Contract Research Organization Market Nov 9, 2017 Equity Research | Healthcare Primary beneficiary of pharma technology upgrade Natalie Chiu SFC CE No. AVH029 [email protected]+852 3760 2030 GF Securities (Hong Kong) Brokerage Limited 29-30/F, Li Po Chun Chambers 189 Des Voeux Road Central Hong Kong Key beneficiaries of healthcare reform As outsourcing partners for both pharmaceutical and biotech companies, contract research organizations (CROs) in China are seeing rapid growth, with a market size currently less than one-tenth that of their US counterparts. Proposed healthcare reform should accelerate industry transformation and lead to higher market growth. Favorable industry landscape for leading players There are about 400 CROs in China, most of which are small and regional players. The top three accounted for less than 20% of the market in 2014, much smaller than the market share of the top three players in the US. This high degree of industry fragmentation means there are opportunities for consolidators. Biologics service providers growing faster with higher margins Biologics is the most active area of pharmaceutical development, with eight out of the top ten best-selling drugs globally. This will benefit the biologics outsourcing services market given increased R&D spending and meaningful cost savings. Trading at a premium over pharmas and regional peers Regional CROs are trading at hefty premium (600%) to their global peers, following several well-received IPOs and optimism about faster growth in emerging markets, dynamics we view as sustainable. We also think a valuation premium over local pharmas is warranted given CROs’ meaningful exposure to clinical development services. Top pick We initiate coverage of WuXi Biologics (2269 HK) with a Buy rating given its competitive advantage as a full-service provider. We also like Tigermed (300347 CH), a clinical CRO leader in China, whereas Genscript Biotech’s (1548 HK, NR) valuation would keep us on the sidelines. Peer comparison (stock prices as of Nov 8, 2017) Sources: Bloomberg, Wind, GF Securities (Hong Kong) Mkt Cap PEG (x) Ticker Rating (HK$ m) Currency Price YTD FY16 FY17E FY18E FY19E FY16 FY17E FY18E FY19E FY18E China CROs Hangzhou Tigermed 300347 CH NR 18,815 RMB 32.0 19 107 57 42 32 (10) 101 38 32 1.1 Boji Medical 300404 CH NR 3,511 RMB 22.3 (31) 1,418 77 36 21 (92) 1833 112 72 0.3 Bai Hua Cun 600721 CH NR 5,790 RMB 12.3 (34) 25 44 30 26 (134) (7) 20 20 1.5 Yatai Pharma 002370 CH NR 9,164 RMB 14.5 (1) 51 37 28 25 126 71 33 12 0.8 Genscript Biotech 1548 HK NR 16,749 HKD 9.7 162 617 569 461 403 50 17 24 30 19.6 Wuxi Biologics 2269 HK NR 4,989 HKD 42.9 51 167 118 72 40 217 109 78 96 0.9 Net profit growth (%) P/E (x)
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Contract Research Organization Market
Nov 9, 2017 Equity Research | Healthcare
Primary beneficiary of pharma technology upgrade
Natalie Chiu SFC CE No. AVH029 [email protected] +852 3760 2030 GF Securities (Hong Kong) Brokerage Limited 29-30/F, Li Po Chun Chambers 189 Des Voeux Road Central Hong Kong
Key beneficiaries of healthcare reform As outsourcing partners for both pharmaceutical
and biotech companies, contract research organizations (CROs) in China are seeing rapid growth, with a market size currently less than one-tenth that of their US counterparts. Proposed healthcare reform should accelerate industry transformation and lead to higher market growth. Favorable industry landscape for leading players There are about 400 CROs in China,
most of which are small and regional players. The top three accounted for less than 20% of the market in 2014, much smaller than the market share of the top three players in the US. This high degree of industry fragmentation means there are opportunities for consolidators. Biologics service providers growing faster with higher margins Biologics is the most
active area of pharmaceutical development, with eight out of the top ten best-selling drugs globally. This will benefit the biologics outsourcing services market given increased R&D spending and meaningful cost savings. Trading at a premium over pharmas and regional peers Regional CROs are trading
at hefty premium (600%) to their global peers, following several well-received IPOs and optimism about faster growth in emerging markets, dynamics we view as sustainable. We also think a valuation premium over local pharmas is warranted given CROs’ meaningful exposure to clinical development services. Top pick We initiate coverage of WuXi Biologics (2269 HK) with a Buy rating given its
competitive advantage as a full-service provider. We also like Tigermed (300347 CH), a clinical CRO leader in China, whereas Genscript Biotech’s (1548 HK, NR) valuation would keep us on the sidelines.
