VAs another follow-up to my ADR series, I am going to take a look at the Chinese and Hong Kong healthcare sector. There are 6 key Chinese and Hong Kong ADRs within the GICS healthcare sector: Mindray Medical International (MR), Chine Medical Technologies (CMED), Wuxi PharmaTech (WX), Simcere Pharmaceutical (SCR), 3SBio (SSRX), and Tongjitang Chinese Medicines (TCM)

Chinese & HK Helathcare Sector ADRs

Source: Bloomberg

The Companies:

Mindray Medical International (MR, Outperform): Mindray Medical International Limited develops, manufactures, and markets medical devices. The Company offers patient monitoring devices, diagnostic laboratory instruments, and ultrasound imaging systems. (Bloomberg)

MR’s outlook in a nutshell: Unlike the other companies discussed in this piece MR has significant exposure to China and ex-China markets, it is also China’s largest medical device company. The medical devices sector is expected to grow substantially in China over the next several years, and MR is well positioned to take advantage of that growth. MR specializes in patient monitors, diagnostic lab equipment, and anesthesia & ultrasound machines. MR is also in the process of integrating Datascope’s patient monitoring business (DPM) into its own. MR acquired DPM, a U.S. company, earlier in 2008. This acquisition should play out well for MR, I anticipate it could take 1 to 2 years for the the full synergies of this acquisition to be realized, but these companies are very good compliments with little cannibalization as DPM’s sales were mostly centered on the US and Europe. Additionally, MR just received FDA approval for DPM’s next generation AS3000 anesthesia delivery system. Domestically, MR has been supported by the Chinese government’s healthcare reforms and initiative to purchase medical equipment for rural hospitals; I expect this trend to continue as China attempts to develop other rural areas. Further strengthening the case for MR is its robust pipeline which includes digital radiography equipment, a digital defibrillator, and various other patient monitoring and chemical analysis equipment. The digital radiography system is essentially an X-Ray machine that shoots a high-res X-ray onto digital film, allowing for simpler analysis and digital storage. I see significant upside for MR given its strong domestic position and growing international presence. This coupled with increased demand in China for medical devices, successful integration of DPM, and an innovative product line should help support MR’s future growth. (Expected Q208 Earnings Report 8/20/08)

Events which could improve outlook:

• Exceeding 2008’s company guidance of USD560-580mn in revenues and USD132-134mn for income.
• Successful integration of DPM, with stronger than anticipated synergies (i.e. cross-selling)
• Stronger domestic and international demand for MR’s product line.

Events which could deteriorate outlook:

• Higher costs and potential FX risk.
• Increased competition in both the domestic and foreign markets.
• Changes in government policy reducing domestic sales.

China Medical Technologies (CMED, Outperform): China Medical Technologies, Inc. is a medical device company that develops, manufactures, and markets products using high intensity focused ultrasound, or HIFU, for the treatment of solid cancers and benign tumors in China. (Bloomberg)

CMED’s outlook in a nutshell: CMED has a unique characteristic when it comes to Chinese healthcare companies; it is the only company in China certified to conduct FISH testing. Fish testing (fluorescence in situ hybridization) is a genetic test that can detect chromosome abnormalities and can be used prenatally to detect Down’s syndrome and other genetic conditions. Given CMED’s unique position in the market and China’s untapped potential I believe this area will help support CMED’s long term growth development. CMED’s other primary markets include ECLIA (electrochemiluminescence immunoassay) and HIFU (high intensity focused ultrasound). They segments should also continue to see growth, but nowhere close to that of the FISH segment. As CMED is award further approvals by the SFDA they will be permitted to begin advertising FISH and have access to additional probes to increase scope. Additionally, we have begun to see significant improvements in the company’s margins primarily due to an increased emphasis on high margin reagent products, and convincing hospitals to buy low margin equipment, such as microscopes, directly from suppliers. This strategy has led to a non-GAAP margin increase to 79.1% from 72.3% for 1Q08 vs. 1Q07; I anticipate this growth rate to moderate, but continue. Recently, the company as also began to give free ECLIA equipment to new customers, who in turn will end up purchasing high-margin reagent products to operate the machine. This could cause increased expenditures in the short-term but will be more than made up for in the long-term via reagent sales. All in all, I believe CMED is a great play in the Chinese healthcare industry given its unique position regarding the FISH test, and new strategy emphasizing higher margin products. (1Q08 Earnings Report 8/04/08 Est: 0.52 Act: 0.42)

Events which could improve outlook:

• Further SFDA approvals for new FISH probes.
• Continued growth in company margins.
• Reaching or exceeding expectations of 500 hospitals with FISH capabilities by the end of 2008.

Events which could deteriorate outlook:

• Increased competition.
• Lower than anticipated FISH sales.
• Changes in government policy adversely affecting the sector.

Wuxi PharmaTech (WX, Neutral): WuXi PharmaTech Cayman Inc. provides pharmaceutical and biotechnology research and development outsourcing. The Company's services include discovery chemistry, service biology, analytical, pharmaceutical development, and manufacturing. (Bloomberg)

WX’s outlook in a nutshell: While the healthcare outsourcing business should remain robust in China, the recent acquisition of AppTech, a biologics manufacturing company, by WX raises some concerns. WX is a market leader in China’s CRO industry, and I anticipate this portion of WX’s business to continue experiencing strong growth over the next several years. On June 24^th 2008 WX announced they have entered into a memorandum of understanding to create a 50-50 joint venture for contract research with Covance. The joint venture will be located at WX’s Suzhou facility; specific financial terms are expected to be released once the deal is complete. This deal should help boost WX’s CRO segment’s long term growth potential. However, WX’s USD169mn acquisition of U.S. based Apptech will likely add significant cost pressure and could lead to higher earnings variance due to the volatility of the biologics manufacturing industry. All in all given the recent Apptech acquisition and the potential for increased costs and compressed margins we do not see much upside potential for WX. (Expected Q208 Earnings Report 8/13/08 Post-market)

Events which could improve outlook:

• Strong demand for biologics manufacturing.
• Significantly higher CRO business in China.
• Streamlined integration of Apptech combined with successful cross-selling initiative.

