China Pharma Sector - Credit Suisse

DISCLOSURE APPENDIX CONTAINS ANALYST CERTIFICATIONS AND THE STATUS OF NON-US ANALYSTS. U.S. Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

06 October 2011 Asia Pacific/China Equity Research

Healthcare

China Pharma Sector SECTOR REVIEW

Bottom-fishing future winners in China

Source: iStockphoto

Time to bottom-fish future winners in a significantly derated China pharma sector. We initiate coverage on Sihuan Pharma (Sihuan) and China Medical Systems (CMS) with OUTPERFORM ratings and reiterate our OUTPERFORM calls on Sino Biopharm and Shanghai Pharma

■ Top-three misperceptions about the China market. We highlight three common misperceptions about the China pharma market: (1) Generic drug value: Never underestimate a generic drug’s commercial value—Chinese generic drugs could enjoy originator privileges and first-to-market (FTM) generic drugs will likely drive growth. (2) Exclusivity beyond IP: We have discussed ways other than intellectual properties (IP) for achieving exclusivity. (3) Concerns about price cuts: The true impact is exaggerated; we would explain the reasons behind it.

■ Top-three criteria for identifying the winners. Although indentifying the leaders among China’a pharma companies is challenging, we highlight the three most critical criteria: (1) Right product portfolio. (2) Well-planned pipeline. (3) Strong commercialisation capability: The China market has decentralised to local regions with complex tendering, pricing and reimbursement rules regulated by a large number of government bodies; therefore, local commercialisation capability is a must.

■ Initiate coverage on Sihuan Pharma and China Medical Systems. Based on the above criteria, we recommend the potential outperformers. We initiate coverage with OUTPERFORM ratings on Sihuan (TP HK$5.0, 87% potential upside) and CMS (TP HK$9.0, 78% potential upside) for their 40%-plus earning CAGR over 2010-13E. We reiterate our OUTPERFORM calls on Sino Biopharm (TP HK$3.6, 55% potential upside) and Shanghai Pharma (TP HK$24.3, 54% potential upside) for their market leadership.

Research Analysts

Lefei Sun 852 2101 7658

[email protected]

Jinsong Du 852 2101 6589

[email protected]

Iris Wang 852 2101 7646

[email protected]

06 October 2011

China Pharma Sector 2

Focus table and charts Figure 1: China generic drugs could enjoy originator privileges Features Western market China market

Launch time After original product patent expires Could be earlier than the original; the first approved even block the original

Brand name No Can have a brand name

Pricing premium Significant discount to originator Can have a pricing premium for the first-to-market generic

Tendering category By molecule By specification

Reimbursement By disease code By co-pay percentage

Protection period No Can have 3-5 years of monitoring period (which can block competitors)

IP No Can have IP in China

Source: Company data, Credit Suisse

Figure 2: Generic is good—first-to-market generic

‘Runzhong’ outperformed original drug

Figure 3: IP not the only way to grant exclusivity—‘Kaishi’

achieved a billion HK$ sales due to drug delivery system

0

10

20

30

40

50

$0 Q 1 Q 2 Q 3 Q 4 Q 5

Sal es (R MB m n)

R unz ho ng (launc he d in M arc h, 20 10)

Ba rac lude (to p perform er in M N C p roduc t lau nch )

0

200

400

600

800

1,000

1,200

2006 2007 2008 2009 2010

Sino Biopharm (Alprostadil micro-sphere injections)

Zhuhai Schwarz Pharma AG (Alprostadil injections not in micro-sphere)

Sales (HKD mn)

Source: IMS Source: Company data, Credit Suisse estimates

Figure 4: Complex drug mark-up allocation requires local commercialisation capability

~20-30%

~20-30% ~5-8%

>30-40%

>15% >115%

Ex -

m anufac turer

Sales -agents Dis tributors for

logis tic s

Phy s ic ians and

hos pital ac cess

ex pens es

Hos pital R etail pric e to

patient

M ax retail pric e

set by N DR C

Can be in-housed or outsourced

Tendering price = 100%

Note: Hospital access expenses include but not limited to tendering/pricing/reimbursement/hospital listing-related expenses; VAT not included in

rough estimate; mark-up varies by product.

Source: Company data, Credit Suisse estimates

06 October 2011


Finding the future winners in China We believe the China pharma market is one of the most attractive markets worldwide. According to IMS, China will be the third-largest pharmaceuticals market globally in 2011 (with over US$50 bn in size) and grow more than 20% in the next five years. However, the stock market is witnessing significant correction, mainly on concerns about increasing price cuts and uncertain policies, leading to slower growth and margin erosion. In our view, typical misperceptions about the China pharma market have led to exaggeration of the impact of market changes. We believe that in this market environment, pharma companies with local knowledge will stand out and that the actual impact of changes in the market environment will be different on each company. Given the China market’s special dynamics and moving trends, we suggest investors to review three key criteria in selecting companies that will succeed as future leaders.

Top-three misperceptions about China pharma market The China pharma market faces unique challenges and opportunities in terms of market access and product commercialisation; however, people may not fully appreciate these special market features. We highlight three common misperceptions about the China pharma market and believe investors should benefit by leveraging on these specific market features: (1) Generic drug value: Don’t underestimate the generic drug’s commercial value; Chinese generic drugs could be entitled to originator privileges, and first-to-market and differentiated generic drugs will likely drive growth. (2) Exclusivity beyond IP: Exclusivity and differentiation are the two most important defence against competitors, but IP is not the only way to do it. (3) Concerns about price cuts: Don’t focus on the wrong price—tendering price is the key, rather than the retail price and competition will be the ultimate driving force. Thus, the impact varies by product and is minimal for exclusive drugs.

Top-three criteria to select the future winners Indentifying the leaders in China’s pharma market is challenging, given the complex market access and commercialisation requirements. We highlight the three most critical criteria for identifying the leaders: (1) Right product portfolio: A global blockbuster drug does not guarantee success, as it needs to be the right fit for local needs and vice versa (we summarise the six key success factors that make a China blockbuster drug later in the report). (2) Well-planned pipeline: China’s drug lifecycle could be prolonged if managed well, as market demand is far from saturated. Leaders could sustain growth by focusing on proprietary and FTM generic drug pipelines through active M&A and/or in-house R&D. (3) Strong commercialisation capability: The China market has decentralised to local regions with complex tendering, pricing and reimbursement rules regulated by an overwhelming number of government bodies; therefore, local commercialisation capability is a must—this can be achieved by establishing either an experienced in-house team or a comprehensive external agent sales network.

Initiate on Sihuan and CMS with OUTPERFORM rating We initiate coverage on Sihuan Pharma (OUTPERFORM, TP HK$5.00, 87% potential upside) for its efficient agency sales model and China Medical Systems (CMS) (OUTPERFORM, TP HK$9.00, 78% potential upside) for its solid academic promotion capabilities. We maintain our OUTPERFORM rating (TP HK$3.6, 55% potential upside) on Sino Biopharm for its strong in-house R&D capabilities and Shanghai Pharma (OUTPERFORM, TP HK$ 24.3, 54% potential upside) for its legacy brand, leadership position and potential upside from acquisition.

Top-three misperceptions about the China pharma market relate to: (1) generic drug value, (2) exclusivity beyond IP and (3) price cut impact

China’s pharma market is attractive as well as evolving—it’s time to select the companies that should succeed as future market leaders

To select the future winners, choose those with: (1) right product portfolio, (2) well-planned pipeline and (3) strong commercialisation capability

We recommend Sino Biopharm, Sihuan, CMS and Shanghai Pharma as potential future leaders in the China pharma sector

06 O

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Ch

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China pharma sector valuation comps Figure 5: China Pharma sector valuation comps Volume 6M

average Mkt cap Price TP CS P/E (x) EV/EBITDA (x) P/S (x) 2011-

13E PEG ROE (%) EPS (local)

Company Ticker Shares mn US$ mn

(US$ mn)

(local) (local) Rating 2011E 2012E 2011E 2012E 2011E 2012E EPS CAGR

2011E 2011E 2012E 2011E 2012E 2013

Hong Kong-listed

Sihuan Pharmaceutical Hldgs 460-HK 14.09 7.35 1,844 2.67 5.0 OP 13.5 9.5 6.0 3.7 5.0 3.3 35% 0.27 12.3 16.2 0.2 0.28 0.4

China Medical System Hldgs 867-HK 0.89 0.61 1,108 5.05 9.0 OP 14.1 11.2 14.1 8.9 4.9 3.3 33% 0.34 21.3 22.4 0.4 0.45 0.6

Sino Biopharmaceutical Ltd. 1177-HK 5.90 2.12 1,432 2.20 3.6 OP 19.9 15.1 9.0 6.8 2.0 1.5 31% 0.49 14.7 18.2 0.1 0.15 0.2

Shanghai Pharmaceuticals 2607-HK 4.22 11.36 1,621 15.68 24.3 OP 20.1 13.3 2.9 2.0 0.7 0.5 42% 0.32 8.6 11.6 0.8 1.21 1.6

Sinopharm Group Co. Ltd. 1099-HK 4.42 14.33 5,641 19.58 30.0 OP 25.6 20.5 8.9 7.2 0.4 0.3 26% 0.80 11.6 14.0 0.8 0.95 1.2

Tong Ren Tang Technologies 1666-HK 0.79 0.67 331 7.64 n.a. NR 15.5 13.0 1.2 0.9 28% 0.47 14.4 17.0 0.5 0.59 0.8

China Pharmaceutical Group 1093-HK 3.19 1.60 373 2.01 n.a. NR 5.9 5.2 3.5 3.2 0.4 0.3 28% 0.19 8.3 7.8 0.3 0.39 0.6

China Shineway Pharma 2877-HK 3.23 6.60 970 10.36 n.a. NR 8.4 7.4 4.5 4.1 2.7 2.3 18% 0.42 23.9 23.6 1.2 1.40 1.7

Lijun International Pharma 2005-HK 6.60 1.50 270 0.92 n.a. NR 8.3 6.8 5.1 4.0 0.9 0.8 22% 0.30 10.9 12.4 0.1 0.14 0.2

United Laboratories Intern’l 3933-HK 4.46 6.06 1,010 6.23 n.a. NR 12.4 9.7 7.7 6.3 1.2 1.0 20% 0.48 13.1 11.3 0.5 0.64 0.7

Lee's Pharmaceutical Holdings 950-HK 0.22 0.09 146 2.48 n.a. NR 14.6 10.8 10.3 7.5 3.2 2.4 31% 0.35 29.7 31.6 0.2 0.23 0.3

Average 14.4 11.1 7.2 5.4 2.1 1.5 28% 0.40 15.3 16.9

US-listed

Simcere Pharma Group ADS SCR 0.07 0.79 523 9.67 n.a. NR 17.1 15.2 11.2 9.1 1.5 1.3 20% 0.78 12.5 9.8 0.6 0.64 0.8

China Nuokang Bio-Pharma NKBP 0.03 0.14 83 4.21 n.a. NR 12.8 11.4 1.7 1.6 15.1 0.3 0.37

3SBio Inc. ADS SSRX 0.09 1.52 259 13.27 n.a. NR 18.4 14.0 6.6 5.2 3.2 2.6 5% 2.57 9.4 10.7 0.7 0.95 0.8

Average 16.1 13.5 8.9 7.2 2.1 1.8 13% 1.67 12.3 10.2

China pharma off-shore listing average 14.7 11.7 7.5 5.7 2.1 1.6 26% 0.60 14.7 15.9

China-listed

Shanghai Pharmaceuticals 601607-CN 13.00 38.47 4,546 15.09 n.a. NR 17.6 14.7 10.7 8.0 0.6 0.5 21% 0.70 15.3 17.8 0.9 1.03 1.3

Yunnan Baiyao Group Co. Ltd. 000538-CN 1.98 18.91 6,419 59.50 n.a. NR 33.7 26.0 27.8 21.7 3.4 2.8 28% 0.92 22.6 23.2 1.8 2.29 2.9

Harbin Pharmaceutical Group 600664-CN 10.96 18.69 2,318 9.19 n.a. NR 10.9 9.3 6.9 6.3 1.0 0.9 15% 0.62 16.9 17.1 0.8 0.99 1.1

Tianjin Tasly Pharmaceutical 600535-CN 2.49 16.57 3,346 41.51 n.a. NR 33.4 27.0 26.1 21.7 3.8 3.1 25% 1.09 17.7 18.5 1.2 1.54 1.9

Zhejiang Hisun Pharmaceutical 600267-CN 1.40 8.44 2,953 35.50 n.a. NR 35.5 25.9 24.1 18.1 3.5 3.0 29% 0.89 11.5 13.3 1.0 1.37 1.7

Jiangsu Hengrui Medicine Co 600276-CN 3.58 16.33 5,197 29.56 n.a. NR 35.2 27.9 27.2 21.7 7.0 5.8 23% 1.19 21.9 22.2 0.8 1.06 1.3

Guangxi Wuzhou Zhongheng 600252-CN 14.79 38.90 2,381 13.63 n.a. NR 20.2 15.7 10.2 13.0 7.5 6.4 40% 0.39 43.0 39.0 0.7 0.87 1.3

Shenzhen Salubris Pharma 002294-CN 0.94 5.01 1,988 36.38 n.a. NR 30.1 23.3 23.2 17.6 8.2 6.7 29% 0.81 19.8 21.1 1.2 1.56 2.0

Beijing SL Pharmaceutical Co 002038-CN 2.02 11.04 1,985 33.95 n.a. NR 27.8 23.4 26.6 19.2 18.9 13.8 24% 0.98 31.0 26.2 1.2 1.45 1.9

Wuhan Humanwell Healthcare 600079-CN 4.30 15.87 1,677 22.29 n.a. NR 33.3 25.4 19.9 15.6 3.1 2.4 27% 0.93 12.8 14.3 0.7 0.88 1.1

Zhejiang Xianju Pharma 002332-CN 2.24 5.40 671 12.59 n.a. NR 28.6 23.1 19.2 15.4 2.5 2.2 25% 0.92 13.1 14.5 0.4 0.55 0.7

Shanghai Modern Pharma 600420-CN 2.55 6.20 595 13.46 n.a. NR 28.6 20.9 15.4 12.7 2.0 1.6 24% 0.88 14.7 15.9 0.5 0.65 0.7

Kangmei Pharmaceutical Co 600518-CN 18.52 43.26 4,964 14.47 n.a. NR 27.8 21.1 21.9 15.6 6.4 4.6 32% 0.67 16.4 18.2 0.5 0.69 0.9

Shanghai Fosun Pharma 600196-CN 7.64 14.03 2,913 9.75 n.a. NR 15.5 14.4 9.1 9.5 3.0 2.3 16% 0.92 12.6 12.8 0.6 0.68 0.8

Beijing Tongrentang Co. Ltd. 600085-CN 18.52 34.03 3,088 15.11 n.a. NR 47.4 38.1 27.3 4.2 3.5 24% 1.61 12.0 13.0 0.3 0.40 0.5

Harbin Gloria Pharmaceuticals 002437-CN 1.47 6.16 974 22.50 n.a. NR 26.3 21.2 13.1 7.3 5.8 29% 0.74 9.7 11.2 0.9 1.06 1.4

Average 28.2 22.3 19.3 15.4 5.1 4.1 26% 0.89 18.2 18.6 Source: Company data, FactSet, Credit Suisse estimates

06 October 2011


Top-three misperceptions about the China pharma market Misperception #1: Branded generic drug potential underestimated in China ■ Common view: The China pharma market is dominated by generic drugs, with limited

innovative drugs available. Generic companies have limited growth potential and are not worthy of investing in.