Higher entry barriers Like small-molecule CROs, there are several hundred small and medium-
sized, limited-service providers, and a small number of large, full-service, global biologic CROs.
Compared to CROs which provide traditional clinical services, biologics outsourcing services
providers require higher capital and technical requirements to manage the biologics development
process, in particular at the commercialization stage. Currently, the top global six players accounted
for a combined ~28% of the market in 2016. Lonza and Boehringer Ingelheim are the top two players
with 11.4% and 8.0% market share respectively. The other companies each have a market share
of 3% or less.
2013 2014 2015 2016
Chemical drugs 274 286 286 528
TCM 49 65 46 120
Vaccines 23 45 54 35
Biologics 93 132 169 278
Total 439 528 655 961
0.7
2.1
9.2
0
1
2
3
4
5
6
7
8
9
10
2012 2016 2021E
34.8%
26.6%
16.5%
26.7%
17.1%
0%
5%
10%
15%
20%
25%
30%
35%
40%
China Asia ex-China
US ROW Europe
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Figure 13: CROs at the core of the pharmaceutical R&D industry chain
Sources: Company data, GF Securities (Hong Kong)
Upstream Downstream
All types of professionals involved in clinical research services (i.e. liaising with China’s top medical experts in various fields)
Institutions with clinical trial qualifications (i.e. liaising with China’s major tertiary medical resources)
Tertiary hospitals with provincial/ director
level experts
Secondary hospital and attending/ chief
doctor
Primary medical institutions and front-line/
General Practitioner
Foreign multinational corporations
Innovative drug research corporations
Innovative drug
corporations
Generic drug corporations
Domestic and foreign innovative drug companies and other new drug research start-ups (i.e. liaising with domestic and foreign elite drug R&D corporations)
Middle
Direct dealing with national drug evaluation center
Contract Research
Organization
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WuXi Biologics (2269 HK)
Buy (initiation)
Target price: HK$50.10
Biologic CRO market leader in China with full-service offering
Diversified biologics CRO with WuXi Biologics was China’s largest biologics
outsourcing services provider in 2016 with a market share of 48%. Established in 2010, it was one of the five business units of WuXi PharmaTech, alongside small molecules, cell & gene therapies, medical devices and genomics. It offers a range of services that support drug discovery, development and manufacturing of biologics to its customers, which are primarily pharmaceutical and biotechnology companies. “Follow-the-molecule” strategy through end-to-end services platform Customer
demand for CRO services typically increases as their biologics advance through the biologics development process and ultimately to commercial manufacturing. As a result, revenue and profit from each integrated project also increases as the project advances. WuXi Biologics has been working on customer projects from an early stage of the biologics development process and develops an in-depth understanding of the relevant biologics drug candidates. With a solid track record in growing its customer base, WuXi Biologics should see improving quality and efficiency for its services for such projects once it progresses to later stages. Favorable government support for the biologics industry The current regulatory
regime allows applicants to conduct simultaneous in-country clinical trials for new biologics drugs and adopt qualified clinical data obtained directly from multicenter clinical
trials. In addition, the CFDA is planning to establish a green channel for foreign innovative
biologics that are manufactured locally in China to reduce regulatory approval waiting time. Expanding production capacity to ensure sustainable growth In 2016, the utilization
rate at the company’s biologics clinical manufacturing facilities was around 84%. To help expand its commercial and research manufacturing capacities, the company began construction of commercial drug substance manufacturing facilities at its Wuxi site as well as clinical manufacturing facilities at its Shanghai site. Upon completion, the company’s clinical and commercial manufacturing capacity will increase from the current 5,000L to 35,000L in Wuxi and 7,000L in Shanghai. Initiate at Buy with TP of HK$50.10 As of Nov 8, WuXi Biologics’ shares were trading at
72x our 2018 EPS estimate, a premium to its peer group of global biologics CROs (14.8x) and H-share pharma peers (17.8x), reflecting considerable enthusiasm for WuXi given increasing new orders and an improving backlog mix. Thus, we view a valuation premium as justified, given a constructive industry backdrop. Our target price of HK$50.10 is based on 1.0x PEG on 80.5% EPS CAGR during FY17-19 to account for the near-term benefits from expanding its addressable market in late-stage and commercial manufacturing and the competitive advantage in its broad service offering. We also used a DCF valuation to cross-check our PEG valuation. The DCF valuation gave us HK$47.80/share for the intrinsic value of the company, with a WACC of 8% and terminal growth rate of 2%. Investment risks: 1) Customer concentration; 2) Project cancellations and delays; 3)
Changes in regulations on the drug development process.