Events which could deteriorate outlook:

• Increased costs from Apptech acquisition.
• Decrease in biologics demand.
• Slow-down in CRO business

Simcere Pharmaceutical (SCR, Neutral): Simcere Pharmaceutical Group manufactures and supplies branded generic pharmaceuticals to the China market. The Company's products include antibiotics, anti-cancer medications and anti-stroke medications. (Bloomberg)

SCR’s outlook in a nutshell: SCR and the Chinese generic drug industry in general face strong competition. SCR’s sales suffered in Q208 due to shifting its legacy Yidasheng sales model to agent sales from direct sales, which led to a reduction in selling price. This shift was made to become more competitive in the market as other companies begin to release similar drugs. Nonetheless, SCR has at least one first-to-market generic expecting approval during 2H08, which could help bolster sales. I anticipate SCR will continue experiencing sales growth in its generic markets, but it is likely that due to increased competition sales prices will continue facing downward pressure. An example of this is switching to an agency sales model. Also, an SCR rival has released a drug to compete with Yidasheng that is selling slightly below Yidasheng’s price. Increased sales volumes to small and medium sized hospitals and pharmacies should help offset some of the decline in prices, but I do not believe this will be at a strong enough magnitude to drive growth at the levels I would like to see. SCR also mentioned on its 2Q08 earnings call its consideration of acquisitions given its strong cash base. All in all, despite the fact that we believe SCR’s sales volume should continue to growth, it will likely be somewhat off-set by increased competition forcing lower drug prices in the sector. (2Q08 Earnings Report 8/05/08 Est: 1.44 Act: 1.48)

Events which could improve outlook:

• Stronger than anticipated drug sales.
• Competitors bringing rival drugs onto market slower than expected
• Approval and eventual ability to market drugs in SCR’s pipeline including Biapenem, Palonosetron, Iguratimod, and Levamisole.
• Any significant acquisition that could improve SCR’s bottom line.

Events which could deteriorate outlook:

• Continued pricing pressure from competitors.
• Lower than anticipated drug sales.
• Rejection of drugs in SCR’s pipeline.
• Any government regulation regulating drug costs.

3SBio (SSRX, Outperform): 3SBio, Inc. is a biotechnology company. The Company researches treatments in the areas of nephrology, oncology, supportive cancer care, inflammation, and infectious diseases. (Bloomberg)

SSRX’s outlook in a nutshell: SSRX is a growing company in a growth industry in China. SSRX’s two main products are EPIAO and TPIAO, which experienced record sales increases of 42% and 104% in 1Q08, respectively. EPIAO is an EPO drug, which helps stimulate the body’s red blood cell production that can be prescribed to patients with anemia, or who are undergoing chemo-therapy. According to the company, in Europe roughly 17% of chemo-patients are using EPO drugs, while in China the ratio is currently 2%, implying a large growth potential for the drug. TPIAO is a THPO treatment, which increases the body’s production of platelets; this drug can also be prescribed to oncology patients. Looking ahead SSRX has an apparently strong pipeline, with its high dosage EPIAO treatment and second generation IL-2 treatment both finishing Phase III trials. SSRX expects to file with the SFDA regarding both these drugs during 2H08. SSRX also expects to file with the SFDA to allow it to use its TPIAO drug to treat ITP, a bleeding disorder, by the end of 2008. Management expects to continue investing heavily into the company, increasing sales force and building new plants. Despite higher costs seen in 1Q we foresee SSRX will continue to penetrating China’s oncology market and margins should remain stable. All in all given SSRX’s growth and its future pipeline, I believe SSRX is a good play in the Chinese healthcare industry. SSRX is a growth company with a management team who seem to be making wise investment decisions for the company’s future. SSRX also has the right to buy-back company shares through March of 2009. Lastly, I expect the company could upwardly revise its 2008 guidance during its Q208 earnings call, this of course depending on 2Q results. (Expected Q208 Earnings Report 8/12/08 Post-market)

Events which could improve outlook:

• Improved 2008 company guidance.
• Stronger than anticipated EPIAO & TPIAO sales.
• Approval of new treatments by the SFDA.

Events which could deteriorate outlook:

• Strong competition from other market players, which could reduce market share or add pricing pressures.
• Any pipe-line drugs failing to get approval from the SFDA.
• Higher than anticipated costs reducing margins.

Tongjitang Chinese Medicine (TCM, Neutral): Tongjitang Chinese Medicines Co. is a pharmaceutical company. The Company develops, manufactures and markets modernized traditional Chinese medicines. (Bloomberg)

TCM’s outlook in a nutshell: I am hesitant on TCM’s outlook for several reasons 1) nearly 80% of TCM’s revenue comes from its Xianling Gubao product, which is used to treat osteoporosis; 2) the traditional Chinese medicine industry is extremely competitive; & 3) canceling its privatization due to what was reported as a deteriorations in the credit market. All in all, if it were not for this equities recent sell-off after the cancelation announcement I would have rated them ‘underperform’, but given the sell-off and the challenges the company still faces I don’t see much upside or downside for TCM.

Events which could improve outlook:

• Higher than expected earnings.
• Re-initiating privatization.
• Creating a more robust product base.

Events which could deteriorate outlook:

• Slower than anticipated sales of Xianling Gubao.
• Earnings below expectations.