■ Our view: The definition of a generic drug in China is different from that by western standards. Some ‘branded’ generic drugs, such as first-to-market (FTM) generic drugs and the ones with unique or differentiating features, enjoy many innovator privileges in China. Selective generic drug companies in China can sustain their high growth given the limited competition. Investors can pick companies with a ‘branded’ generic product portfolio and those who can develop/acquire such a portfolio in the future. Figure 6 shows a brief comparison of China generic drugs versus western generic drugs.

Figure 6: China generic drugs could entitle more privileges than western generic drugs Features Western market China market

Launch time After original product patent expires Could be earlier than the original; the first approved generic can even block the original

Brand name No Can have a brand name

Pricing premium Significant discount to originator Can have a pricing premium for the first-to-market generic

Tendering category By molecule By specification

Reimbursement By disease code By co-pay percentage

Protection period No Can have 3–5 years of monitoring period (which can block competitors)

IP No Can have IP in China


Case studies

■ Case one: Runzhong as FTM generic outperformed the originator

Sino Biopharm launched Runzhong, a FTM generic to Baraclude, in 2010 March, which has since outperformed the originator drug.

In China, branded generic and first-to-market generic drugs could enjoy privileges enjoyed by innovators

06 October 2011


Figure 7: Sino Biopharm’s first-to-market generic drug Runzhong sales outperformed the

originator since its product launch

0

50

28

43

6

38

22

16

0 4

11

20

0

10

20

30

40

50

Launch Q1 Q2 Q3 Q4 Q5

Sales (RMB mn)

Runzhong (launched in March, 2010) Baraclude (top performer in MNC product launch)

Source: IMS

■ Case two: New ossified estriol as FTM generic enjoyed rapid growth and market expansion

Shanghai Roche is the originator of ossified estriol and has been losing market share to local ‘generic’ players since 2006. According to MENET, in 2010, the market was dominated by Qingdao Haier Pharma (Sino Biopharm’s subsidiary), and Shanghai Roche had only 1.2% market share (from 79.8% in 2006).

Figure 8: Market size of new ossified estriol* Figure 9: Market share of new ossified estriol

~53

~154

2006 2010

Market size (RMBmn)

CAGR 30.6%

79.8%

1.2%

20.0%

52.1%

0.2%

46.7%

2006 2010

Shanghai Roche - originator Sino Biopharm Others

*Generic drug name 1A,25-dihydroxycholecalciferol

Source: Menet

Source: Menet

■ Case three: Mingzheng as FTM generic enjoyed rapid growth and market expansion

GSK is the originator of Adefovir Dipivoxil, but its leadership is under severe threat from local brands such as Sino Biopharm’s Mingzheng, which had 26.8% market share in 2010, according to MENET.

06 October 2011


Figure 10: Market size of Mingzheng* Figure 11: Market share of Mingzheng

~63

~215

2006 2010

CAGR 36%

42.9% 36.6%

1.8%26.8%

55.3%36.5%

2006 2010

GSK - originator Sino Biopharm Others

*Generic drug name Adefovir Dipivoxil

Source: Menet

Source: Menet

06 October 2011


Misperception #2: Exclusivity in China—IP is not the only way to differentiate and enjoy price premium ■ Common view

(1) Compound IP of innovative drug is the only way for ‘exclusivity’ and price premium, so we should only focus on such IP to evaluate drug competitiveness.

(2) IP protection is weak in China, so pharma companies find it hard to have exclusivity and charge price premiums for their drugs in China.

■ Our view

First, exclusivity and differentiation are key to competing in China: The Chinese market is oversupplied with commodity generic drugs. Since, physicians are overwhelmed by numerous such products, the exclusivity and differentiation would be critical for a drug to stand out and defend competition.

For example, China is an oversupplied market with numerous suppliers, the majority of which are small ones below Rmb50 mn in sales annually.

Figure 12: China has much more drug suppliers than the US as of 2011

~200

5000+

U.S. China

Number of pharmaceutical companies

Source: Menet

Exclusivity, differentiation are the key to compete in China given the fragmented market facing an oversupply situation

06 October 2011


Figure 13: China has an overwhelming number of products in the market as of 2011

~1000

~100000

U.S. China

Number of drugs on the market

Source: SFDA

Figure 14: China physicians are not as well trained as US physicians

~100%

~8%

U.S. China

Percentage of medical practitioners with graduate degrees

Source: China MOH Yearbook 2010

Second, there are alternative ways to enjoy exclusivity and differentiation in China than through IP alone: IP is almost the only way to guarantee a price premium in the western market; however, there are multiple alternative to protect a product in China. Thus, investors have to evaluate product potential from various angles, including formulation, pricing, manufacturing know-how, market access barriers and costs of copying, active pharmaceutical ingredient (API) source, IP, physician prescription preferences, competitive landscape, reimbursement policy and patient affordability.

■ Case one: Kaishi from Sino Biopharm enjoyed exclusivity via proprietary manufacturing technology and drug delivery system

Kaishi (Alprostadil micro-sphere injections) from Sino Biopharm enjoyed market leadership due to its pioneering micro-sphere technology in manufacturing and innovative drug delivery system. It outperformed other generic Alprostadil competitors and successfully became a super blockbuster drug in 2010 with more than HK$1 bn in sales and a dominant market share.

Kaishi by Sino Biopharm successfully built exclusivity by proprietary drug delivery technology, not compound IP

06 October 2011


Figure 15: Sino Biopharm outperformed Zhuhai Schwarz due to proprietary micro-sphere

technology applications for Alprostadil injections (HK$ mn)

443

310

602

758

1,094

624 272518

0

200

400

600

800

1,000

1,200

2006 2007 2008 2009 2010

Sino Biopharm (Alprostadil micro-sphere injections)

Zhuhai Schwarz Pharma AG (Alprostadil injections not in micro-sphere)

Sales (HKD mn)

Source: Company data

Figure 16: Kaishi had a dominant market position in Alprostadil in 2010

Sino Biopharm83%

Harbin Pharm13%

Benxi Leilong (Sihuan)2%

Zhuhai Schwarz0.4% Others

2%

Source: MENET

Figure 17: KSFs to achieve differentiation and exclusivity—proprietary drug delivery system 1 Proprietary drug delivery system developed on micro-sphere technology with government support (which received national awards)

2 High entry barriers for followers

3 First-mover advantage in anchoring physicians' prescription preferences; endorsed by key opinion leaders


06 October 2011


■ Case two: Ursofalk from CMS enjoyed exclusivity via unique dosage formulation

Figure 18: CMS has built Ursofalk as a blockbuster drug

1.86 2.60 5.15 7.4211.26

14.7621.07

28.3335.88

44.49

54.28

65.13

76.86

88.39

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011E 2012E 2013E 2014E 2015E

Ursofalk sales (USD mn)

CAGR 67%

CAGR 37%

CAGR 18%Launched in 1998

from scratch


Figure 19: KSFs to achieve differentiation and exclusivity: Exclusive dosage form 1 Exclusive dosage form (the only imported capsule dosage form supplier, compared to ~40 domestic generic versions in tablet dosage)

2 Pioneer of academic promotion and close relationship with key opinion leaders; makes it hard to compete with

3 First-mover advantage in anchoring physicians' prescription preferences


Third, there are smarter ways to enjoy compound IP exclusivity, but you need local insights: The most valuable IP in the western pharma industry is a drug’s compound IP. However, in China, the definition and standards for compound IP could be different from that by global standards. There are smarter ways to develop “me-better” drugs (by developed market’s definition) for China compound IP, and these may not necessarily be as per the global standards for compound IP. Having “China compound IP” is good enough to win in the China market, as it helps you enjoy exclusivity and pricing premium, as well as higher return on R&D investment.

■ Case one: Tianqingganmei from Sino Biopharm succeed in Chiral technology

Figure 20: Tianqingganmei sales since launch

0.7 18.059.9

168.1

333.9

454.3

681.5

0

100

200

300

400

500

600

700

800

2005 2006 2007 2008 2009 2010 2011E

Sales of Tainqingganmei injections (HK$ mn)

CARA: 216%


Ursofalk by CMS enjoys exclusivity via unique dosage formulation

IP is not the only way to achieve exclusivity; China’s definition of compound IP is also different from that of the developed market

Tianqingganmei by Sino Biopharm leveraged on itschiral technology to gain compound IP

06 October 2011


Figure 21: KSFs to achieve differentiation and exclusivity: Chiral technology 1 Class 1.2 innovative drug status under innovative chiral technology application as exclusive supplier

2 Leveraged successful track record of three generations of licorice-based products

3 The first liver protection drug that uses the chiral technology, which not only provides innovation, but also builds a high entry barrier


■ Case two: Kelinao from Sihuan succeeded in production IP and lifting generic manufacturing standards

Figure 22: Kelinao/Anjieli has recorded impressive growth as a top-selling CCV drug

29 2653

103

191

306

406

570

2003A 2004A 2005A 2006A 2007A 2008A 2009A 2010A

Kelinao/Anjieli sales rev enue (RMB mn)

1998-2011E CAGR:47%

Note: CVC stands for cardio-cerebral vascular.


Figure 23: KSFs to achieve differentiation and exclusivity—production IP and higher standard 1 IP in production method of molecular crystal and synthesis process obtained

2 Significantly increased national product standard so as to defend generic copy

3 Exclusive selling point—the only approved product with Maleate as active ingredient in the PRC

4 Two dosage forms with two brand names to extend exclusivity; more flexibility for physicians to prescribe


Misperception #3: Price cut concerns—true impact is product-specific ■ Common view: The Chinese government frequently implements price cuts, which have

turned recently severe. All drug manufacturers will be hurt inevitably. Price cuts are so deep that they can hardly be offset by volume gains, so sector growth will be badly hurt.

■ Our view: Investors should not be too concerned about the price cuts. Pricing erosion is an inevitable trend in China, just like in any other country, to contain the cost. The price erosion impact will be quite different on different drugs. The important thing to watch is the tendering price—not all drugs are badly hurt by government control. Exclusive and differentiated drugs have seen minimal erosion pressure. And the winning players are able to mitigate the risks through a well-managed product lifecycle and a well-planned product pipeline to sustain growth.

First, the impact from NDRC direct price cut on max retail price is limited as there are hedge gaps to actual tendering price

The drug prices in China are controlled by the government in two ways:

Sihuan’s Kelinao significantly lifted generic manufacturing standards to defend competition

Price control is the trend; the key is to identify products that see minimal impact from price cuts

06 October 2011


■ Direct price control on max retail price by the NDRC: The national and provincial NDRC directly regulates the maximum retail drug prices in the national and provincial reimbursement drug list (RDL) and essential drug list (EDL). The NDRC from time to time announces price cuts on selective drug categories. Although up to now, the NDRC has implemented 28 rounds of price cuts, reducing prices by around 20% on average in each round in the past 10 years, the real impact on the industry’s drug sales is only at 3% average yearly erosion, according to IMS. There are two reasons for this: (1) A price cut initiative impacts only a few hundreds drugs of totally over 10,000 drugs in the market, or at less than 1% of the market. (2) There is a significant gap between the maximum retail price and the actual tendering price for many drugs, so a retail price reduction has limited impact on the actual tendering price if the hedge gap is big enough [Figure 24 and 25].

■ Indirect price control on tendering price by changing the tendering policy: China decentralised drug procurement to hospitals and started the drug tendering process in early 2000. The most recent progress is organising centralised tendering from the provincial level. In fact, the tendering process in China is mainly a supplier qualification and tendering price negotiation process as it does not tie up with the actual procurement volume from the group of hospitals. In order to ramp up drug sales, each supplier has to deal with individual hospitals to make the drug enlisted and prescribed accordingly. Therefore, winning a tender is just an entry ticket and beginning of the commercialisation process. Although government cannot implement direct price cuts on the tendering price, it can change the tendering rules and procedures. This is why the Anhui model and the Fujian model had a bigger impact on the industry , as they are changing the traditional tendering procedures and rules of the game, leading to a higher tender price erosion pressure.

■ Case study

For example, the tendering price is more important to watch; announced NDRC max retail price-cut in August, 2011 does not hurt new ossified estriol capsules and the exclusive drugs can have as high as 51% hedge gap from current tendering price and max retail price, big enough for multiple rounds of direct NDRC price cut.

Figure 24: Price cut did not hurt new ossified estriol capsules due to enough hedge gap

between existing maximum retail and tendering price

41.9

43.5

48.1

50

Jiangsu 2010 Tender Price Max New Tender Price 2011 Jiangsu 2010 Max Retail Price Max New Retail Price 2011

New ossified estriol capsules (Sino Biopharm)

Source: Menet, Jiangsu NDRC

The NDRC directly controls the maximum retail price and announces price cuts from time to time; however, the tendering price is more important to watch as there is hedge gap between the retail and tender prices

Government can change the tendering policy, which can affect the tendering price

06 October 2011


Figure 25: Hedge gaps of exclusive drugs are as high as 51% Selective exclusive product Tendering price Max retail price* Gap (%)

Tianqingganmei (Sino Biopharm)

35 42 20% Kaifen (Sino Biopharm)

70 87 25% Kelinao (Sihuan)

43 52 20% Anjieli (Sihuan)

125 160 29% Chuanqing (Sihuan)

17 25 51% Deanxit (CMS)

55 68 24% Exacin (CMS)

55 76 39%

Max retail price is from Hebei and Fujian province as example, tendering price is based on 2011 lowest

available tender prices

Source: Menet, Fujian and Hebei NDRC and FDA, Credit Suisse estimates

Second, competition is the ultimate driving force determining the tendering price. No matter how each provincial government changes the tendering rules, in our view, the ultimate force driving the tender price and pressure is competition. We recommend investors to focus on how the competition scenario will be for each pharma company’s key products under any new tendering policy. In fact, the changes in tendering rules that could be affected by either the Fujian model or the Anhui model just relate to the different ways of enlarging the competitor pool in different steps to increase the competition level, which will lead to a higher pricing pressure. However, if the drug is proprietary and exclusive, no matter how the competitors are grouped, it will face limited competition and minimal price erosion.

