Deutsche Bank Markets Research
Asia
HY Corporate Credit Healthcare
Company
Biostime International Limited
Date 7 July 2016
Competition & regulations key to expected growth; Initiate with Hold
________________________________________________________________________________________________________________
Deutsche Bank AG/Hong Kong
DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 057/04/2016.
Vikash Agarwalla, CFA
Research Analyst
(+65 ) 6423 5718
Biostime (Ba2/BB; M/S) recently issued USD400 million of 5NC2 bonds at 7.25% ytm. Bonds have done well (up ~4pts since issuance) as it provided yield pick up over recently issued Degree 21 as well as other BB China HY Industrial names. We note strong technicals given current market sentiment as well as China HY industrial supply expected to be limited. That said, we don’t see significant upside from current levels and initiate on new 2021 with Hold. Looking regionally, Biostime 21 (ask price of 104.5; ask ytm of 6%) is trading flat to recently issued Degree 21 (ask price of 105.25; ask ytm of 5.9%). Both Biostime and Degree are similar rated (issuer level rating) and operate on an asset light model. Degree benefits from lower leverage and high cash balance. At the same time, Biostime has superior market position (#1 domestic player) and better product diversity, in our view. We also take comfort from Biostime more disciplined working capital. Overall we prefer Biostime 21 over Degree 21 (we initiated on Degree 21 with sell last month; please refer to our report for more details). Looking elsewhere, car rental companies are facing similar evolving regulatory risk. However, both car rental companies in our space are relatively more asset heavy with better shareholder backing (Enterprise and Ctrip for eHi and Legend Holdings for Car Inc), in our view. Similar rated and shorter dated eHi 18 is trading at ask ytm of 5.1% (104.75/105.25 ) while better rated Car Inc 21 continues to trade tight at ask ytm of 4.5% (105/105.5). Most international competitors, Nestle, Mead Johnson, Danone, etc., are much larger and IG rated and thus trades tight. Similar rated, US based dairy company, Whitewave (Ba2/BB) has USD 2022 bonds which is currently trading at ask ytm of 4% (ask price of 107.5). Comparatively, Biostime is bigger in size with higher margins and its bonds do look attractive. But one needs to account for US-China differential as well as recent press articles about potential acquisition of Whitewave by a bigger player. Looking at another VHMS player, GNC which is rated BB+ by S&P, it has 2020 bond which is trading at ask ytm of 6.1% (ask price of 83.5). Relatively Biostime 2021 looks fair to us.
Figure 1: RV comparison
Source: Deutsche Bank
Key risks: Key downside risks include
ongoing weakness in IMF market in China,
high competition, adverse regulatory
changes while key upside risk includes
better than expected demand for VHMS
products in China.
Distributed on: 07/07/2016 07:53:35GMT
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HY Corporate Credit,Healthcare
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Page 2 Deutsche Bank AG/Hong Kong
Company Background
About the company
Biostime is sixth largest IMF (infant milk formula) providers in China. It also manufactures and distributes probiotic supplements for children, dried baby food products and baby care products. Biostime and ADiMIL are its two principal brands primarily sold in China. It expanded into VHMS market in Sep, 2015 through its acquisition of Swisse Wellness Group. Swisse primarily sells its product in Australia and New Zealand as well as in select international markets through distribution agreement with PGT Healthcare (JV between P&G and Teva Pharmaceuticals). Company operates on an asset light model sourcing its premium IMF on a finished basis from three major suppliers in Europe – Laiterie de Montaigu and Isigny Sainte Mere in France and Arla in Denmark. Even VHMS products under Swisse brand are sourced through external manufacturers (Australia Government Department of Health Therapeutic Good Administration licensed suppliers). Its product offering is divided into three broad segments:
formulas for infants and children under seven years old as well as for expectant and nursing mothers (52% of FY15 PF revenue)
adult nutrition and care products (39% of FY15 PF revenue)
probiotic and other pediatric supplements, dried baby foods and baby care products (9% of FY15 PF revenue)
Listed on HKSE, company has current market cap of USD2.1 billion. Company is 71.4% by Biostime Pharmaceuticals (China) Limited which in turn is 47.7% controlled by two founders with remaining being controlled by management team. Remaining 28.6% of Biostime is held publicly.
