products include first-to-market generic anti-strong medication under the brand name Bicun, which is currently benefiting from a government protection period. As a result, no other companies can make or sell the same drug in China until the protection period expires at the end of this year - an arrangement that has allowed Simcere to get a dominating position in the market for so called endaravone injection medicines in China that it is unlikely to lose even with more players in the market.

SimcereÆs trading debut should be encouraging for Acorn International, which is currently on the road trying to drum up support for an IPO of up to $111.7 million led by Deutsche Bank and Merrill Lynch. The Chinese retailer, which sells its products through shopping channels on Chinese TV, is offering 7.7 million ADS at $12.50 to $14.50 apiece.
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