■ Case study

Competition plays a critical role in price erosion: Even under the Fujian tendering model, proprietary and exclusive drugs such as Tianqingganmei, Kaifen and Yuanzhijiu should have only a minimal tendering price erosion of 2–8%, compared with those facing fierce competition such as Docetaxel and Adefovir dipivoxil with 20%+ erosion. The significant erosion for Kaishi and Runzhong could be because more competitors have been entering the market recently. Thus, competition is still the ultimate driving force determining the price, in our view.

Figure 26: Proprietary drugs with limited competition have minimal tender price erosion Ex-national

Ex-national 2011 lowest

Product lowest Fujian tendering No.

name Product tendering tendering price of

Product name (CN) Generic name category Marketer Dosage Specification Unit price* price vs Fujian competitors

Aisu 多西他赛 Docetaxel Generic Jiangsu Hengrui Injection 0.5ml:20mg Bottle 323.0 239.0 -26% >10

Mingzheng 阿德福韦酯 Adefovir dipivoxil capsules Generic Sino Biopharm Capsule 10mg Pack 128.0 99.2 -23% >10

Runzhong 恩替卡韦 Entecavir dispersible tablets Generic Sino Biopharm Dispersible tablet 0.5mg Pack 153.9 129.5 -16% >3

Kaishi 前列地尔 Alprostadil injections Proprietary Sino Biopharm Injection 1ml:5μg

(Micro-sphere)

Vial 58.0 40.0 -31% >5

Tianqingganmei 异甘草酸镁 Magnesium Isoglycyrrhizinate Proprietary Sino Biopharm Injection 10ml:50mg Vial 35.7 35.2 -2% 0

Kaifen 氟比洛芬酯 Flurbiprofen Axetil injections Proprietary Sino Biopharm Injection 5ml:50mg Vial 73.3 70.0 -4% 0

Yuanzhijiu 曲克芦丁脑蛋

白水解物

Troxerutin and Cerebroprotein

hydrolysate injection

Proprietary Sihuan Injection 2ml Bottle 50.4 46.5 -8% 0

*The lowest tendering price is based on available database and may not be exhaustive search.


Competition is the ultimate driving force determining tendering price; proprietary and exclusive drugs have minimal erosion pressure

Even under the Fujian tendering model, proprietary and exclusive drugs have only 2–8% price erosion

06 October 2011


Figure 27: Kaishi did not have tendering price erosion until the competitors came in

0 0 0 0

-2%

-15%

2006 2007 2008 2009 2010 2011

Kaishi average tendering price erosion trend

Source: Menet, Baiduyy, NDRC, Credit Suisse estimates

Third, volume gains could be sufficient to offset the price erosion even under an extreme Fujian model tendering scheme. The negative impact of price erosion from the extreme tendering model (e.g. in a Fujian model) is product-specific, and all products will not be equally hurt. Exclusive and leading FTM drugs are more defensive, and may even be better off through volume gains that should offset the potential price erosion. Commodity-like generic drugs should get hurt the most. Note that volume gain is not mainly driven by price erosion but by changes in tendering rules, such as reducing supplier numbers and hospital’s preferences.

■ Case study

Illustrative case: Sino Biopharm’s Entecavir volume gain vs price erosion in Fujian Even under the extreme Fujian tender model for non-essential drugs, selective drugs are more defensive and can see volume gains, which could offset the potential price erosion. For example, even the newly tested tendering system implemented multiple measures that increased the pricing pressure, but it benefited certain players. For example, only a few suppliers were selected for each product (if there were less than three suppliers for one product, they could directly go to expert panel review). Thus, these new features should help the leading players with exclusive, differentiated and high-margin products. Below is a brief illustrative case for Sino Biopharm’s Entecavir, a rapidly growing first-to-market generic product, which could gain in volume high enough to offset price erosion.

Figure 28: Volume growth could offset potential price cut in Fujian tender model Entecavir Tender Market Sales No. of Key

(Sino Biopharm) price (Rmb) share Volume (Rmb) competitors competitor

Old tender in Fujian 154 20% 65,789 10,000,000 >4 BMS

New tender in Fujian 130 50% 164,474 21,381,579 ~2 Jiangxi Qingfeng

Growth -16% 150% 150% 114% Significantly decreased Significantly decreased

Source: Fujian FDA and NDRC

Even if there is price erosion due to changes in the tendering model, volume gains could offset that

Volume gain could off-set price erosion due to significantly reduced suppliers.

06 October 2011


Figure 29: Sino Biopharm’s Entecavir—volume growth could offset potential price

erosion in Fujian tender model

-16%

150% 150%

110%

Tender price (RMB) Market share Volume Sales (RMB)

Changes in Fujian model

Source: Fujian FDA and NDRC

06 October 2011


Top-three criteria to select the future winners Criteria #1: Right product portfolio ■ Market feature: The China pharma market has its own features and requires insights

into local products. There are significant differences between the top-ten best-selling drugs in China and those in the US. Chinese physicians have their own prescribing preferences, and it is possible that local products meet the needs better and sell better than their counterparts made by MNCs. Therefore, the product portfolios of pharma companies are different in China compared to those in the developed countries. Drug sales growth can be sustained by developing good relationship with physicians and understanding their prescribing preferences. A product’s lifecycle can be prolonged if managed well. The market winner must understand local demand and insightfully develop a localised product portfolio.

■ Key success factors for China blockbuster drugs, in our view

(1) Huge unmet medical needs: Drugs for therapeutic areas such as oncology, stroke, cardiovascular and infectious diseases are favourable given the huge patient pool and imminent inelasticity of medical needs. Chronic diseases are also increasing in China with population. Since most ailments are at an advanced stage when diagnosed, top-selling drugs are targeted more on critical treatment rather than prevention. In addition, adoption of new therapy methods for hypertension, diabetes, chronic hepatitis, oncology and cardiovascular diseases is on the rise and can potentially ramp up faster than expected.

(2) Broad and deep coverage of hospitals, physicians and patients: China is a large market with 30+ provinces, 300+ prefecture cities, 2,000+ counties, 20,000+ hospitals, 500,000+ grass roots healthcare institutions, 2 mn+ physicians and 1.4 bn+ population. In order to make blockbuster drugs, a player has to ensure a broad coverage of key hospitals and physicians. However, how to penetrate into the market deeply and cost-effectively is a big challenge. Since different drugs would have different adaptation patterns among hospital/physicians, the company needs to gain local insights to identify the major prescribers and effectively expand the market potential. Some new drugs require intensive physician and patient education, and the pharma companies must balance the cost and return.

(3) High ASP and margin: The commercialisation value chain of China’s pharma market is complex with multiple stakeholders. Product margins must be high enough to ensure that each party along the chain has an incentive to promote the product. Generally speaking, in the hospital channel, physicians and selling agencies prefer high-ASP products for higher profit, which is a fixed mark-up of ~15% on the tendering price. Higher the drug price, higher is the absolute mark up.

(4) Reasonable affordability and favourable reimbursement: The insurance coverage in China is getting better but the average affordability of patients is still relatively low. Inclusion into the provincial, local or national reimbursement plan would be important for the drugs to reach a critical mass in sales. Although there is potential price-control risks associated with government reimbursement plans, in general, the volume gain is significant enough to offset such price erosion.

(5) Unique selling point and exclusivity: The competition in the China market is fierce, both at molecular level and treatment methods level. The standardisation of treatment is still under-developed in China, and physicians have the ultimate control on what specific drug or treatment to use. They usually have multiple choices for the same disease.

China market requires local products to succeed; a global blockbuster does not guarantee success

We believe China blockbuster drugs have the following six features: (1) huge unmet needs, (2) broad coverage of physicians, (3) high-priced drugs, (4) favourable reimbursement, (5) exclusivity and (6) high entry

06 October 2011


Therefore, a unique selling point, or exclusivity, is important for a drug to stand out. Commodity-like products find it hard to achieve price premium and substantial volumes.

(6) High barriers to entry: Besides the differentiating features, a company can gain higher market share and maintain market leadership by lifting the entry barriers to prevent direct competitors from launching similar products. Entry barriers can be raised by multiple approaches such as IP protection on the compound, unique formulation or dosage form, complex manufacturing process, significantly higher manufacturing standards and high capex.

Figure 30: Majority of China’s top-ten drugs are local products US top 10 drugs

Brand name Generic name Manufacturer 2010 sales (US$ bn) YoY (%)

Nexium Esomeprazole Magnesium AstraZeneca Pharmaceuticals 5.28 0.049

Lipitor Atorvastatin Calcium Pfizer Inc 5.27 -0.023

Plavix Clopidogrel Bisulfate Bristol-Myers Squibb Company 4.68 0.102

Advair Diskus Fluticasone Propionate GlaxoSmithKline 3.66 -0.01

OxyContin Oxycodone Hydrochloride Purdue Pharma LP 3.55 0.131

Abilify Aripiprazole Bristol-Myers Squibb Company 3.51 0.127

Singulair Montelukast Merck & Co., Inc. 3.32 0.089

Seroquel Seroquel AstraZeneca Pharmaceuticals 3.22 0.024

Crestor Quetiapine Fumarate AstraZeneca Pharmaceuticals 2.92 0.27

Cymbalta Duloxetine HCl Eli Lilly and Company 2.64 0.076

China Top 10 drugs

Brand name Generic name Manufacturer 2010 3Q sales (Rmb bn) YoY (%)

*Kelinao Cinepazide Maleate Injection Beijing Sihuan 1.004 32.70

Plavix Clopidogrel Bisulfate Sanofi-Synthelabo Minsheng 0.831 33.90

*Shen Jie Ganglioside Shandong Qilu 0.747 31.30

*Shu Xue Tong TCM Mudanjiang Youbo 0.747 23.90

*Bei Tong TCM Shandong Jinan Buchang 0.700 35.30

Glucobay Acarbose Bayer Beijing 0.658 24.80

Losec Omeprazole AstraZeneca 0.633 33.10

*Xue Shuan Tong TCM Guangxi Wuzhou 0.591 46.00

*Kai Shi Alprostadil fat Emulsion Injection Beijing Taide 0.562 21.80

*Zuo Ke Levofloxacin Hydrochloride Injection Jiangsu Yangzijiang 0.550 3.80

*Kelinao, Shen Jie, Shu XueTong, Bei Tong, Xue Shuan Tong, Kai Shi and Zuo Ke are local products

Source: http://www.drugs.com; IMS

06 October 2011


■ Case study

Sihuan made Kelinao a successful local blockbuster drug …

Figure 31: Kelinao/Anjieli has recorded impressive growth as top-selling CCV drug

29 2653

103

191

306

406

570

2003A 2004A 2005A 2006A 2007A 2008A 2009A 2010A

Kelinao/Anjieli sales rev enue (RMB mn)

1998-2011E CAGR:47%

Note: CVC stands for cardio-cerebral vascular; Source: Company data, Credit Suisse estimates

… with more room to grow

Figure 32: Kelinao still has room to grow via further hospital coverage penetration

888

3,588

2,197

1233

6523

5110

Class 3 hospital Class 2 Hospital Class 1 Hospital

Current covered Total number of hospitals


06 October 2011


Leading cardio-cerebral vascular (CCV) drugs are mostly local products

Figure 33: Local top selling CCV drugs recorded higher-than-market growth From 06-10

CAGR

20.0%

29.1%

48.5% 50.8%

62.5%

79.4%

Industry CCV Clopidogrel Edarav one Cinepazide

Maleate

GM1

Sales CAGR (2006-2010)

LocalGlobal

Note: Edaravone, Cinepazide Maleate and GM1 are all local products

Source: IMS, Company data

Leading pharma players are built up by China blockbuster drugs

Figure 34: Leading China pharma players with blockbuster drugs

18

12

9

6

3

Shanghai Pharma Sino Biopharm Hengrui (2009) Simcere Sihuan

No. of blockbuster drugs in 2010


06 October 2011


Many advanced treatments are still highly under-penetrated; need the right local product portfolio to address unmet medical needs

Figure 35: Significant growth potential for oncology drugs due to low penetration

607, 753638, 141

2 ,9 35 3,613

3 ,3352 ,401

-

100,000

200,000

300,000

400,000

500,000

600,000

700,000

2009 2010

Number of Lung Cancer Patients

Patients on Irressa

Patients on Tarceva

RMB

Treatment Cos t for Iressa 120,000

Treatment Cos t for Tarceva 130,000

Average monthly salary in Sh anghai 2,000

Number of Months 60

2009 2010

Nu mber of Lun g Cancer 607,75 3 638,141

P atients on I rre ssa 2,93 5 3,613 0.6%

P atients on Ta rceva 2,40 1 3,335 0.5%607, 753638, 141

2 ,9 35 3,613

3 ,3352 ,401

-

100,000

200,000

300,000

400,000

500,000

600,000

700,000

2009 2010

Number of Lung Cancer Patients

Patients on Irressa

Patients on Tarceva

RMB

Treatment Cos t for Iressa 120,000

Treatment Cos t for Tarceva 130,000

Average monthly salary in Sh anghai 2,000

Number of Months 60

2009 2010

Nu mber of Lun g Cancer 607,75 3 638,141

P atients on I rre ssa 2,93 5 3,613 0.6%

P atients on Ta rceva 2,40 1 3,335 0.5%

Source: Eddingpharm

06 October 2011


Criteria #2: Well-managed pipeline ■ Market feature: The core competency of a winning pharma company is its capability of

building a platform to deliver sustainable growth. But in reality, it is quite hard to grow faster than market in the long run, especially for those who have already reached a sizable topline. One critical criteria is not finding the current winner but identifying more sustainable future leaders. We recommend evaluating the two following factors to judge the sustainability: (1) Pipeline and (2) product lifecycle management. A promising pipeline can be built by either in-house R&D or M&A.

■ Two ways to deliver sustainable growth: Pipeline and Lifecycle management

(1) High-potential pipeline: The first step is to have the right products to sell in the market. The high potential pipelines are those proprietary drugs that cater to huge unmet medical needs with limited competition and high entry barrier, or first-to-market generic products that can quickly follow the original.

(2) Well-managed product/franchise lifecycle: The second step is to extract the maximum value from an existing successful product. If the product pipeline development cannot match with the current marketed product lifecycle, it could impact the sustainable revenue growth trend.