Use of proceeds and PF leverage
The net proceeds from notes will be deposited into the escrow account. About USD250 million will be used to repay the Company’s HKD 3.1 billion of zero coupon convertible bonds due 2019 tendered in the tender offer. The remainder in the Escrow Account will be released from time to time to repay the Convertible Bonds. As a result transaction is expected to be leverage neutral with no significant impact on total debt or leverage, but will lengthen Biostime’s debt maturity and thus improve short-term liquidity profile.
We look at the pro-forma capital structure and leverage in Figure 2. Considering full year 2015 EBITDA attribution from Swisse, pro-forma EBITDA comes to RMB1.5 billion and gross leverage shall stands at 5x.
Swisse acquisition
On 17 Sep 2015, Biostime announced to enter into an agreement to acquire 83% stakes in Swiss Wellness for an aggregate consideration of ~AUD1,386 million (~RMB6,276 million) via its wholly owned subsidiary Biostime Healthy Australia Investment Pty Ltd. The consideration was paid in the form of 1) AUD1,336 million in cash with cash on hand and USD450 million bridge loan and 2) AUD50 million by issuance of 20.5 million shares
Figure 2: PF capital structure
2015 (A) 2015 (PF)
Cash and cash equivalents 1,198 1,144
Swisse Acq. Secured Bridge Loan 2,901 -
Secured Bank Loan 1,804 1,804
Convertible Bonds 2,659 -
HSBC Unsecured Facility 35 35
Senior Secured Term Loan - 2,915
Notes - 2,591
Total Debt 7,400 7,346
Net Debt 6,201 6,201
Total Equity 4,269 4,269
Total Capitalization 11,669 11,615
EBITDA 732 1,477
Total Debt / EBITDA 10.1 5.0 Source: Deutsche Bank, company data. Note: Pro-forma debt numbers are after adjustment of the repayment of the Bridge Loan & Convertible bonds with the drawings under the Senior Facility Agreement & issuance of USD bonds. Pro-forma EBITDA number include full year contribution from Swisse in 2015. PF EBITDA is based on DB calculation
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(or 3.3% of the enlarged shares). On 24 Apr 2016, Biostime successfully refinanced USD450 million bridge loan with a USD450 million 3-year senior secured term loan facility.
Swisse sells VHMS, superfoods, sport nutrition and skincare products under the "Swisse" brand mainly in Australia and New Zealand. According to IRI data, Swisse made up 19% of total Australian VHMS market by scanned retail sales value as of March 2016. It has to obtain FDA license from government regulators before it can legally sell through offline channels, which takes about two years on an average. Currently it primarily relies on cross-border e-commerce channels and other passive methods for selling in China. Biostime consolidated Swisse from the 4Q15.
Company is looking to benefit from increasing demand of VHMS product in China and expects to use its existing distribution network to market Swisse brands of products. It is already the highest selling brand in the healthcare category on both Tmall and Taobao.
Key positives
Established brand within premium segment – Biostime has an established market position both in Chinese infant formula and probiotics markets as well as Australian VHMS market. It is the second largest player in the super-premium tier with a 16% market share by retail sales value and 6% market share by retail sales value of the overall infant formula market in China. Strong market position is primarily driven by its strategy of sourcing IMF on a finished basis from reputed suppliers in Europe, established distribution network and value added services such as membership program. VHMS market share is even higher at 19%, as per scanned retail sales value of the Australian VHMS market as of March 2016.
Favorable growth prospect – Favorable demographic development post abolishment of one-child policy is expected to be one of the key drivers for IMF market in China. Consumer preference for premium and super premium segment is further positive for Biostime though competition is also high from better known foreign brands within this segment. Growth outlook for VHMS segment is infact even more positive as growing middle class in China is expected to drive the demand on the back of easier access to foreign products.
