3-S Bio ( Nasdaq - SSRX ) -- Shrugs Off Regulatory Threat

3-S Bio (SSRX $14.00) reported excellent on target Q4 results.  The company is a leading provider of nephrology and oncology drugs in China.  Management consists of American trained scientists.  Products are developed internally and in collaboration with international pharmaceutical companies.  3-S Bio has plenty of industry knowledge and marketing talent.  The company doesn't rely on the Central Government.  Above average growth has been sustained with merit.  Earnings doubled in the December quarter to $.16 a share.  Last year's figure was reduced by a one time licensing fee.  Excluding that, income improved 23%.  Sales advanced faster than we predicted, at a 45% rate, to $22.2 million.  The Chinese health care reform law expanded the potential market, bolstering unit volume.  Performance was enhanced by aggressive marketing efforts.  Margins were reduced by lower reimbursement rates that were part of the new law.  3-S Bio also suffered from over capacity.  The company tripled its manufacturing potential in 2010.  Utilization rates were in the 30%-40% range in 2011, allowing depreciation and other fixed costs to depress margins.

Another round of Government mandated price reductions is likely.  Our estimates reflect an across the board cut of 8%-10%.  That's probably a worst case scenario.  3-S Bio will offset some of that with lower unit costs.  Volume is poised to expand, as well.  Reliable numbers are hard to come by but the company estimates only 10%-20% of the Chinese population receives the kind of drugs the company makes.  As the society modernizes and more citizens take advantage of the national health care law the penetration rate could rise materially.

A recent deal with U.S. based Davita validates the company's legitimate status.  Davita is the largest provider of independent kidney dialysis centers with more than 1,800 locations in the United States.  It established a joint venture with 3-S Bio in March to create a similar operation in China.  The initial investment is $20 million, 70% supplied by Davita, 30% by 3-S Bio.  Profits will be shared using those percentages, as well.  3-S Bio will earn extra income by supplying the essential drugs to the venture.  The initial foray will encompass two provinces comprising 5% of the country's total population.  Even that probably will take 2-3 years to really get rolling.  But the long term potential is enormous.  The deal also should make it easier for 3-S Bio to establish partnerships with other American companies that want to break into the Chinese health care market.

We estimate 2012 sales will advance 16% to $100 million.  A stronger performance is possible if the Government slashes prices less than we predict, or unit volume accelerates.  Exports totalled 4% of 2011 sales.  They could jump, as well.  Earnings appear headed to $.90 a share (+17%).  At year end cash and equivalents stood at $5.53 a share ($122 million).  So 3-S Bio has plenty of flexibility to make investments if the opportunity arises.

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