Contract signing process WuXi generally enters into either project-based service contracts or
long-term service agreements with customers for their integrated services. The project-based
service contracts typically have a term ranging from a number of months to several years, while
long-term service agreements do not have a maturity date and set forth the general rights and
obligations of the parties. The company is required to deliver a technical laboratory report,
products/samples and/or other deliverables and transfer the relevant data and rights to the customer
after all the services have been rendered at each step in the process. A particular step is deemed
to be completed upon the customer’s acceptance of the deliverables in relation to that stage.
Revenue from the services rendered for that particular step is then recognized and the project
progresses to next step, until the entire task is completed.
Novel mAb Discovery Discovery Biology/Drug Screening Cell Line Engineering/Construction Bio-analytical Testing Research Manufacturing Assay/Formulation/Process Development Cell Banking/Cell Line Characterization Viral Clearance Validation cGMP Manufacturing Lot Release/Stability Testing
Figure 33: CRO covering various stages in new drug R&D
Sources: Company data, GF Securities (Hong Kong)
Figure 34: Current major China CROs
Sources: Company data, GF Securities (Hong Kong)
Select DiseaseSelect Family Target
Gene FunctionRelated Target
Xxx Compound Candidate Drugs PreclinicalStage I to II
ClinicalStage II to III
ClinicalStage II Clinical
Registration and Listing
Post Registration Verification
Stage IV Clinical
New drug R&D process
Drug R&D outsourcing
services
Drug Source
Chemical Synthesis
Biological Counseling
Drug Modification
Drug Selection
Xxx Test
Safety Evaluation
Pharmacokinetic Research
Services
Post Registration Verification
Services
Sales & Marketing
Services
Clinical Data Management and Statistical
Analysis
Registration Services
Stage I to IV Clinical Trial
Services
Pharmacology Research Services
Other Research Services
Preclinical CRO Clinical CRO
CRO Representative Corporation
Drug discovery and early research Preclinical study Clinical Research Approval and Production
Company Company Overview Market Position
WuXi AppTec was founded in 2000, and is one of the earliest companies to enter the CRO industry. They are also one of China's leading pharmaceutical,biotechnology and medical equipment R&D and outsourcing company with operational companies in China and the United States. Mainly serving China’s pharmaceutical, biotechnology and medical equipment companies with laboratory development, R&D in production services. Wuxi was listed in NYSE in the year of 2007 and subsequently privatized in 2015. Operating income in 2014 was 670m USD.
One of the earliest company in China to enter the CRO industry and one of the leading CRO company within Asia. Specializes in drug R&D and preclinical R&D services.
Founded in 2004, Tigermed is committed to the development of drugs by providing services in clinical trials, data management and biotechnology, registration and other services that covers more than 50 cities in China with more than 1,800 employees. Listed in Shenzhen Stock Exchange (ChiNext) in 2012 (300347.SZ). Operating income in 2015 was 957m RMB and net profit was 156m RMB.
One of the leading CRO company in China. Focuses in preclinical R&D services.
Founded in 2002, Boji entered the industry relatively early with the aim of providing pharmaceutical and/or new drug R&D outsourcing services to pharmaceutical corporations. Listed in Shenzhen Stock Exchange (ChiNext) in 2015 (300404.SZ). 2015’s operating income in pharmaceuticals was 126m RMB and net profit was 25m RMB.