High cash flow conversion - Company sources most of its IMF on a finished basis from suppliers in Europe and VHMS production is also outsourced to contract manufacturers. Thus, ongoing capital expenditure requirement is expected to remain limited. Low capital expenditure along with moderately high profit margin and relatively disciplined working capital does translate to good cash flow conversion.
Diversified exposure – Swisse acquisition has helped Biostime to diversify its product portfolio within China and also diversify geographically away from China.
Key concerns
High competition – One of the key concerns for Biostime is competition from international brands. These brands are globally well-known and backed by large companies with greater financial and marketing resources. Foreign companies continue to dominate IMF market in China especially within premium and super premium segment. Thus, despite Biostime’s early mover advantage we do expect competitive pressure to remain
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intense and do not rule out possibility of customers switching to better known international brands.
Regulatory risks – Apart from high competition, changing regulations and product safety standard are key risks to IMF as well as VHMS industry in China. Evolving regulations around product registration, cross-border ecommerce and import tax changes will continue to cast uncertainty over company’s future performance specifically for VHMS. We also note past regulatory clampdown including anti monopoly and price fixing investigation in 2013.
Weakness in IMF could continue in near term – Given the new food safety law requiring manufacturer to be certified and produce only three series of formula we expect industry de-stocking to continue in near future which will continue to weigh on company’s IMF business. This was also evidenced in 1Q16 operational update where baby nutrition and care revenue dropped 13% YoY.
Asset light nature and subordinated bond structure – Biostime business is asset light with both IMF as well as VHMS products primarily sourced from third party suppliers. Consequently, their access to onshore funding might remain limited, in our view. Even the bond structure is weaker with bonds being subordinated to other offshore senior secured facility.
1Q16 operational update
Biostime reported revenue of RMB1.5 billion in 1Q16, up 5% yoy on pro-forma basis. The baby products (mainly IMF) sales dropped 13% yoy to RMB868 million primarily due to intensive market competition. Adult nutrition and care products reached RMB601 million, up 49% yoy on pro-forma basis but down 29% qoq given seasonality impact. Management expects the competitive environment for IMF market to remain intense in 2H16 but remains positive on the outlook for nutritional products.
Key bond covenants
Subsidiary Guarantees on a subordinated basis: Bonds are guaranteed by certain subsidiaries on a senior subordinated basis. As of Mar, 2016, the issuer and guarantors combined represented 76.4% of consolidated assets, and 37.2% of consolidated revenues. However, more importantly guarantee from Swisse subsidiaries is capped at USD450 million which is equivalent to the amount of senior secured debt.
Change of Control: Triggering Event requires occurrence of both CoC and rating downgrade by any of S&P, or Moody’s. CoC is defined when permitted holders cease to own 23% of, or the largest portion of, the total voting power, or the adoption of a plan relating to the liquidation or dissolution of Biostime. Permitted holders refer to Mr. Luo Fei, Mr. Luo Yun and their respective family members.
Other key covenants: Other key covenants include FCCR of minimum 2.5x and Consolidated Senior Leverage of maximum 2x. Permitted investment (general basket up to greater of USD 50 million and 2.5% Total Assets and other investments including JVs up to greater of USD 50 million and 2.5% Total Assets) and Permitted debt cave out are largely standard.
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Peer Comparison
Biostime is smaller in size compared to domestic listed players like Mengniu and Yili though it is bigger in size than Yashili, which is more direct comparable. Biostime has historically enjoyed superior margins than domestic peers given the focus on premium segment though its 2015 margins were impacted by one-off product discount as well as ongoing industry destocking. Its leverage has been historically been conservative though currently it is elevated post Swisse acquisition. We expect the leverage to normalize post full year contribution from Swisse. Biostime’s margin is superior even compared to global players such as GNC and Whitewave.