■ Two major valuable pipeline assets: Proprietary and FTM drugs

(1) Proprietary drug: This asset brings a sustainable revenue stream but requires longer timeline and higher R&D cost. But on reaching an inflection point, it delivers superior returns. Proprietary drugs are still scarce assets among local players, as only highly selective proprietary drugs are approved each year by the SFDA (only nine approvals under class one new drug category out of 1,712 applications in 2009). This is not only due to the stringent application standards raised by SFDA from time to time, but also local players’ weak innovative R&D capabilities and limited resources. The government is in favour a strong push to advance local R&D capabilities by implementing favourable policies and higher funding, but emerging leaders have already capitalised on this. For example, Sino Biopharm and Hengrui have been investing on R&D for years and have begun to see early rewards.

(2) First-to-market generic drug: This asset generates faster revenue but may face fiercer competition; therefore it has less sustainable growth than proprietary drugs. Although the first-to-market generic pathway seems straightforward, it is not an easy task. Companies have to compete hard to become the first to get approval. The critical success factor is an established R&D platform for reverse engineering and a thorough understanding of local regulatory policies to speed up the approval process. Established leaders can better capitalise on this first-mover advantage given their advanced planning, established network and local know-how.

■ Two ways to build pipeline: R&D and M&A

(1) In-house R&D: In our view, R&D capabilities have become increasingly important as registration standards have been lifted significantly and the market needs more differentiating and proprietary products rather than generic products. However, R&D is a long-term investment given the long development cycle (over five years). A company cannot build a solid R&D platform without years of investment. It also takes time to learn by trial and error; besides the absolute amount of funding invested, local know-how and the ability to quickly respond to dynamic changes are also crucial for success. All else equal, we like companies that have been investing in R&D heavily since five or more years ago.

Sustainability is built by strong pipeline and well-managed product lifecycle

Proprietary drug offers longer value but requires higher R&D; FTM drug is a more cost-effective option but competes for speed to market

Both in-house R&D and external M&A are effective ways to build pipeline; We favour first mover in R&D who invested from 5 years ago to be able to capitalize the investment in near future

06 October 2011


(2) External M&A: Due to historical reasons, the drug approval criteria in China was not as stringent as today. A large portion of the current blockbuster drugs were approved before 2006 when the SFDA scandal happened (these drugs may not get approval under the current SFDA standards). Most of the recent industry M&As are centred on such legacy drug approval certificates, but it is not from a pure clinical R&D perspective but for commercialisation potential, in our view. M&A in the China pharma space still focuses more on high-potential legacy drug approvals to ramp up near-term revenue growth rather than building up manufacturing scale or strengthen R&D capabilities. We believe in the future, there will less and less such high-potential legacy drugs available to acquire and companies will have to shift focus to products developed from R&D and from future pipeline perspective.

■ Case study: Two ways to deliver sustainability—pipeline and lifecycle

China product life cycle is quite different from the developed market, with longer lifecycle and not as sensitive to patent expiration as in developed market

Figure 36: China product life cycle is quite different from developed market

Source: Eddingpharm

M&A mainly focuses on legacy-approved products that already have SFDA certificates and are ready to sell

06 October 2011


Winner can manage product/franchise lifecycle well to deliver sustainability

■ Licorice-based franchise product roadmap and lifecycle management by Sino Biopharm—remains sustainable via innovation

Figure 37: Sustainability in licorice franchise through continuous innovation

0

500

1,000

1,500

2,000

2,500

1998 2000 2002 2004 2006 2008 2010 2012E 2014E

Sales (HK$ mn)

Ganlix in injections and capsules Tainqingganping enteric capsules

Tainqingganmei injections Tainqingganmei enteric capsules

1998-2015E CAGR22%


Figure 38: Product launch roadmap for licorice franchise liver protection drugs

Enteric Capsule

Qianglining


■ Anti-viral franchise product roadmap and lifecycle management by Sino Biopharm—sustainability through FTM launches

06 October 2011


Figure 39: Sustainability in anti-viral franchise by speedy FTM drug launches

-

500

1,000

1,500

2,000

2,500

3,000

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011E 2012E 2013E 2014E 2015E

Sales (HK$ mn)

Tainqingfux in injections and capsules Mingzheng capsules Runzhong dispersible tabletsEntecav ir capsules "Me better" Entecav ir "Me better" Viread

2002-2015E CAGR:33%


Figure 40: Product launch roadmap for anti-viral hepatitis B drugs


06 October 2011


■ Two major valuable pipeline assets: Proprietary and FTM drugs

Proprietary drugs are still scarce assets in China: IP protected category 1 new drugs are still scarce assets, owned by only a few companies in China and see handful approvals each year.

Figure 41: Category 1 new drugs are still scarce assets in China

5239

3089

7613

13318

8598

1636 1415 1712

2083 93 120

37 16 10 90

2000

4000

6000

8000

10000

12000

14000

2002 2003 2004 2005 2006 2007 2008 2009

0

100

200

300

400

500

600

700

800

900

1000

Generics drugs Category 1 new drugs (RHS)


Figure 42: Proprietary drug Tianqingganmei leading Sino Biopharm to growth

Sino Biopharm revenue growth breakdown 1H11 vs.1H10

Tainqingganmei (Proprietary)

23%

Runzhong (FTM)20%

Others57%


FTM drugs have promising near-term growth potential: Since the original drugs are usually better accepted in the physician community, FTM drug suppliers could significantly leverage the originator brand and quickly follow up to expand sales.

06 October 2011


Figure 43: Select FTM drugs with high growth potential Drug MNC MNC Sales in Global sales FDA

Brand Drug registration originator/ brand US, 2010 2010 approval

Brand Name name (CN) Generic name category category marketer name (US$ mn) (US$ mn)

Yilunping 依伦平 Irbesartan and hydrochlorothiazide FTM 3.1 BMS/Sanofi Avalide 642 1,176 1997

Tuotuo 托妥 Rosuvastatin FTM 3.1 AstraZeneca Crestor 2,640 5,691 2003

Runzhong 润众(恩替卡韦) Entecavir FTM 3.1 BMS Baraclude 179 931 2005

Tianqingsule 天晴速乐 Tiotropium Bromide FTM 3.1 BI Spiriva 1,767 3,801 2004

Yifei 益非 Gemcitabine FTM 3.1 Eli Lilly Gemzar 723 1,149 1996

Tianqingyitai 天晴依泰 Zolebronate Acid FTM 3.1 Novartis Zometa 721 1,511 2001

Benchmark drug sales 2010 6,672 14,259

Source: BioMedTracker, DXY, SFDA, Company data

Figure 44: Sino Biopharm is the leader in FTM drugs applications by 1H2011

32

91

47

95

3.1 category new drug submissions Total new drug submissions

Hengrui Sino Biopharm

Source: DXY, SFDA

■ Two ways to build pipeline: R&D and M&A

Sino Biopharm (SBP) is one of the leaders in in-house R&D

Figure 45: Sino Biopharm (SBP) one of the leaders in in-house R&D by 1H2011

No. of new drug application submission

9591

75 73 73 7368

63

56 5653

22

SBP(JCTT+NJCTT)

Hengrui (No.1)Shandong NewTime (No.2)

JCTT (No.3) Haosen (No.4) ChangchunOversea (No.5)

Jinan Bainuo(No.6)

Beijing SihuanKebao (No.7)

BeijingFuruikangzheng

(No.8)

TianjingHankang (No.9)

ShandongLuoxin (No.10)

NJCTT (No.11)

Source: DXY, SFDA

06 October 2011


Shanghai Pharma has built one of the largest R&D teams within the industry

Figure 46: Shanghai Pharma has one of the largest R&D teams

>300>300>300>300

~550

Shanghai Pharma Sino Biopharm Hengrui Simcere Sihuan

No. of R&D staff


Sihuan has a successful track record of acquiring high-potential products

Figure 47: Newly acquired products attributed over 40% of Sihuan’s 1H11 revenue

Sihuan 1H11 revenue breakdown

Post IPO newly acquired products

43%

Existing products57%


06 October 2011


Criteria #3: Superior commercialisation capability ■ Market feature: Drug sourcing in China is decentralised and the decision power is at

the local level with multiple barriers to overcome. Most national policies would need to be tailor-made to local market conditions. The key is how to interpret and execute the policy locally. Thus, local execution capabilities are critical. It takes years to build trustworthy relationships with physicians and different stakeholders. Investor should focus on the company that already has such relationships and knows the local market.

■ Challenges in commercialisation

(1) Multiple steps involved: There are multiple pharma market access steps that each company has to address, from product registration, provincial hospital tendering, hospital listings to physician prescriptions and final drug dispensing to patients. Further, to make the product ready to sell, the company not only needs to obtain a drug manufacturing permit from the SFDA, but also needs to negotiate the pricing in each provincial or local pricing bureau and lobby for inclusion into the national and provincial drug reimbursement lists.

(2) Multiple stakeholders involved: Since China’s pharma market is decentralised and highly regulated by the government, multiple government agencies are involved in pharma commercialisations. For example, the hospital tendering is conducted at a provincial level, so the company needs to bid in at least 30 provinces and at the same time lobby for inclusion in that many provincial drug reimbursement lists. Further, government insurance schemes financing are decentralised to prefecture city level, so each prefecture city is in charge of its own insurance plans. In any tendering, several government bodies are involved, such as Ministry of health, SFDA, NDRC and MOLSS.

■ Case study

■ Multiple steps involved in local market access for commercialization

First, Multiple participants in China pharma market

Figure 48: Main participants of China’s pharma market

Source: CMS, Company data

China commercialisation is highly decentralised with multiple market access barriers and multiple stakeholders

06 October 2011


Second, multiple steps during drug commercialisations …

Figure 49: CMS illustrated key steps in drug commercialisation

Source: CMS company data

Third, particularly more complex in drug tendering, pricing and reimbursement

Figure 50: Multiple local market access steps for commercialisation Key commercialisation steps No. of tasks to concur

No. of tenders to bid 60-plus provincial tendering EDL tender 30-plus provincial tendering Non-EDL tender 30-plus provincial tendering

No. of pricing to work on By number of drugs to bid No. of reimbursement to lobby

EDL National Local EDL 30-plus provincial tendering RDL National Provincial RDL 30-plus provincial tendering

Source:, Credit Suisse estimates

06 October 2011


■ Multiple government bodies involved during the process, an overwhelming task

Figure 51: An overwhelming number of government bodies are involved in drug industry Regulated activity Lead national government body Lead local government body

Pricing NDRC 30+ provincial NDRC; Provincial price bureau Product registration SFDA 30+ provincial SFDA Pharma company set up SAIC Local SAIC Reimbursement (Detailed in below four schemes)

Rural new cooperative scheme MOH, MOF 2000+ local MOH and MOF Urban residence scheme MOLSS 300+ local MOLSS Urban employee scheme MOLSS 300+ local MOLSS Social aid scheme MCA 300+ local MCA Manufacturing company operation MIIT 30+ provincial MIIT Distribution company operation MOC 30+ provincial MOC Services company operation MOH 30+ provincial MOH R&D MOST 30+ provincial MOST Tendering MOH; State council office for rectifying

malpractices; NDRC; MOF; SAIC; SFDA 30+ MOH; 30+ provincial council office for rectifying malpractices; 30+ provincial NDRC; 30+ provincial MOF; 30+ Price Bureau; 30+ provincial SAIC and 30+ provincial SFDA

Vaccine CDC 300+ local CDC

Note: NDRC (National Development and Reform Commission); SFDA (State Food and Drug Administration); SAIC (State Administration For

Industry & Commerce); MOH (Ministry of Health); MOLSS (Ministry of Labour and Social Security); MIIT (Ministry of Industry and Information

Technology); MOC (Ministry of Commerce); MOST (Ministry of Science and Technology); CDC (Centers for Disease Control); MCA (Ministry of

Civil Affairs) MOF (Ministry of Finance);

Source: Expert interviews, NDRC, MOH, State Council

■ Two-pronged sales model: In-house and external agent

(1) Direct academic promotion model: Generally speaking, for drugs with clear superior clinical efficacy or differentiated clinical profile than existing therapies, academic promotion by in-house commercialisation teams is an effective approach. The academic promotion initiatives usually require a dedicated professional sales and marketing team with medical knowledge of the products to educate, promote and market the new therapy or drugs with academic and clinical research support via conferences, seminars, papers and forums, etc. Although the initial ramp up could take time (educating physicians and patients), the growth is more sustainable and can benefit from economies of scale. It is not an easy task especially for local players to build such comprehensive academic promotion capabilities, as China lacks valuable non-generic drugs with clinical efficacy and educated teams with sufficient degree of experience.

(2) Indirect external agent sales model: Generally speaking, for drugs with high margin, exclusivity and differentiated simple selling points covering a broader and deeper market, indirect promotion by external agent commercialisation teams is an effective approach. The external agent teams are usually well-connected local sales experts in the market with close working relationship with the local government, hospitals and physicians. This is a particularly effective approach to cover places where in-house sales team cannot effectively reach or has limited resources to address. Although direct control to end-user could be relatively weak, the growth ramp up is faster and it can address deeper market penetration and coverage. Professional screening, incentivising, managing and retaining top local agents are the required capabilities, along with deep market insight and tight relationships. On top of all these, the success of such models relies on the product profile, which has to offer enough incentives to agents and present compelling differentiation with peers.

A two-pronged sales model is an effective way to address the China market: (1) In-house sales team and (2) external agent sales team

06 October 2011


■ Case study: Two-ponged sales model for drug commercialization

■ First, there are complex stakeholders with different interests to be aligned along the value chain, requiring effective sales model to address

Figure 52: Illustrative example for drug mark-up distribution along the value chain

~20-30%

~20-30% ~5-8%

>30-40%

>15% >115%

Ex -

manufacturer

Sales-agents Distributors for

logistics

Phy sicians and

hospital access

ex penses

Hospital Retail price to

patient

Max retail price

set by NDRC

Can be in-housed or outsourced

Tendering price = 100%

Note: Hospital access expenses include but not limited to tendering/pricing/reimbursement/hospital listing-

related expenses; VAT not included in rough estimate; mark-up varies by product


■ Second, key differences between logistic distributor and promotion provider, more value-add demand generation function from promotions

Figure 53: Distinction between promotion services and distribution services

R&D Manufacturing Physicians

Purchasing Dept. / Hospital Pharmacy

Demand Generation

Physician Education/

Product Detailing

Order Fulfillment

Ensure orders fulfilled efficiently

and effectively

Physicians inform purchasing Dept. who will then issue orders accordingly

Within a healthcare institution (e.g. hospitals, clinics, etc。 )

DistributionService

PromotionService

Example companies:

• Promotion service providers: CMS, Eddingpharm, NT, etc.

