CSL Scores Significant Opportunity In China

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After many years searching, CSL has moved into the Chinese plasma market and acquired an 80% stake in a small Chinese fractionator.

-High price but the transaction structurally supported by both demand and price
-CSL has already built dominant position in Chinese albumin market
-Long-dated benefit of ownership based on emerging supply gap in Chinese market
 

By Eva Brocklehurst

After many years searching, CSL ((CSL)) has moved into the Chinese plasma market and acquired an 80% stake in a small Chinese fractionator. This will provide an entry point into a high growth, yet highly regulated market with minimal risk, brokers believe.

At face value the price of US$352m is considered high but this reflects competition for Chinese plasma assets and equates to more than 14 times expected operating earnings, if the current facility was operating at full capacity, which requires a threefold increase in plasma collections, Ord Minnett estimates.

CSL will be the first foreign group to gain full access to the Chinese market. China is the second largest market in the world, with immunoglobulin sales expected to grow at around 15% per annum. Given import restrictions, ownership of domestic collections and capacity is required to fully access the market. CSL expects the current supply shortage of immunoglobulin to open up a large opportunity, especially if it can successfully transfer its operating efficiencies to China.

Ord Minnett calculates that the company's net debt-to-operating-earnings ratio will be 1.2 in FY18, in the middle of management's target range. Hence, it is unlikely CSL will announce a further buy-back in FY18. Strong earnings growth is expected in FY18 despite the dilution from the deal. Ord Minnett forecasts 24% growth in earnings per share in FY18.

Credit Suisse agrees the price appears high but, based on a contested sale and noting the benefits of first-mover advantage, believes the transaction is strategically sound. The historical lack of utilisation of IVIG and clotting factors in China is well documented and the broker suspects that increased awareness and diagnosis of diseases in which these products are used will drive strong growth rates over the longer term.

Albumin sales in China over the past five years were strong, the broker notes, supported by continued investment in hospital infrastructure, the traditional setting where albumin is used. Within this market CSL has built a dominant position, accounting for around 25% of share by value.

Credit Suisse observes China's health system is still developing and hospital infrastructure continues to improve. Chinese per capita use of albumin has increased by around 14% per year over the past two years. Despite this recent growth, per capita albumin consumption lags other developed countries, particularly the US.

Wilsons has downgraded CSL to Hold, given limited upside to its revised target of $131. The broker, not one of the eight monitored daily on the FNArena database, believes CSL is better placed than its peers to succeed in China as a manufacturer but this will be a decades-long undertaking.

The broker also is mindful that the update did not contain a guidance upgrade for the second half, despite the fact that a stable US market, pricing mix and the take-up of Idelvion were all pointing to this as a possibility.

The Deal

The company will pay US$352m for 80% of Chinese plasma fractionator Wuhan Zhong Yuan Rui De Biologicals (Ruide). Ruide markets albumin, IVIG and hyper immune immunoglobulins and plans to launch new products to significantly expand its collection infrastructure and capacity.

CSL is guiding to US$100m in revenue in five years time, versus US$30m currently, at margins similar to those within its Behring business. CSL is able to move to 100% ownership of Ruide over time for further consideration of US$96-142m, depending on milestones.

Opting for one of the smaller, higher quality Chinese plasma groups mitigates much of the regulatory risks entering this market as a foreign-owned manufacturer, Wilsons contends. The move into China was inevitable, given there are strong structural supports from both demand and pricing.

Morgan Stanley believes the supply gap in Chinese immunoglobulin that will emerge in a 10-20 year time scale makes taking an early foothold sensible from a strategic point of view. The debt- funded acquisition places the total transaction value, at 100% ownership, at US$448-494m, subject to milestones, the broker calculates.

Morgan Stanley believes inclusion of financing costs gives rise to a small dilution to earnings per share in the initial years but the implied transaction multiple suggests it should be accretive to value.

Citi considers the acquisition a positive development, providing a strategic presence in the Chinese plasma market and the first foreign control domestic manufacturer in the country. Humanwell will retain 20% and CSL is able to increase its holding to 100% over three years. The broker believes this should facilitate a smooth transition of personnel and provide incentives to achieve the necessary milestones.

Pros And Cons

The broker highlights that the local market's ability to supply immunoglobulin is contained because of a limited number of licenses that exist to open collection centres or operate fractionation facilities, and there is no likely change forthcoming to regulations restricting the importation of plasma proteins other than albumin.

Although CSL has an existing albumin import franchise, UBS believes the acquisition will allow it to execute a more comprehensive long-term growth strategy for China. Longer term, the company will bring greater integration with its global footprint but the broker concedes China is challenging from an integration and consolidation point of view.

Plasma collection is heavily regulated and there are limits on the frequency in volumes alongside a ban on inter-province transfer of raw plasma. The business is small versus the scale of CSL but the challenges of integration should not be underestimated, in the broker's opinion. The impact on near-term earnings is not considered material

Ruide has plans to launch a plasma-derived FV111 in the next two years and this should allow the company to seek permission to expand the collection centres from the current footprint of four, Citi suggests.

There are five Buy ratings on the database and one Hold (Morgan Stanley). The consensus target is $137.55, signalling -1.5% downside to the last share price. Targets range from $120 (Morgan Stanley) to $148 (Citi).
 

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