Figure 3: Peer comparison: Key financials
Period 2014 2015 2015 (PF) 2014 2015 2014 2015 2014 2015 2014 2015 2014 2015
Currency RMB mn RMB mn RMB mn RMB mn RMB mn RMB mn RMB mn RMB mn RMB mn USD mn USD mn USD mn USD mn
Income statement
Revenue 4,732 4,819 6,457 53,959 59,863 50,049 49,027 3,554 2,762 2,613 2,639 3,437 3,866
Gross Profit 2,927 2,985 4,018 17,374 21,237 15,434 15,375 1,819 1,402 980 985 1,153 1,323
EBITDA 1,165 732 1,477 6,070 6,735 4,270 3,963 397 92 496 450 377 452
Interest expense (87) (154) (253) (183) (169) (327) (309) (11) (27) (47) (51) (37) (58)
NPAT 807 293 215 4,167 4,654 2,691 2,520 333 118 256 219 140 168
Cash flow statement
Operating cash flow 972 366 NA 2,436 9,536 3,080 1,909 437 243 304 355 285 315
Capex & Acquisition (148) (6,112) NA (3,946) (3,652) (3,227) (3,043) (713) (344) (77) (46) (292) (258)
Free cash flow 824 (5,746) NA (1,510) 5,884 (147) (1,134) (276) (101) 227 309 (8) 57
Dividends paid (493) (197) NA NA NA (491) (655) (131) (75) (57) (60) - -
Balance sheet
Cash 3,347 1,198 1,144 14,273 13,084 4,650 7,931 800 2,480 134 56 50 39
Total Assets 6,631 13,832 13,778 39,494 39,631 47,081 50,653 5,693 7,664 2,678 2,552 3,319 4,229
ST Debt - 4,740 1,840 8,072 6,190 4,479 6,125 141 462 5 5 21 51
LT Debt 2,411 2,659 5,506 710 0 5,464 4,970 621 - 1,338 1,448 1,472 2,079
Total Debt 2,411 7,400 7,346 8,782 6,190 9,943 11,094 763 462 1,342 1,452 1,493 2,130
Net Debt (937) 6,201 6,202 (5,491) (6,893) 5,293 3,163 (37) (2,018) 1,209 1,396 1,443 2,092
Total Capital 5,328 11,000 11,615 27,603 26,336 34,436 37,709 4,213 6,442 2,098 1,921 2,570 3,341
18,822 20,146 756 469 1,076 1,211
Key Ratios
Revenue growth yoy 3.7% 1.8% 34.0% 13.5% 10.9% 15.4% -2.0% -8.7% -22.3% -0.5% 1.0% 35.2% 12.5%
Gross margin 61.9% 61.9% 62.2% 32.2% 35.5% 30.8% 31.4% 51.2% 50.8% 37.5% 37.3% 33.6% 34.2%
EBITDA margin 24.6% 15.2% 22.9% 11.2% 11.2% 8.5% 8.1% 11.2% 3.3% 19.0% 17.1% 11.0% 11.7%
Total Debt/EBITDA 2.1 10.1 5.0 1.4 0.9 2.3 2.8 1.9 5.0 2.7 3.2 4.0 4.7
Net Debt/EBITDA net cash 8.5 4.2 net cash net cash 1.2 0.8 net cash net cash 2.4 3.1 3.8 4.6
EBITDA/Interest 13.4 4.8 5.8 33.1 39.8 13.1 12.8 37.7 3.4 10.6 8.8 10.2 7.8
YashiliBiostime GNCYili WhitewaveMengniu
Source: Deutsche Bank, company data, Bloomberg Finance LP
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Figure 4: Biostime: Financial summary
Income Statement 1H14 2H14 1H15 2H15 2014 2015
RMB mn RMB mn RMB mn RMB mn RMB mn RMB mn
Total Revenues 2,189 2,543 1,963 2,856 4,732 4,819
Gross Profit 1,346 1,581 1,143 1,842 2,927 2,985
SG&A (886) (877) (826) (1,430) (1,763) (2,256)
EBITDA 462 703 305 427 1,165 732
Gross Interest Expense (40) (46) (48) (106) (87) (154)
Pretax Income 433 685 280 224 1,118 504
Income Taxes (121) (190) (75) (135) (312) (211)
Net Income 312 495 205 88 807 293
Cash Flow 1H14 2H14 1H15 2H15 2014 2015
RMB mn RMB mn RMB mn RMB mn RMB mn RMB mn
Funds from Operations(FFO) 159 662 104 257 821 361
Change in Working Capital (352) 503 43 (39) 151 5
Operating Cash Flow(CFFO) (193) 1,165 147 218 972 366
Capex (58) (91) (63) (49) (148) (113)
Acqusition 0 0 (61) (5,938) 0 (5,999)
Free Cash Flow(FCF) (251) 1,074 23 (5,769) 824 (5,746)
Dividends (368) (124) (196) (1) (493) (197)