• Distribution service providers: Sinopharm, Shanghai Pharma, etc


06 October 2011


■ Third, two major commercialisation models are emerged in the market

Figure 54: Direct academic and indirect agency are two major commercialisation models

Direct promotion

• Professional academic promotion builds up brand image

• More physician-oriented• Immediate feedback about

physicians’ prescription preferences• Longer product life cycle

Agency promotion

• National-wide network coverage• Quick penetration, especially into

low-tier cities• Leverage third-party’s in-depth

understanding of local market and relationship with physicians

• No need to invest on in-house commercial team

• Takes longer time to build up scale• May not be cost-effective to market

on low-tier cities

Pros

Cons

• Lack first-hand information about physicians’ feedback

• Potential competition with other products marketed by the same agent

Direct promotion

• Professional academic promotion builds up brand image

• More physician-oriented• Immediate feedback about

physicians’ prescription preferences• Longer product life cycle

Agency promotion

• National-wide network coverage• Quick penetration, especially into

low-tier cities• Leverage third-party’s in-depth

understanding of local market and relationship with physicians

• No need to invest on in-house commercial team

• Takes longer time to build up scale• May not be cost-effective to market

on low-tier cities

Pros

Cons

• Lack first-hand information about physicians’ feedback

• Potential competition with other products marketed by the same agent


06 October 2011


Choosing the future winners Healthcare stocks have derated significantly Year to date, the healthcare sector has derated significantly, underperforming the MSCI China index (by 5% more YTD). Stocks such as Sihuan, Sino Biopharm and Shanghai Pharma have also derated significantly, with CMS being one of the few outperformers. One of the key concerns has been the pricing erosion pressure, triggered by an uncertain government policy. Investors doubt whether the sector can sustain 20%-plus growth after the pricing erosion. Further, there are concerns about the inflated cost of raw material and labour, in addition to the fact that increased competition will imply higher selling and R&D expenses, leading to margin erosion. In our view, the concerns are valid, but the actual impact will be different for individual players. While some will be badly hurt, leaders could gain. It is the time for the stronger to get stronger and take more. Particularly, after the significant sector derating, most stocks are now fairly valued, which represents a good entry point.

Figure 55: China healthcare sector has derated significantly YTD

-40%

-35%

-30%

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0%

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06-Sep-2011

14-Sep-2011

21-Sep-2011

MSCI China MSCI - China Healthcare


Healthcare sector has significantly derated YTD and offers good entry point from a valuation point of view

06 October 2011


Figure 56: Sino Biopharm has derated YTD (as of 2011 Oct. 3)

-40%

-35%

-30%

-25%

-20%

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0%

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02-Sep-2011

26-Sep-2011

MSCI China MSCI - China Healthcare Sino Biopharm


Figure 57: Sihuan has derated significantly after its IPO (as of 2011 Oct. 3)

-60%

-50%

-40%

-30%

-20%

-10%

0%

10%

28-Oct-2010

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MSCI China MSCI - China Healthcare Sihuan


06 October 2011


Figure 58: CMS has outperformed the market (as of 2011 Oct. 3)

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

28-Sep-2010

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06-May-2011

27-May-2011

21-Jun-2011

13-Jul-2011

03-Aug-2011

24-Aug-2011

15-Sep-2011

MSCI China MSCI - China Healthcare CMS


Figure 59: Shanghai Pharma has derated since its IPO (as of 2011 Oct. 3)

-40%

-35%

-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

20-May-2011

27-May-2011

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20-Jun-2011

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26-Jul-2011

02-Aug-2011

09-Aug-2011

16-Aug-2011

23-Aug-2011

30-Aug-2011

06-Sep-2011

14-Sep-2011

21-Sep-2011

28-Sep-2011

MSCI China MSCI - China Healthcare Shanghai Pharma


Stock calls: Bottom-up approach to pick leaders Under the current policy trend with cost containment, price control, industry consolidation and R&D upgrade, we feel that it’s the time to take a bottom-up approach to identify the true leaders who have built solid capabilities and would benefit the most in the future. Based on the three criteria we referred to above, we have identified the following stocks:

■ Sino Biopharm for its strong in-house R&D capabilities and blockbuster drug portfolio

■ Sihuan for its efficient agency sales model and rapidly growing exclusive drugs

■ CMS for its solid academic promotion capabilities and upside in margin expansion

■ Shanghai Pharma for its legacy brand, leadership position and potential upside from acquisition of sizable drug players

Given the attractive valuation after the sector’s derating, we would recommend investors to bottom fish for future leaders. Based on the three key criteria covering product portfolio,

We use a bottom-up approach to pick the industry leaders: Sino Biopharm, Sihuan, CMS and Shanghai Pharma

06 October 2011


pipeline and commercialization capabilities, we have screened leading China-listed pharma companies and would like to initiate coverage on Sihuan Pharma (OUTPERFORM, TP HK$5.00, 87% potential upside) for its efficient agency sales model and China Medical Systems (CMS) (OUTPERFORM, TP HK$9.00, 78% potential upside) for its solid academic promotion capabilities. We maintain OUTPERFORM rating (TP HK$3.6, 55% potential upside) on Sino Biopharm for its strong in-house R&D capabilities and Shanghai Pharma (OUTPERFORM, TP HK$ 24.3, 54% potential upside) for its legacy brand, leadership position and potential upside from acquisition.

Since FTM generic drugs could enjoy many originator’s privileges and have already been core assets for leading pharma, we have reviewed the top players’ FTM product portfolios in Figures 60 for investor’s references.

06 O

ctob

er 2011

Ch

ina P

harm

a Secto

r 38

Figure 60: Select FTM drugs from major pharma companies Brand Sales No. of local Approval Originator name Generic Generic 2010 Approval players speed Originator brand Company Brand name (CN) name name (CN) (HK$ ’000) year in 2011 rank name name Sino Biopharm Kaishi 凯时 Alprostadil injections 前列地尔注射液 1,094,460 2003 >5 1 Pfizer Caverject Sai Wei Jian/Tomudex

(SBP) 赛维健 Raltitrexed injections 注射用雷替曲塞 12,000 2010 1 1 AZ Tomudex

Kaina 凯那 Beraprost tablets 贝前列素 10,000 2008 1 1 Toray Dorner Gai San Chun/Rocaltrol

(SBP) 盖三淳 Calcitriol soft capsules 骨化三醇胶丸 218,000 2004 1 1 Roche Rocaltrol

Yilunping/Avalide (SBP) 依伦平 Irbesartan and hydrochlorothiazide tablets

厄贝沙坦氢氯噻嗪片 146,920 2005 5 1 BMS/Sanofi Avalide/CoAprovel

Runzhong/Baraclude (SBP)

润众(恩替卡韦)

Entecavir dispersible tablets 恩替卡韦分散片 144,800 2010 4 1 BMS Baraclude

Tianqingsule/Spiriva (SBP)

天晴速乐 Tiotropium Bromide inhalation powder

噻托溴铵粉吸入剂 - 2006 2 1 BI Spiriva

Getai/Alvenor (SBP) 葛泰 Diosmin tablets 地奥司明片 - 2005 2 1 Servier Alvenor Tianqingyitai/Zometa

(SBP) 天晴依泰 Zolebronate Acid injections 唑来膦酸注射液 115,000 2004 24 1 Novartis Zometa

Tiance 天册 Biapenem injections 注射用比阿培南 80,000 2008 4 2 Meiji NA Mingzheng/Hepsera (SBP) 名正 Adefovir dipivoxil capsules 阿德福韦酯胶囊 647,910 2006 16 2 GSK Hepsera Taibai 泰白 Metformin SR tablets 盐酸二甲双胍缓释片 36,800 2003 45 2 BMS Glucophage Tuotuo/Crestor (SBP) 托妥 Rosuvastatin calcium tablets 瑞舒伐他汀钙片 5,000 2008 4 3 AZ Crestor Yifei/Gemzar (SBP) 益非 Gemcitabine hydrochloride

injections 注射用盐酸吉西他滨 - 2010 7 3 Eli Lilly Gemzar

Tianqingning 天晴宁 Hydroxyethyl starch injections 羟乙基淀粉 130/0.4氯化钠注射液

155,010 2006 22 5 Fresenius Kabi Voluven

Drug Sales No. of local Approval Originator name 2010 Approval players speed Originator brand Company Drug name (CN) Generic name Generic name (CN) (Rmb ‘000) year in 2011 rank name name Sihuan Kelinao 克林澳 Cinepazide maleate injection,

80mg 马来酸桂哌齐特注射液 456,103 2002 1 1 N/A N/A

Anjieli 安捷利 Cinepazide maleate injection, 320mg

马来酸桂哌齐特注射液 113,878 2006 1 1 N/A N/A

Qingtong 清通 Edaravone injection 依达拉奉注射液 35,786 2008 7 4 Mitsubishi Pharma Radicut Yimaining 益脉宁 Alprostadil lipid emulsion

injection 前列地尔注射液 2006 >5 3 Pfizer Caverject

Brand Sales No. of local Approval Originator Name Generic Generic 1H 2011 Approval players speed Originator brand Company Brand name (CN) name name (CN) (USD ‘000) year in 2011 rank name name

CMS Yinuoshu 伊诺舒 Ambroxol Hydrochloride for Injection

盐酸氨溴索注射液 4,939 2004 6 1 Boehringer Ingelheim

Mucosolvan

Quzhiquan 曲之全 Tirofiban Hydrochloride for Injection

注射用盐酸替罗非班 102 2009 3 2 Medicure Pharma/ Irokocardio

Aggrastat

Drug Sales No. of local Approval Originator name 2010 Approval players speed Originator brand Company Drug name (CN) Generic name Generic name (CN) (Rmb ‘000) year in 2011 rank name name

Simcere Bicun 必存 Edaravone Injection 依达拉奉注射液 668 2003 7 1 Mitsubishi Pharma Radicut Yingtaiqing 英太青 Diclofenac Sodium Sustained

Release Capsules/Gel

双氯芬酸钠缓释胶囊/凝胶 175 2002 9 4 Novartis Voltaren

Sinofuan 中人氟安 Fluorouracil Implants 氟尿嘧啶植入剂 152 2003 1 1 Pharmacia and UpJohn

Adrucil

Anxi 安信 Biapenem injection 注射用比阿培南 N/A 2008 4 1 Meiji None

Biqi 必奇 Smectite Powder 蒙脱石散 N/A 1999 >15 2 Beaufour Ipsen Industrie

Smecta

Source: Company data, SFDA, DXY, MENET, BioMedTracker, Credit Suisse estimates

06 October 2011


Asia Pacific / Hong Kong Major Pharmaceuticals

Sihuan Pharmaceutical Holdings Group Ltd. (0460.HK / 460 HK)

INITIATION

M&A pay off; pioneer of the agent sales model ■ Initiate coverage with OUTPERFORM and HK$5.00 target price. Sihuan

Pharma is a leading pharmaceutical company with the largest cardio-cerebral vascular (CCV) drug franchise in China. It has established a rapidly growing product portfolio with exclusive CCV drugs through its unique external sales agent network and strategic acquisitions. Our target price of HK$5.0, implying 87% potential upside, is based on 18x 2012E EPS and 0.5% PEG, in line with peers. Initiate coverage with OUTPERFORM.

■ Pioneer of the external agent sales model. We believe Sihuan’s external agent sales model is an effective way to cover the China market with deep local insights. Besides, not all players were successful in operating in this market as product features too are key. Exclusivity, favourable reimbursement, high awareness and high-priced products are crucial pre-conditions. Sihuan has not only established such a rare-found portfolio but also developed a comprehensive distinct external agent sales network.

■ M&A pay off. Sihuan actively pursues M&As as its core growth strategy. In fact, it has been successfully acquiring high potential products since its first acquisition of the best-selling product ‘Kelinao.’ Also, its recent acquisitions of Dupromise and Vinise have strengthened its rare-found high-potential product stable. Such an M&A activity has paid off with 49% earnings growth YoY in 1H11 driven also by the faster ramp-up of newly acquired Dupromise’s products. Further, it is well-prepared for the long-term growth by investing in in-house R&D.

■ Visible near-term growth. Two key growth drivers should support Sihuan’s 44% YoY earnings growth from 2010 to 2013E: (1) ‘Kelinao’ growth should rebound after the removal of reimbursement restrictions, and (2) the creation of more ‘Kelinao-like’ blockbuster drugs—most of the newly acquired drugs have a similar profile like Kelinao in terms of exclusivity and high awareness.

■ Key risks include delayed tendering, a non-transparent structure, drastic policy changes and unsuccessful M&A.

Share price performance

23456

Sep-11

98100102104106

Price (LHS) Rebased Rel (RHS)

The price relative chart measures performance against the HANG SENG INDEX which closed at 16294.7 on 03/10/11 On 03/10/11 the spot exchange rate was HK$7.79/US$1

Performance Over 1M 3M 12M Absolute (%) -15.8 -25.8 — Relative (%) 3.6 1.8 —

Financial and valuation metrics

Year 12/10A 12/11E 12/12E 12/13E Revenue (Rmb mn) 1,036.9 2,271.2 3,409.8 4,546.6 EBITDA (Rmb mn) 595.3 1,093.3 1,755.4 2,206.0 EBIT (Rmb mn) 559.3 863.0 1,346.9 1,818.6 Net income (Rmb mn) 522.1 837.1 1,195.6 1,561.2 EPS (CS adj.) (Rmb) 0.13 0.16 0.23 0.30 Change from previous EPS (%) n.a. Consensus EPS (Rmb) n.a. 0.16 0.21 0.26 EPS growth (%) 49.8 23.8 42.8 30.6 P/E (x) 16.8 13.5 9.5 7.3 Dividend yield (%) 2.0 4.4 3.2 4.1 EV/EBITDA (x) 9.2 6.0 3.7 2.9 P/B (x) 1.3 1.6 1.5 1.3 ROE (%) 13.8 12.3 16.2 18.7 Net debt/equity (%) net cash net cash net cash net cash

Source: Company data, Thomson Reuters, Credit Suisse estimates

*Stock ratings are relative to the relevant country benchmark. ¹Target price is for 12 months.

