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WuXi’s Margins Dwarfing U.S. Lead China’s Drug Targets: Real M&A

Technicians At Wuxi PharmaTech
Technicians at the WuXi PharmaTech facility in Wuxi, China. Photographer: Ariana Lindquist/Bloomberg

Companies looking to profit from the world’s fastest growing drug market and conduct animal research at half the cost of U.S. testing are making China’s WuXi PharmaTech (Cayman) Inc. and ShangPharma Corp. takeover targets.

WuXi, China’s biggest medical contract researcher, is generating profit margins that outstrip its U.S. rivals by almost five times, according to data compiled by Bloomberg. ShangPharma, which like WuXi offers research including animal testing, traded at 7.9 times estimated 2012 profit yesterday, half the average for its U.S. rivals, the data show.

With China’s pharmaceutical market projected to grow to $115 billion by 2015, WuXi and ShangPharma’s position as the nation’s largest research contractors by sales may spur takeover offers from global rivals including Quintiles Transnational Corp. and Pharmaceutical Product Development Inc., Oppenheimer & Co. and CLSA said. WuXi, which analysts project will post record sales for four more years, could justify a bid 60 percent higher than yesterday’s price, according to William Blair & Co.

“We see a big gap between WuXi and ShangPharma valuations versus their U.S. peers,” said Ingrid Yin, New York-based China health-care analyst with Oppenheimer. “WuXi and ShangPharma are both very interesting potential targets. They represent a big opportunity in China.”

WuXi’s shares climbed 3.4 percent to $14.02 at 11:04 a.m. in New York today, while ShangPharma rose 2.3 percent to $8.90.

‘Not Surprising’

Ron Aldridge, a spokesman for Shanghai-based WuXi, declined to comment on takeover speculation.

“Given the current valuations and multiples, it’s not surprising that a lot of people are interested in ShangPharma from a value perspective,” William Dai, chief financial officer for Shanghai-based ShangPharma, said in a telephone interview. He declined to comment on whether the company has been approached by potential buyers.

Quintiles, the world’s biggest conductor of medical studies, would be “delighted to acquire” companies of the right quality, Chief Executive Officer Dennis Gillings said in a Jan. 13 interview in Shanghai. He didn’t specifically refer to WuXi or ShangPharma.

Growing wealth and changing lifestyles are opening up new markets for drugmakers in China, where almost 100 million people suffer from diabetes alone. The Chinese pharmaceutical market is forecast to grow as much as 22 percent a year to reach about $115 billion by 2015, the fastest pace in the world, according to research firm IMS Health Inc.

Local Testing

With China demanding local testing of medicines before it licenses them domestically, and the cost of conducting animal research about half that in the U.S., demand for services of contract research organizations, or CROs, is surging, said Greg Scott, president of Shanghai-based ChinaBio LLC, which advises companies on biotechnology investments in the country. Revenue at China’s CROs may grow between 20 and 25 percent annually over the next three to five years, from an estimated $1.35 billion last year, according to McKinsey & Co.

WuXi and ShangPharma’s success reflects their “ability to deliver a cost advantage while maintaining very high quality,” said Scott. “WuXi and ShangPharma have really brought the quality up significantly compared to what it was in China several years ago.”

WuXi, which employs 5,600 people in its more than 3 million square feet of laboratory facilities, derives more than 70 percent of its revenue from research for U.S. companies, according to data compiled by Bloomberg. Analysts estimate WuXi will report sales of $406 million for 2011, triple its revenue in 2007, the year it first sold shares in the U.S.

Charles River Deal

The company, which counts nine of the top 10 drugmakers among its clients, agreed to a $1.6 billion takeover by Wilmington, Massachusetts-based Charles River Laboratories International Inc. in April 2010. The bid, which valued WuXi at about 30 times 2009 profit, was scrapped three months later after Charles River’s shareholders objected to the “unreasonable price.”

The management of WuXi, which had a market value of $964 million yesterday, is unlikely to accept a takeover worth less than the Charles River bid, according to Liping Cai, a Shanghai-based health-care analyst for William Blair. An offer with an equity value of $1.6 billion would represent a 66 percent premium above WuXi’s price yesterday, Bloomberg data show.

‘Improved a Lot’

With WuXi’s 2011 earnings estimated to have increased 49 percent from the 2009 level, Charles River’s bid would now value the company at about 20 times profit, data compiled by Bloomberg show. Including net cash, a $3.4 billion bid for PPD by Carlyle Group LP and Hellman & Friedman last year valued the company at 21 times, data compiled by Bloomberg show.

WuXi’s “earning capabilities have improved a lot,” Oppenheimer’s Yin said.

The company earned about 19 cents for every dollar of sales in the past 12 months, according to data compiled by Bloomberg. That’s almost five times the median profit margin of 4 percent for 23 U.S. health-care service companies with market values of more than $100 million. WuXi’s rivals Covance Inc., Icon Plc and Parexel International Corp. all have profit margins of less than 6 percent, the data show.

Covance, Icon and Parexel all traded for at least 16 times estimated 2012 earnings yesterday, compared with a price-to-earnings ratio of 10.8 for WuXi. ShangPharma, which had a market value of $163 million, traded for 7.9 times projected profit. The average U.S. health-care services company had a multiple of 21 times, the data show.

‘More Interesting’

“WuXi has a larger scale and ShangPharma is smaller but sometimes smaller could be more interesting to strategic buyers,” Oppenheimer’s Yin said.

ShangPharma’s sales reached $113 million last year, according to analysts’ estimates compiled by Bloomberg. That’s an 86 percent increase from 2008’s level, the data show.

Like WuXi, ShangPharma gets most of its revenue from U.S.- based companies, the data show. ShangPharma is focused on early stage discovery research, screening compounds to see which have the potential to cure diseases.

Both companies generate the bulk of their revenue from laboratory research, rather than the later stage of drug testing -- conducted on patients in doctor’s offices or hospitals --that many global peers focus on.

The former requires infrastructure with high fixed costs and may deter buyers, said Tim Evans, New York-based senior health care analyst for Wells Fargo & Co.

“The businesses have very different economics,” he said.

‘In China Somehow’

Still, the industry has lured bids from private equity firms, which are interested in generating cash flow from the CROs, according to Paul Knight, New York-based life sciences analyst with CLSA. Avista Capital Partners and Ontario Teachers Pension Plan last year agreed to pay $341 million, including debt, to purchase Kendle International Inc.

Global CROs, including PPD, would also be potential bidders, he said. The early stage of research WuXi and ShangPharma focus on ”might be complementary to international CROs like Quintiles,” Oppenheimer’s Yin said.

“They’ve got to be in China somehow,” Knight said. “The opportunity is going to be immense.”

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