Balance Sheet 1H14 2H14 1H15 2H15 2014 2015
RMB mn RMB mn RMB mn RMB mn RMB mn RMB mn
Cash 2,748 3,347 3,998 1,198 3,347 1,198
Restricted cash and other deposits 0 0 0 1,927 0 1,927
Total Assets 6,433 6,631 6,614 13,832 6,631 13,832
Short Term Debt 540 0 135 4,740 0 4,740
Long Term Debt 2,380 2,411 2,456 2,659 2,411 2,659
Total Debt 2,919 2,411 2,590 7,400 2,411 7,400
Total Equity 2,540 2,917 2,958 3,601 2,917 3,601
Total Capitalization 5,459 5,328 5,548 11,000 5,328 11,000
Key Ratios 1H14 2H14 1H15 2H15 2014 2015
Gross Margin 61.5% 62.2% 58.2% 64.5% 61.9% 61.9%
EBITDA Margin 21.1% 27.6% 15.5% 15.0% 24.6% 15.2%
SG&A/Sales 40.5% 34.5% 42.1% 50.1% 37.3% 46.8%
EBITDA/Gross Interest Expense 11.5x 15.2x 6.4x 4.0x 13.4x 4.8x
FFO/Interest Expense 3.9x 14.3x 2.2x 2.4x 9.5x 2.3x
Total Debt/EBITDA 2.1x 2.6x 10.1x 2.1x 10.1x
Net Debt/EBITDA -0.8x -1.4x 8.5x -0.8x 8.5x Source: Deutsche Bank
The author of this report wishes to acknowledge the contribution made by Xiang Gao of CRISIL, a third-party provider to Deutsche Bank of offshore research support services.
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Deutsche Bank AG/Hong Kong Page 7
Appendix 1
Important Disclosures
Additional information available upon request
Disclosure checklist
Institution Disclosure
Biostime
BTSDF 7.25% 2021 1,6,7,9,14,15,17 *Prices are current as of the end of the previous trading session unless otherwise indicated and are sourced from local exchanges via Reuters, Bloomberg and other vendors . Other information is sourced from Deutsche Bank, subject companies, and other sources. For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr.
Important Disclosures Required by U.S. Regulators
Disclosures marked with an asterisk may also be required by at least one jurisdiction in addition to the United States. See Important Disclosures Required by Non-US Regulators and Explanatory Notes.
1. Within the past year, Deutsche Bank and/or its affiliate(s) has managed or co-managed a public or private offering for this company, for which it received fees.
6. Deutsche Bank and/or its affiliate(s) owns one percent or more of any class of common equity securities of this company calculated under computational methods required by US law.
7. Deutsche Bank and/or its affiliate(s) has received compensation from this company for the provision of investment banking or financial advisory services within the past year.
14. Deutsche Bank and/or its affiliate(s) has received non-investment banking related compensation from this company within the past year.
15. This company has been a client of Deutsche Bank Securities Inc. within the past year, during which time it received non-investment banking securities-related services.
Important Disclosures Required by Non-U.S. Regulators
Please also refer to disclosures in the Important Disclosures Required by US Regulators and the Explanatory Notes.
1. Within the past year, Deutsche Bank and/or its affiliate(s) has managed or co-managed a public or private offering for this company, for which it received fees.
6. Deutsche Bank and/or its affiliate(s) owns one percent or more of any class of common equity securities of this company calculated under computational methods required by US law.