Research Analysts

Lefei Sun 852 2101 7658

[email protected]

Jinsong Du 852 2101 6589

[email protected]

Iris Wang 852 2101 7646

[email protected]

Rating OUTPERFORM* Price (03 Oct 11, HK$) 2.67 Target price (HK$) 9.00¹ Chg to TP (%) 87.3 Market cap. (HK$ mn) 13,817 Enterprise value (Rmb mn) 6,587 Number of shares (mn) 5,175.02 Free float (%) 25.9 52-week price range 6.17 - 2.58

06 October 2011


Financial summary Figure 61: Income Statement Year-end 31 December (Rmb mn) 2007A 2008A 2009A 2010A 2011E 2012E 2013E

Revenue 286 510 709 1,037 2,271 3,410 4,547

Gross profit 226 376 517 745 1,794 2,762 3,774

Operating profit 187 276 373 613 931 1,449 1,955

Net profit 179 237 326 522 837 1,196 1,561

Reported EPS – diluted (Rmb) 0.087 0.130 0.161 0.231 0.301

CS adjusted EPS – diluted (Rmb) 0.091 0.117 0.148 0.211 0.275


Figure 62: Balance sheet Year-end 31 December (Rmb mn) 2007A 2008A 2009A 2010A 2011E 2012E 2013E

Total current assets 310 442 797 6,165 5,356 5,751 5,982

Total non-current assets 320 420 376 738 3,637 3,768 3,921

Total assets 631 862 1,173 6,902 8,993 9,519 9,903

Total current liabilities 96 127 219 233 1,898 1,482 618

Non-current liabilities 10 19 30 10 110 166 221

Total liabilities 106 146 249 243 2,008 1,647 839

CMS shareholders' equity 525 701 908 6,657 6,965 7,802 8,894

Non-controlling interests - 15 17 3 20 70 170

Total equity 525 716 924 6,660 6,985 7,872 9,064


Figure 63: Cash flow statement Year-end 31 December (Rmb mn) 2007A 2008A 2009A 2010A 2011E 2012E 2013E

Net cash generated from operating activities 183 257 386 380 2,369 898 882

Net cash (used in)/generated from investing activities (156) (115) 16 (364) (2,993) (420) (420)

Net cash generated from/(used in) financing activities 194 (73) (120) 5,222 (502) (359) (468)

- - - - - - -

Net increase in cash and cash equivalents 221 69 282 5,239 (1,126) 119 (6)

Cash and cash equivalents at the beginning of the year 42 262 331 613 5,851 4,726 4,845

Cash and cash equivalents at the end of year 262 331 613 5,851 4,726 4,845 4,839


Figure 64: Key ratios Year-end 31 December 2007A 2008A 2009A 2010A 2011E 2012E 2013E

Profitability

Gross margin 79% 74% 73% 72% 79% 81% 83%

Operating margin 65% 54% 53% 59% 41% 43% 43%

Net margin 63% 46% 46% 50% 37% 35% 34%

Growth

Revenue growth 78% 39% 46% 119% 50% 33%

Gross profit growth 67% 37% 44% 141% 54% 37%

EBITDA growth 50% 33% 62% 79% 60% 26%

Reported net profit growth 32% 38% 60% 60% 43% 31%

Reported EPS (diluted) growth 50% 24% 43% 31%

CS adjusted EPS (diluted) growth 29% 27% 42% 30%

Cash conversions cycle

Days receivable 2 2 5 35 35 35

Days inventory 84 77 59 55 57 55

Days payable 18 16 27 37 37 37


06 October 2011


Asia Pacific / Hong Kong Pharmaceutical Distribution

China Medical System Holdings Ltd. (0867.HK / 867 HK)

INITIATION

Partner of choice to access the China market ■ Initiate coverage with OUTPERFORM and HK$9.00 TP. China Medical

Systems (CMS) is a leading China-based pharmaceutical services company with the largest third-party commercialisation network. Given expected 50%+ and 60%+ CAGR from 2010 to 2013E for its revenue and net profit, respectively, we initiate coverage with an OUTPERFORM rating and target price of HK$ 9.0, which implies 78% potential upside based on 20x 2012E EPS and PEG at 0.6, in-line with offshore-listed peers without premium.

■ Value of academic promotion capability. CMS has built the largest third-party prescription drug academic promotion team with 1,000+ sales representatives covering 13,000+ hospitals. It converted Deanxit into a blockbuster drug with over US$52 mn in sales in 2010 (from nil in 1997), outperforming many leading multinationals. Such comprehensive commercialisation capability and solid track record is unique.

■ Well-planned portfolio driving sustainable growth. CMS’ sustainable growth is driven by its well-planned product portfolio. It has established a solid portfolio of fast-growing flagship and increasing new products through continuous licensing and M&A efforts. Further, CMS has added a second growth engine by acquiring Tianjin Precede to build its external agency sales platform. This will complement its current sales coverage and skills set.

■ Upside to margin expansion. CMS is one of the few healthcare companies enjoying both impressive revenue growth and margin expansion. Three main features highlight its margin upside: (1) a majority of the products have passed the investment phase and are waiting to reap the harvest; (2) an efficient operations track record and (3) the newly acquired agency sales platform offers additional margin upside.

■ Key risks include fierce competition, severe policy change, unsuccessful new products licensing and M&A.


4

6

8

10

Sep-11

8090100110120


The price relative chart measures performance against the HANG SENG INDEX which closed at 16294.7 on 03/10/11 On 03/10/11 the spot exchange rate was HK$7.79/US$1

Performance Over 1M 3M 12M Absolute (%) -12.9 -19.2 15.6 Relative (%) 6.5 8.5 43.6


Year 12/10A 12/11E 12/12E 12/13E Revenue (US$ mn) 132.2 224.5 330.8 454.0 EBITDA (US$ mn) 39.2 70.1 108.2 151.6 EBIT (US$ mn) 37.7 64.8 100.5 142.1 Net income (US$ mn) 30.6 62.0 93.3 130.6 EPS (CS adj.) (US$) 0.03 0.05 0.06 0.08 Change from previous EPS (%) n.a. Consensus EPS (US$) n.a. — — — EPS growth (%) 39.0 52.0 25.9 39.9 P/E (x) 21.5 14.1 11.2 8.0 Dividend yield (%) 0.7 2.0 2.2 3.1 EV/EBITDA (x) 23.3 14.1 8.9 6.0 P/B (x) 3.2 2.3 2.3 1.9 ROE (%) 24.1 21.3 22.4 25.9 Net debt/equity (%) net cash net cash net cash net cash

Source: Company data, Thomson Reuters, Credit Suisse estimates.

*Stock ratings are relative to the relevant country benchmark. ¹Target price is for 12 months.

Research Analysts

Lefei Sun 852 2101 7658

[email protected]

Jinsong Du 852 2101 6589

[email protected]

Iris Wang 852 2101 7646

[email protected]

Rating OUTPERFORM Price (03 Oct 11, HK$) 5.05 Target price (HK$) 9.00¹ Chg to TP (%) 78.2 Market cap. (HK$ mn) 8,130 Enterprise value (US$ mn) 988.70 Number of shares (mn) 1,609.83 Free float (%) 29.7 52-week price range 7.08 - 3.79

06 October 2011


Financial summary Figure 65: Income statement Year-end 31 Dec (US$ mn) 2006 2007 2008 2009 2010 2011E 2012E 2013E

Sales 37.6 51.7 72.6 96.5 132.2 224.5 330.8 454.0

COGS (11.7) (18.1) (27.8) (35.6) (54.1) (100.7) (148.0) (201.9)

Gross profit 25.9 33.6 44.8 60.9 78.1 123.8 182.9 252.1

Selling expense (13.2) (13.9) (18.6) (24.8) (31.0) (44.4) (62.7) (85.3)

Administrative expense (5.1) (6.0) (6.9) (7.4) (9.5) (14.7) (19.7) (24.7)

R&D expense (2.3) (1.6) (2.3) (2.0)

Operating profit 5.4 12.1 16.9 26.6 37.7 64.8 100.5 142.1

Finance costs (0.1) (0.3) (0.2) (0.4) (0.6) (0.7) (1.1) (1.1)

Profit before tax 5.4 10.3 19.5 26.9 34.6 70.6 106.2 148.6

Net profit to CMS 4.0 8.7 14.9 20.7 30.6 62.0 93.3 130.6

Reported EPS ($ cent) - Diluted - 0.99 1.58 2.17 3.02 4.59 5.80 8.11

CS adjusted net profit 3.9 10.2 12.3 20.0 33.2 55.5 86.6 123.1

CS adjusted EPS ($ cent) - Diluted - 1.16 1.30 2.10 3.28 4.11 5.38 7.64


Figure 66: Balance sheet Year-end 31 Dec (US$ mn) 2006 2007 2008 2009 2010 2011E 2012E 2013E

Total current assets 21.9 47.8 55.0 77.1 204.6 210.0 248.8 339.8

Total non-current assets 5.1 7.2 15.5 13.7 18.6 237.4 271.2 303.2

Total assets 27.0 54.9 70.5 90.8 223.2 447.4 520.0 642.9

Total current liabilities 13.9 13.1 10.8 29.8 16.5 56.7 56.1 78.0

Total non-current liabilities 7.0 7.1 6.8 7.0 7.6 8.4

Total liabilities 13.9 13.1 17.8 36.8 23.2 63.7 63.7 86.5

Equity attributable to CMS 13.2 42.0 52.8 53.7 200.0 381.2 453.7 553.7

Non-controlling interests (0.1) (0.2) (0.1) 0.2 2.5 2.6 2.8

Total equity 13.1 41.8 52.7 53.9 200.0 383.7 456.4 556.5


Figure 67: Cash flow statement Year-end 31 Dec (US$ mn) 2006 2007 2008 2009 2010 2011E 2012E 2013E

Net cash from operating activities 8.0 6.6 10.2 15.5 11.2 53.9 86.3 132.5

Net cash from investing activities 3.9 (1.9) (1.7) (16.6) 10.1 (248.0) (39.4) (39.0)

Net cash from financing activities (7.6) 3.1 (7.2) (4.0) 97.1 140.6 (23.4) (34.7)

Net increase (decrease) in cash and cash equivalents 4.3 7.8 1.2 (5.1) 118.4 (53.5) 23.6 58.8

Effect of foreign exchange rate changes 0.3 0.9 1.3 0.1 0.5 3.0 2.5 2.0

Cash and cash equivalent at beginning of the year 4.4 8.9 17.6 20.1 15.1 134.0 83.5 109.6

Cash and cash equivalent at end of the year 8.9 17.6 20.1 15.1 134.0 83.5 109.6 170.4


Figure 68: Key ratios Year-end 31 Dec 2006 2007 2008 2009 2010 2011E 2012E 2013E

Profitability (%)

Gross margin 68.9 64.9 61.7 63.1 59.1 55.2 55.3 55.5

Operating margin 14.4 23.3 23.3 27.6 28.5 28.8 30.4 31.3

Net margin 10.7 16.8 20.6 21.4 23.1 27.6 28.2 28.8

Growth (%)

Sales growth 37.5 40.3 32.9 37.0 69.8 47.4 37.2

Gross profit growth 29.5 33.2 35.9 28.3 58.5 47.7 37.8

Net profit growth 116.4 72.1 38.4 47.9 102.8 50.5 39.9

Growth of CS adjusted net profit 160.3 20.5 63.4 65.7 67.3 56.0 42.1


06 October 2011


Asia Pacific / China Major Pharmaceuticals

Sino Biopharmaceutical Limited (1177.HK / 1177 HK)

COMPANY UPDATE

Proprietary drugs to drive sustainable growth ■ Proprietary drugs to drive 2011 growth. Sino Biopharm’s long-term R&D

commitments have started to pay off with superior growth. One of its proprietary drugs, Tianqingganmei, accounted for over 23% of revenue growth from 1H10-1H11 and is the company’s No.1 growth driver. We expect proprietary and first-to-market (FTM) generic drugs to be the main drivers of future growth and remain confident about its 30%-plus revenue growth.

■ Promising drug pipeline. Sino Biopharm has a robust pipeline which includes both “me-too” FTM drugs and proprietary drugs protected by IP. In 2Q11, it received the clinical trial permit for one of its leading proprietary drugs, Sinotecean, a first-line oncology drug with high growth potential. We believe its established R&D platform and rich pipeline will continue to be its core competencies.

■ First mover in new GMP upgrade. Sino Biopharm received the first new GMP licence in China for its manufacturing facility in Lianyungang, Jiangsu. This is a solid validation of its manufacturing quality and market leadership. With more proprietary and FTM drugs in the pipeline and the new GMP upgrade, the company’s first-mover advantage will strengthen, in our view.

■ Should enjoy a higher premium; reiterate OUTPERFORM. Given its strong in-house R&D capabilities with a balanced product portfolio and a robust pipeline, we believe Sino Biopharm’s high growth is sustainable. It is only trading at 15x 2012E EPS, implying 0.5 PEG; it should enjoy a higher premium than peers, and hence we reiterate our OUTPERFORM rating.


0

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Oct-09 Feb-10 Jun-10 Oct-10 Feb-11 Jun-11

0100200300400


The price relative chart measures performance against the MSCI CHINA F IDX which closed at 4540.14 on 03/10/11 On 03/10/11 the spot exchange rate was HK$7.79/US$1

Performance Over 1M 3M 12M Absolute (%) -2.2 -23.3 -29.5 Relative (%) 21.7 9.8 3.9


Year 12/10A 12/11E 12/12E 12/13E Revenue (HK$ mn) 4,086.1 5,600.9 7,429.0 9,730.3 EBITDA (HK$ mn) 937.0 1,101.9 1,462.5 1,922.6 EBIT (HK$ mn) 851.4 1,005.2 1,349.1 1,787.4 Net income (HK$ mn) 566.9 573.5 752.8 981.3 EPS (CS adj.) (HK$) 0.11 0.12 0.15 0.20 Change from previous EPS (%) n.a. 0 0 0 Consensus EPS (HK$) n.a. 0.11 0.14 0.19 EPS growth (%) 30.5 1.2 31.3 30.4 P/E (x) 19.2 19.0 14.5 11.1 Dividend yield (%) 3.6 2.9 3.8 4.9 EV/EBITDA (x) 10.0 8.7 6.5 4.9 P/B (x) 3.0 2.8 2.6 2.4 ROE (%) 18.5 15.2 18.7 22.5 Net debt/equity (%) net cash net cash net cash net cash

Source: Company data, Thomson Reuters, Credit Suisse estimates

*Stock ratings are relative to the relevant country benchmark. ¹Target price is for 12 months. [V] = Stock considered volatile (see Disclosure Appendix).