Leading company with significant market influence that provides comprehensive clinical CRO company.
Founded in 2010, CTS mainly provides technical services for stage 1 to 3 clinical trials, data management, statistical analysis, new drug registration and other clinical R&D services. Listed in China’s SME share transfer system in 2014 (831257). Operating income in 2014 was 68m RMB.
Ranked 4th within the industry rankings in 2014 with a market share of 0.20%. A relatively well-known company with a degree of influence.
Founded in 2006, Highthink Med provides new drug clinical R&D professional and technical services to pharmaceuticals and medical equipment corporations. Listed in China’s SME share transfer system in 2015 (834524). Operating income in 2015 was 17m RMB.
Highthink Med has a stable team, with good relationships with a number of institutions, due to numeroussuccessful project experience and project management advantages. Has a certain degree of market influence.
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Company overview
WuXi Biologics evolved out of a group restructuring in 2016 following the privatization of WuXi
PharmaTech from the NYSE in Dec 2015 for US$3.3bn. As part of the strategic restructuring, WuXi
PharmaTech realigned its businesses through three primary business units: its biologics business
as well as its small molecules business (WuXi AppTec) and its genomics business (Nextcode).
WuXi Biologics completed its IPO in Hong Kong on June 13, 2017, issuing about 193m shares at
HK$20.6/share.
Dedicated investments in its employee base As of Dec 2016, more than 160 of the company’s
employees had a Ph.D or equivalent degree in biotechnology, biology, chemistry, chemical
engineering and other relevant fields. The strong talent pool allows WuXi Biologics to undertake
projects at any development stage with a minimum waiting time. The company launched an
employee incentive program prior to its listing in 2016. As one of the largest CROs in China, we
think the program and future share-based compensation could better align management interest
with company growth, and lead to better results in the next 2-3 years.
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Figure 35: Financial summary
Sources: company data, GF Securities (Hong Kong)
Year-end Dec 31 (Rmb m) FY15 FY16 FY17E FY18E FY19E Year-end Dec 31 (Rmb m) FY15 FY16 FY17E FY18E FY19E
Proceeds from issue of ordinary shares 0 0 3,573 0 0 ROA (%) 10% 16% 19% 12% 21%
Dividend paid (18) 0 0 0 0
Others 400 (562) (697) (227) (249)
Financing cash flow 377 343 2,171 (227) (249)
Net change of cash flow 148 4 1,939 (622) 483
Forex changes 4 17 (18) 0 0
Cash and cash equivalents an beginning 6 158 169 2,108 1,486
Cash and cash equivalents at end of year 158 169 2,108 1,486 1,969
Financial Ratios
Income Statement Balance Sheet
Cash Flow Statement
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Rating definitions Benchmark: Hong Kong Hang Seng Index Time horizon: 12 months
Company ratings
Buy Stock expected to outperform benchmark by more than 15%
Accumulate Stock expected to outperform benchmark by more than 5% but not more than 15%
Hold Expected stock relative performance ranges between -5% and 5%
Underperform Stock expected to underperform benchmark by more than 5%
Sector ratings
Positive Sector expected to outperform benchmark by more than 10%
Neutral Expected sector relative performance ranges between -10% and 10%
Cautious Sector expected to underperform benchmark by more than 10%
Analyst Certification The research analyst(s) primarily responsible for the content of this research report, in whole or in part, certifies that with respect to the company or relevant securities that the analyst(s) covered in this report: (1) all of the views expressed accurately reflect his or her personal views on the company or relevant securities mentioned herein; and (2) no part of his or her remuneration was, is, or will be, directly or indirectly, in connection with his or her specific recommendations or views expressed in this research report.
Disclosure of Interests (1) The proprietary trading division of GF Securities (Hong Kong) Brokerage Limited (“GF Securities (Hong Kong)”) and/or its affiliated or associated companies do not hold any shares of the securities mentioned in this research report. (2) GF Securities (Hong Kong) and/or its affiliated or associated companies do not have any investment banking relationship with the companies mentioned in this research report in the past 12 months. (3) Neither the analyst(s) preparing this report nor his/her associate(s) serves as an officer of the company mentioned in this report and has any financial interests or hold any shares of the securities mentioned in this report.