7. Deutsche Bank and/or its affiliate(s) has received compensation from this company for the provision of investment banking or financial advisory services within the past year.
9. Deutsche Bank and/or its affiliate(s) owns one percent or more of any class of common equity securities of this company calculated under computational methods required by India law.
17. Deutsche Bank and or/its affiliate(s) has a significant Non-Equity financial interest (this can include Bonds, Convertible Bonds, Credit Derivatives and Traded Loans) where the aggregate net exposure to the following issuer(s), or issuer(s) group, is more than 25m Euros.
For disclosures pertaining to recommendations or estimates made on a security mentioned in this report, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr
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Analyst Certification
The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s) about the subject issuer and the securities of the issuer. In addition, the undersigned lead analyst(s) has not and will not receive any compensation for providing a specific recommendation or view in this report. Vikash Agarwalla
Deutsche Bank debt rating key Bond rating dispersion and banking relationships
CreditBuy (“C-B”): The total return of the Reference Credit Instrument (bond or CDS) is expected to outperform the credit spread of bonds / CDS of other issuers operating in similar sectors or rating categories over the next six months.
CreditHold (“C-H”): The credit spread of the Reference Credit Instrument (bond or CDS) is expected to perform in line with the credit spread of bonds / CDS of other issuers operating in similar sectors or rating categories over the next six months.
CreditSell (“C-S”): The credit spread of the Reference Credit Instrument (bond or CDS) is expected to underperform the credit spread of bonds / CDS of other issuers operating in similar sectors or rating categories over the next six months.
CreditNoRec (“C-NR”): We have not assigned a recommendation to this issuer. Any references to valuation are based on an issuer’s credit rating.
Reference Credit Instrument (“RCI”): The Reference Credit Instrument for each issuer is selected by the analyst as the most appropriate valuation benchmark (whether bonds or Credit Default Swaps) and is detailed in this report. Recommendations on other credit instruments of an issuer may differ from the recommendation on the Reference Credit Instrument based on an assessment of value relative to the Reference Credit Instrument which might take into account other factors such as differing covenant language, coupon steps, liquidity and maturity. The Reference Credit Instrument is subject to change, at the discretion of the analyst.
DB Credit Opinion Definition : The DB Credit Opinion follows the same scale as S & P's credit ratings ranging from AAA for the Highest credit quality to C for the Weakest credit quality. It reflects our opinion on the creditworthiness of a company. We derive our Credit Opinion from fundamental credit analysis of the company, comparable analysis, benchmarking against rating agencies and qualitative judgement.
9 %
80 %
11 %42 %
28 %
42 %
050
100150200250300350400450500
Buy Hold Sell
Asia-Pacific Universe
Companies Covered Cos. w/ Banking Relationship
(a) Regulatory Disclosures
(b) 1.Important Additional Conflict Disclosures
Aside from within this report, important conflict disclosures can also be found at https://gm.db.com/equities under the "Disclosures Lookup" and "Legal" tabs. Investors are strongly encouraged to review this information before investing.
(c) 2.Short-Term Trade Ideas
Deutsche Bank equity research analysts sometimes have shorter-term trade ideas (known as SOLAR ideas) that are consistent or inconsistent with Deutsche Bank's existing longer term ratings. These trade ideas can be found at the SOLAR link at http://gm.db.com.
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(d) Additional Information
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7 July 2016
HY Corporate Credit,Healthcare
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Deutsche Bank AG/Hong Kong Page 11
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Copyright © 2016 Deutsche Bank AG
David Folkerts-Landau Group Chief Economist and Global Head of Research
Raj Hindocha Global Chief Operating Officer
Research
Michael Spencer Head of APAC Research
Global Head of Economics
Steve Pollard Head of Americas Research
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Anthony Klarman Global Head of Debt Research
Paul Reynolds Head of EMEA
Equity Research
Dave Clark Head of APAC
Equity Research
Pam Finelli Global Head of
Equity Derivatives Research
Andreas Neubauer Head of Research - Germany
Stuart Kirk Head of Thematic Research
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