Research Analysts

Lefei Sun 852 2101 7658

[email protected]

Jinsong Du 852 2101 6589

[email protected]

Iris Wang 852 2101 7646

[email protected]

Rating OUTPERFORM Price (03 Oct 11, HK$) 2.20 Target price (HK$) 5.00¹ Chg to TP (%) 63.6 Market cap. (HK$ mn) 10,871 Enterprise value (HK$ mn) 9,556 Number of shares (mn) 4,941.46 Free float (%) 54.0 52-week price range 3.28 - 2.04

06 October 2011


Financial summary Figure 69: Income Statement and key ratio Year-end 31 Dec (RMB '000) 2007 2008 2009 2010 2011 2012 2013

Revenue 1,164,274 2,282,213 3,234,975 4,086,144 5,600,867 7,429,024 9,730,271

Gross Profit 958,510 1,808,968 2,595,339 3,301,286 4,341,430 5,616,659 7,077,196

EBITDA 275,269 555,935 799,681 937,020 1,199,611 1,575,103 2,014,217

EBIT 246,308 514,392 739,420 851,354 1,101,250 1,458,910 1,881,343

Net Profit 308,344 482,003 664,447 859,369 944,759 1,227,310 1,561,032

Diluted EPS 0.050 0.066 0.088 0.114 0.126 0.163 0.208

Dupont Analysis

Net Margin 19.3 13.0 12.3 13.9 10.2 10.1 10.1

Asset Turn 48.5 78.0 92.0 87.1 92.8 107.9 121.1

A/E Leverage 122.1 137.7 149.5 153.3 160.1 171.2 184.3

ROE (average) 11.4 14.0 16.9 18.5 15.2 18.7 22.5

Profitability

Gross Margin 82.3 79.3 80.2 80.8 77.0 76.7 76.4

Operating Margin 21.2 22.5 22.9 20.8 17.9 18.2 18.4

Net Margin 19.3 13.0 12.3 13.9 10.2 10.1 10.1

Growth

Gross Revenue Growth - 96.0 41.7 26.3 37.1 32.6 31.0

Gross Profit Growth - 88.7 43.5 27.2 30.6 32.1 30.5

EBITDA Growth - 102.0 43.8 17.2 17.6 32.7 31.5

Net Income Growth - 32.7 33.4 42.8 1.2 31.3 30.4


Figure 70: Balance sheet Year-end 31 Dec (RMB '000) 2007 2008 2009 2010 2011 2012 2013

Inventories 70,125 185,244 211,368 369,158 654,343 815,790 1,197,443

Trade receivable 199,751 359,288 479,034 625,908 969,955 1,228,222 1,757,505

Cash and Bank Balances 1,775,751 1,875,005 1,881,211 2,829,718 1,975,796 2,044,633 2,050,799

Current Assets 2,073,885 2,458,779 2,639,829 4,029,719 4,578,101 5,106,963 6,106,678

Non-Current Assets 508,214 808,601 1,126,492 1,591,117 1,871,384 2,210,804 2,642,336

Total assets 2,582,099 3,267,380 3,766,321 5,620,836 6,449,486 7,317,767 8,749,013

Trade payable 36,167 74,413 123,092 159,515 334,589 329,342 551,447

Short term loan 36,980 102,222 1,136 28,236 42,144 42,144 42,144

Current Liabilities 323,600 579,619 687,004 1,095,560 1,583,247 1,956,897 2,651,558

Non-Current Liabilities 38,196 35,827 51,373 223,728 223,728 223,728 223,728

Total liabilities 361,796 615,446 738,377 1,319,288 1,806,975 2,180,625 2,875,286

Share Capital 56,599 56,599 113,198 123,916 123,916 123,916 123,916 Reserves 1,917,370 2,127,050 2,265,491 3,424,636 3,689,709 3,919,595 4,313,137

Total Capital and Reserves 2,019,248 2,228,928 2,474,348 3,647,685 3,892,475 4,147,019 4,571,982


Figure 71: Cash flow statement Year-end 31 Dec (RMB '000) 2007 2008 2009 2010 2011 2012 2013

Cash Flow from Operating (2,483) (114,636) (27,441) (473,108) (209,814) (103,301) (320,461)

Cash Flow from Investing (142,796) (154,514) (320,607) (1,346,688) (390,199) (462,580) (576,441)

Cash Flow from Financing (134,177) (177,783) (412,449) 647,265 (475,839) (679,999) (876,220)

Net (decrease)/increase in cash (24,490) 83,250 (46,364) (196,752) (134,550) 68,838 6,165

Cash at the end of year 1,680,287 1,794,727 1,738,980 1,619,122 1,484,573 1,553,410 1,559,576


06 October 2011


Asia Pacific / China Major Pharmaceuticals

Shanghai Pharmaceuticals Holding Co., Ltd. (2607.HK / 2607 HK)

COMPANY UPDATE

Neglected assets in pharma manufacturing ■ Under-appreciated market leadership. Although the drug distribution

business has contributed more to its strong growth, Shanghai Pharma is the country’s third-largest drug manufacturer. Also, the company has a diversified product portfolio, with 18 products reaching over Rmb100 mn in annual sales. Furthermore, management plans to develop its manufacturing business by strategic M&A and R&D. We believe its market leadership is under-appreciated and the company has higher growth potential than what the market expects.

■ R&D efforts underestimated. Shanghai Pharma has been committed to pharmaceuticals R&D for years. By leveraging government support and its internal resources, the company has built one of the largest in-house R&D teams and established solid collaboration with innovative research organisations and leading research institutes. According to management, select high-potential proprietary drugs are in the pipeline. We believe the company’s R&D efforts in pharmaceuticals are underestimated—it could offer a growth platform for a sustainable future.

■ Potential upside from M&A. The company is actively looking for sizeable M&A opportunities to strengthen its product portfolio and market presence. According to management, any strategic M&A with a pharma company could be a positive catalyst.

■ Maintain OUTPERFORM. Given Shanghai Pharma’s market leadership and integrated business model with potential upside from future M&A, and the stock trading at 13x 2012E EPS with limited premium to peers, we maintain our OUTPERFORM rating and HK$24.30 target price, and recommend that investors accumulate the stock at current levels.


1618202224

Jun-11

60

80

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120Price (LHS) Rebased Rel (RHS)

The price relative chart measures performance against the MSCI CHINA F IDX which closed at 4540.14 on 03/10/11 On 03/10/11 the spot exchange rate was HK$7.79/US$1

Performance Over 1M 3M 12M Absolute (%) -4.9 -26.9 — Relative (%) 19.0 6.3 —


Year 12/10A 12/11E 12/12E 12/13E Revenue (Rmb mn) 37,381.6 52,694.3 67,602.4 83,195.1 EBITDA (Rmb mn) 2,417.4 3,062.8 4,437.3 5,991.6 EBIT (Rmb mn) 2,038.4 2,611.8 3,870.3 5,314.7 Net income (Rmb mn) 1,350.8 1,802.6 2,715.0 3,630.5 EPS (CS adj.) (Rmb) 0.50 0.67 1.01 1.35 Change from previous EPS (%) n.a. 0 0 0 Consensus EPS (Rmb) n.a. 0.76 0.89 1.13 EPS growth (%) 81.0 33.5 50.6 33.7 P/E (x) 25.6 19.1 12.7 9.5 Dividend yield (%) 0.91 0.59 0.72 0.99 EV/EBITDA (x) 3.5 1.2 0.8 0.4 P/B (x) 3.8 1.7 1.5 1.3 ROE (%) 15.5 12.0 12.2 14.5 Net debt/equity (%) net cash net cash net cash net cash

Source: Company data, Thomson Reuters, Credit Suisse estimates.

*Stock ratings are relative to the relevant country benchmark. ¹Target price is for 12 months. [V] = Stock considered volatile (see Disclosure Appendix).

Research Analysts

Lefei Sun 852 2101 7658

[email protected]

Jinsong Du 852 2101 6589

[email protected]

Iris Wang 852 2101 7646

[email protected]

Rating OUTPERFORM* [V] Price (03 Oct 11, HK$) 15.68 Target price (HK$) 24.30¹ Chg to TP (%) 55.0 Market cap. (HK$ mn) 12,009 Enterprise value (Rmb mn) 3,809 Number of shares (mn) 765.89 Free float (%) 85.7 52-week price range 23.0 - 15.6

06 October 2011


Financial summary Figure 72: Income statement Year-end 31 Dec (Rmb mn) 2008 2009 2010 2011E 2012E 2013E

Turnover 27,441 31,228 37,382 52,694 67,602 83,195

- Pharmaceuticals 6,014 6,370 7,012 9,071 12,235 15,825

- Distribution & supply chain 19,684 23,118 28,348 41,329 52,788 64,471

- Retail 1,414 1,522 1,726 1,984 2,252 2,556

- Others 329 219 296 311 326 343

Gross profit 5,174 5,816 6,658 8,287 10,915 13,833

Operating profit 1,177 1,440 2,038 2,612 3,870 5,315

Net profit 697 1,297 1,368 2,248 2,715 3,631

Core net profit 696 746 1,351 1,803 2,715 3,631


Figure 73: Balance sheet Year-end Dec 31 (Rmb mn) FY08 FY09 FY10A FY11E FY12E FY13E

Cash 3,266 4,887 6,338 8,108 8,237 9,511

Inventories 3,431 3,701 5,041 6,956 8,247 9,983

A/c receivables 5,499 6,078 8,581 11,593 14,399 17,305

Net fixed assets 4,077 4,052 4,101 10,658 13,606 16,257

Total assets 19,781 21,875 28,241 41,849 49,412 58,395

Short-term debt 3,771 3,332 4,818 2,018 2,018 2,018

Accounts payable 6,685 7,461 10,912 14,754 18,929 23,295

Long-term debt 113 84 66 66 66 66

Total liabilities 10,959 11,439 16,357 17,792 22,167 26,850

Total equities 8,823 10,435 11,884 24,057 27,245 31,544


Figure 74: Cash flow statement Year-end Dec 31 (Rmb mn) FY08 FY09 FY10A FY11E FY12E FY13E

Pre-tax profit (ex. one-off items) 1,204 1,579 2,155 2,808 4,196 5,673

Gross cash flow 1,068 1,399 1,845 2,692 3,772 5,127

Net capex (594) (960) (3,571) (7,008) (3,515) (3,328)

Free cash flow 475 367 (2,118) (5,401) 333 1,524

Net cash flow (618) 1,621 1,451 1,770 129 1,274


Figure 75: Key ratios Year-end Dec 31 FY08 FY09 FY10A FY11E FY12E FY13E

Turnover growth (%) 13.8 19.7 41.0 28.3 23.1

Net profit growth (%) 86.1 5.5 64.3 20.8 33.7

EPS growth (%) 86.1 (67.8) 54.0 18.4 33.7

Gross margin (%) 18.9 18.6 17.8 15.7 16.1 16.6

EBIT margin (%) 4.3 4.6 5.5 5.0 5.7 6.4

Net profit margin (%) 2.5 4.2 3.7 4.3 4.0 4.4

Dividend payout ratio (%) 3.7 8.0 23.0 9.0 9.2 9.4

ROE (%) 9.9 16.9 15.7 15.0 12.2 14.5

ROA (%) 3.5 6.2 5.5 6.4 5.9 6.7

Inventory turnover (days) 54 54 54 51 51 50

A/c receivable collection period (days) 65 64 66 62 62 62

A/c payable payment period (days) 70 72 83 81 81 83


06 October 2011


Investment risks We highlight the following potential key risk factors related to China’s pharma market:

■ Policy risks: China’s pharma market is regulated by the government—from drug registration, hospital tendering to pricing and reimbursement, any material changes in the policy framework could place new risks to the industry players.

■ Competition risks: China’s pharma market is a fragmented market with over 4,000 manufacturers. With fierce or irrational competition from competitors, any company or even the industry could be affected.

■ Operational risks: A pharmaceutical company’s success is subject to significant operational risks, including management’s ability to implement its business strategies. We believe any delay, inappropriate implementation or key personnel loss is also a potential risk to the company.

■ Drug risks: A pharmaceutical company’s success relies on enhancing existing drugs as well as developing new ones. If a marketed drug is alleged to be unsafe, the company may have to recall its drugs. We believe this may materially affect the company’s financial conditions and reputation.

■ Pipeline risks: The company’s pipeline is important for its future success and business continuity. Any delay or failure in pipeline development can negatively impact the company’s financial condition. However, drug development has a high failure rate and most Chinese pharmaceutical companies have limited R&D capabilities and resources for innovative drug R&D. We believe this could be one of the key risks for the industry.

■ IP infringement risks: The IP law enforcement is improving in China, but IP infringement continues to be a risk. On the other hand, China is dominated by generic drugs and select companies may have IP dispute with the original multinational developers. The specific dispute may materially impact the company’s financial condition. We believe this is one of the risks for the industry.

■ Compliance risks: There are specific legal or regulatory requirements that qualify the industry players to conduct the business in China’s pharma market such as good-manufacturing-practice (GMP), good-supply-practice (GSP) and drug registration certificates. Further, the players need to follow anti-bribery regulations during drug distribution and commercialisation. We believe any violation of these requirements may be a risk to the company’s financial condition and reputation.

06 October 2011


Appendix: China pharma market overview Hospital accounts for majority of pharma market If we categorise China’s pharma market by end dispensing channel, we can divide it into three key segments. This also represents different target markets for different companies. Significant drugs are still dispensed through hospitals from tier 1 cities to county hospitals in rural areas. The second channel is from pharmacies which dispense most OTC drugs. The third and an emerging segment is the grass-roots market, which mainly comprises city community centre, rural healthcare institutions and village clinics.

■ Rx market: Product-driven hospital market; dominating channel with over 60% share

■ Ox market: Brand-driven consumer market; supplementary channel with 23% share

■ Gx market: Volume-driven grass-roots market; emerging channel with 17% share

Figure 76: Hospitals accounted for 60% of drugs sales in China

Hospitals60%

Retail drugstores23%

Community Health centers

17%

Source: Menet 2010

06 October 2011


Five-level competition’ to win in China hospital pharma market Figure 77: Five-tier commercialisation barriers to overcome

Drug Registration

HospitalListing

GovernmentTender

PhysicianPrescription

Patient Purchase

InsurancePrograms

Pricing

Out-of-pocket

•More stringent •30+ tenders to bid

Key Barriers

Time Frame

•20k hospitals to penetrate •One drug two formulations required

•2 million+ physician pool to target

•13bn population to cover

2-5 years In general, once per year for each tender

In general, once per year for each hospital

Frequent visit /detailing required

•Limited affordability•Multiple insurance programs

Reimbursement list is not regulatory updated. If missed, need to wait for years

*Note: above is rough estimation. The market varies a lot in local level and evolves quickly

Drug Registration

HospitalListing

GovernmentTender

PhysicianPrescription

Patient Purchase

InsurancePrograms

Pricing

Out-of-pocket

•More stringent •30+ tenders to bid

Key Barriers

Time Frame

•20k hospitals to penetrate •One drug two formulations required

•2 million+ physician pool to target

•13bn population to cover

2-5 years In general, once per year for each tender

In general, once per year for each hospital

Frequent visit /detailing required

•Limited affordability•Multiple insurance programs

Reimbursement list is not regulatory updated. If missed, need to wait for years

*Note: above is rough estimation. The market varies a lot in local level and evolves quickly

Note: For innovative new drugs the drug registration time frame could be much longer

Source: Credit Suisse estimates

Conquering China’s pharma market is not an easy task. There are at least five challenging commercialisation barriers to address that range from drug registration, hospital tendering, and hospital listing to retaining physician prescription and patient usage. The following are the key steps. Investors could use this a yardstick to evaluate which players are outperforming peers along these dimensions:

■ Product portfolio: The company should not rely on a single drug but should be backed up by a group of balanced drugs. The drug should ideally address China’s huge unmet medical needs with a unique differentiation (e.g., drugs targeting mass market with significant patient pool and chronic diseases such as diabetes, oncology, cardiovascular diseases and stroke). It should be tailored to local market needs and fit in domestic physician prescribing preferences.

■ Registration: The speed to launch a new drug is important for success. This requires local regulatory know-how and effective R&D capabilities. It’s a coherent capability to plan ahead and effectively manage R&D and regulatory pathway. Since registration policy changes from time to time and requires local interpretation, the company needs to understand local regulatory know-how to cost-effectively build a high-potential pipeline. For example, some of “me-better” products could be granted China compound IP but may not meet global requirement, but that is good enough to defend competition and capture commercial value.

■ Tendering/Pricing/Reimbursement: Wining government tenders at a favourable pricing and inclusion of national/provincial drug reimbursement list are critical for a product’s commercialisation. Understand local regulatory policy framework and have a strong execution team, as there are 30+ provincial tendering schemes. China has significantly improved medical insurance coverage via national programmes. Three main insurance schemes are in the process improvement. This will not only cover more population but also will increase each patient’s affordability for drug consumptions.

■ Hospital listing: Hospital is still the dominating drug dispensing channel, and physicians and hospitals are the ultimate key decision makers for drug prescription. Expanding hospital coverage and affordable patient pool will be critical to expanding drug sales. Companies need a strong commercialisation network to extensively cover hospitals and reach a broader affordable patient pool with an appropriate pricing strategy and/or by enlisting on RDL.

06 October 2011


■ Physician prescription: Compelling drug effectiveness and risk profile with differentiated drug positioning, key opinion leader’s endorsement and effective physician/patient educations are all the desired actions to retain physician prescription preferences. Physician and patient education are important drivers to increase product awareness and prescription adaptation.

06 October 2011


Companies Mentioned (Price as of 03 Oct 11) 3SBio Inc. (SSRX, $11.14) AstraZeneca (AZN.L, 2866 p, UNDERPERFORM, TP 3,000.00 p) Bayer (BAYGn.DE, Eu40.58, OUTPERFORM, TP Eu55.00) Beijing SL Pharmaceutical Co. Ltd. (002038.SZ, Rmb32.35) Beijing Tongrentang Co. Ltd (600085.SS, Rmb13.66) Bristol-Myers Squibb (BMY, $31.49, NEUTRAL, TP $34.00) China Medical System Holdings Ltd. (0867.HK, HK$4.72, OUTPERFORM, TP HK$9.0) China Nuokang Bio-Pharmaceutical Inc (NKBP.OQ, $4.47) China Pharmaceutical Group Limited (1093.HK, HK$1.76) China Shineway Pharmaceutical Group Ltd (2877.HK, HK$9.01) Eli Lilly (LLY, $36.33, NEUTRAL, TP $39.00) GlaxoSmithKline (GSK.L, 1329 p, NEUTRAL, TP 1,310.00 p) Guangxi Wuzhou Zhongheng Group Co Ltd (600252.SS, Rmb12.55) Harbin Pharmaceutical Group Company Ltd (600664.SS, Rmb9.24) Jiangsu Hengrui Medicine Co Ltd (600276.SS, Rmb29.06) Kangmei Pharm (600518.SS, Rmb14.15) Lee's Pharmaceutical Holdings Ltd (0950.HK, HK$2.53) Lijun International Pharmaceutical Holding Ltd (2005.HK, HK$0.68) Merck & Co. (MRK, $31.57, OUTPERFORM, TP $44.00) Modern Pharm (600420.SS, Rmb12.17) Pfizer (PFE, $17.33, OUTPERFORM, TP $23.00) Roche (ROG.VX, SFr146.80, NEUTRAL, TP SFr150.00) Sanofi (SASY.PA, Eu49.01, OUTPERFORM, TP Eu56.00) Shanghai Fosun Pharmaceutical Group Co Ltd (600196.SS, Rmb9.35) Shanghai Pharmaceuticals Holding Co Ltd (601607.SS, Rmb14.52) Shanghai Pharmaceuticals Holding Co., Ltd. (2607.HK, HK$15.68, OUTPERFORM [V], TP HK$24.30) Shenzhen Salubris Pharmaceuticals Co Ltd (002294.SZ, Rmb32.17) Sihuan Pharmaceutical Holdings Group Ltd. (0460.HK, HK$2.55, OUTPERFORM, TP HK$5.0) Simcere Pharmaceutical Group (SCR.N, $9.18) Sino Biopharmaceutical Limited (1177.HK, HK$2.20, OUTPERFORM [V], TP HK$3.60) Tianjin Tasly Pharmaceutical Co Ltd (600535.SS, Rmb39.66) Tong Ren Tang Technologies (1666.HK, HK$6.59) United Laboratories International Holdings Ltd (3933.HK, HK$5.69) Wuhan Humanwell Healthcare (Group) Co. Ltd. (600079.SS, Rmb21.48) Yunnan Baiyao Group Co Ltd (000538.SZ, Rmb56.50) Zhejiang Hisun Pharmaceutical Co Ltd (600267.SS, Rmb32.96)

Disclosure Appendix Important Global Disclosures I, Lefei Sun, certify that (1) the views expressed in this report accurately reflect my personal views about all of the subject companies and securities and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.

See the Companies Mentioned section for full company names.

06 October 2011


3-Year Price, Target Price and Rating Change History Chart for 0867.HK 0867.HK Closing

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06 October 2011



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The analyst(s) responsible for preparing this research report received compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities. Analysts’ stock ratings are defined as follows: Outperform (O): The stock’s total return is expected to outperform the relevant benchmark* by at least 10-15% (or more, depending on perceived risk) over the next 12 months. Neutral (N): The stock’s total return is expected to be in line with the relevant benchmark* (range of ±10-15%) over the next 12 months. Underperform (U): The stock’s total return is expected to underperform the relevant benchmark* by 10-15% or more over the next 12 months. *Relevant benchmark by region: As of 29th May 2009, Australia, New Zealand, U.S. and Canadian ratings are based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return potential within an analyst’s coverage universe**, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. Some U.S. and Canadian ratings may fall outside the absolute total return ranges defined above, depending on market conditions and industry factors. For Latin American, Japanese, and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; for European stocks, ratings are based on a stock’s total return relative to the analyst's coverage universe**. For Australian and New Zealand stocks, 12-month rolling yield is incorporated in the absolute total return calculation and a 15% and a 7.5% threshold replace the 10-15% level in the Outperform and Underperform stock rating definitions, respectively. The 15% and 7.5% thresholds replace the +10-15% and -10-15% levels in the Neutral stock rating definition, respectively. **An analyst's coverage universe consists of all companies covered by the analyst within the relevant sector. Restricted (R): In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances. Volatility Indicator [V]: A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward.

Analysts’ coverage universe weightings are distinct from analysts’ stock ratings and are based on the expected performance of an analyst’s coverage universe* versus the relevant broad market benchmark**: Overweight: Industry expected to outperform the relevant broad market benchmark over the next 12 months. Market Weight: Industry expected to perform in-line with the relevant broad market benchmark over the next 12 months. Underweight: Industry expected to underperform the relevant broad market benchmark over the next 12 months. *An analyst’s coverage universe consists of all companies covered by the analyst within the relevant sector. **The broad market benchmark is based on the expected return of the local market index (e.g., the S&P 500 in the U.S.) over the next 12 months. Credit Suisse’s distribution of stock ratings (and banking clients) is:

Global Ratings Distribution Outperform/Buy* 49% (61% banking clients) Neutral/Hold* 39% (56% banking clients) Underperform/Sell* 9% (55% banking clients) Restricted 2%

*For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, and Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis. (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdings, and other individual factors.

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06 October 2011


Credit Suisse does not provide any tax advice. Any statement herein regarding any US federal tax is not intended or written to be used, and cannot be used, by any taxpayer for the purposes of avoiding any penalties.

See the Companies Mentioned section for full company names. Price Target: (12 months) for (0867.HK) Method: Our target price of HK$9.0 conservatively based on only 20x 2012E EPS and 0.4 PEG (using 45% 2011-2013E CAGR) implying 78% upside. We believe CMS deserves to trade at a higher multiple of 20-22, given its 40% plus earning growth momentum in the next three years and its established, largest third-party academic commercialisation network. Furthermore, our PEG target is still below the industry average for its HK listed peers. Risks: Our target price of China Medical System is HKD 9.0. The key risks include: 1) Shareholder structure risks. Chairman Lam Kong remains dominant with a 50.33% stake in the company, implying related transaction, liquidity and transparency risks. 2) M&A risks. CMS has carried out sizeable M&A and actively looks for M&A opportunities to expand into new businesses and sustain growth. It may fail to integrate the acquired target effectively. 3) Business model risks. CMS has contracted with small and medium western pharma companies or local companies to obtain product selling rights for China. There are risks of a business disruptions if suppliers cancel such contracts for unexpected reasons. 4) Product risks. If a product is alleged to be unsafe or produces a severe adverse drug reaction or side effects, the company may have to recall such a product. We believe this will materially affect the company's finances and reputation. 5) Pipeline risks. CMS invests actively in innovative drug R&D. Any failure in key pipeline product development could materially impact the company's financial condition. 6) Key personnel risks. CMS's success depends on the continued service of its senior management team, as well as key personnel from the R&D and sales and marketing departments from its principal operating subsidiaries. Any significant changes in this area could impact its financial condition. 6) Policy risks. The Chinese pharmaceutical market is under tightening regulatory control by the government from product registration, pricing, tendering, to reimbursement and business conduct. 7) Competition risks. The Chinese pharmaceutical market is highly fragmented and CMS faces increasing competition. 8) Regulatory compliance risks. In order to operate in China's pharmaceutical market, CMS needs to meet compliance requirements under multiple schemes including good manufacturing permit (GMP), environmental regulations, ethical business conduct, and anti-corruption regulations. Any violation or adverse event could materially impact CMS's financial condition and reputation. Price Target: (12 months) for (2607.HK) Method: Our target price of HK$24.3 for Shanghai Pharmaceuticals is based on 20x 2012E core profit 1.01 RMB (1.22 HKD) Risks: Our target price for Shanghai Pharmaceuticals is HK$24.3, key risks include (1) operational risks; (2) risks from competition; (3) policy risks; (4) acquisition risks; (5) orders risks; (6) product risks; (7) elimination or changes to incentives; and (8) key personnel risks. Price Target: (12 months) for (0460.HK) Method: Our target price of HK$5.0 is based on 18x 2012E EPS and PEG at 0.5 Risks: Key risks include delayed tendering, a non-transparent structure, drastic policy changes and unsuccessful M&A. Price Target: (12 months) for (1177.HK) Method: Globally Credit Suisse widely uses proprietary "PharmaValue" method for valuation of pharmaceutical companies. We have applied this NPV/DCF-based valuation approach for Sino Biopharm by projecting each of its 30-plus market and pipeline products to derive the fair value reference. Our target price of HK$3.6 per share is based on HK$17.64 billion total NPV of SBP's marketed products. Risks: Key investment risks to our target price include: (1) holding company structure, (2) business diversification, (3) unsuccessful M&A, and (4) severe price cuts. Our target price for Sino Biopharm is HK$3.60 Please refer to the firm's disclosure website at www.credit-suisse.com/researchdisclosures for the definitions of abbreviations typically used in the target price method and risk sections.

See the Companies Mentioned section for full company names. The subject company (0867.HK) currently is, or was during the 12-month period preceding the date of distribution of this report, a client of Credit Suisse. Credit Suisse provided investment banking services to the subject company (0867.HK) within the past 12 months. Credit Suisse expects to receive or intends to seek investment banking related compensation from the subject company (1177.HK, 0460.HK, 0867.HK) within the next 3 months. As of the date of this report, Credit Suisse Securities (USA) LLC makes a market in the securities of the subject company (0867.HK). As of the end of the preceding month, Credit Suisse beneficially owned 1% or more of a class of common equity securities of (0867.HK). This holding is calculated according to U.S. regulatory requirements which are based on Section 13(d) of the Securities and Exchange Act of 1934. Important Regional Disclosures Singapore recipients should contact a Singapore financial adviser for any matters arising from this research report.

The analyst(s) involved in the preparation of this report have not visited the material operations of the subject company (0867.HK, 2607.HK, 0460.HK, 1177.HK) within the past 12 months.

Restrictions on certain Canadian securities are indicated by the following abbreviations: NVS--Non-Voting shares; RVS--Restricted Voting Shares; SVS--Subordinate Voting Shares. Individuals receiving this report from a Canadian investment dealer that is not affiliated with Credit Suisse should be advised that this report may not contain regulatory disclosures the non-affiliated Canadian investment dealer would be required to make if this were its own report. For Credit Suisse Securities (Canada), Inc.'s policies and procedures regarding the dissemination of equity research, please visit http://www.csfb.com/legal_terms/canada_research_policy.shtml.

The following disclosed European company/ies have estimates that comply with IFRS: AZN.L, BMY, SASY.PA.

As of the date of this report, Credit Suisse acts as a market maker or liquidity provider in the equities securities that are the subject of this report.

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Principal is not guaranteed in the case of equities because equity prices are variable. Commission is the commission rate or the amount agreed with a customer when setting up an account or at anytime after that. Taiwanese Disclosures: Reports written by Taiwan-based analysts on non-Taiwan listed companies are not considered recommendations to buy or sell securities under Taiwan Stock Exchange Operational Regulations Governing Securities Firms Recommending Trades in Securities to Customers.

To the extent this is a report authored in whole or in part by a non-U.S. analyst and is made available in the U.S., the following are important disclosures regarding any non-U.S. analyst contributors: The non-U.S. research analysts listed below (if any) are not registered/qualified as research analysts with FINRA. The non-U.S. research analysts listed below may not be associated persons of CSSU and therefore may not be subject to the NASD Rule 2711 and NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account. • Lefei Sun, non-U.S. analyst, is a research analyst employed by Credit Suisse (Hong Kong) Limited. • Jinsong Du, non-U.S. analyst, is a research analyst employed by Credit Suisse (Hong Kong) Limited. • Iris Wang, non-U.S. analyst, is a research analyst employed by Credit Suisse (Hong Kong) Limited. For Credit Suisse disclosure information on other companies mentioned in this report, please visit the website at www.credit-suisse.com/researchdisclosures or call +1 (877) 291-2683. Disclaimers continue on next page.

06 October 2011 Asia Pacific / China

Equity Research

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China Pharma Sector - Credit Suisse