3-S Bio ( Nasdaq - SSRX ) - Mexican Standoff

3-S Bio (SSRX $13.50) remains subject to a $15.00 per share buyout offer.  A China based private equity firm launched the all cash offer in September.  That group is believed to report to the Central Government, which provides some or all of its funding.  3-S Bio's chief executive officer is part of the buyout group, as well.  One purpose for the transaction is to leave the U.S. stock market.  Several Chinese companies have been pursued by short selling groups.  Even the Securities and Exchange Commission has given greater scrutiny to Chinese accounting practices.  Many of those challenges have proven correct.  But valuations of China based companies have declined across the board.  There's no evidence 3-S Bio is involved with any shady practices.  Yet its shares trade at an unusually low valuation due to the cloud cast over Chinese stocks in general.

A two thirds majority of shareholders is required to accept the offer.  Several funds that own the stock have been reluctant to agree to the $15.00 a share price.  The bone of contention is that 3-S Bio would be worth $25-$30 a share under normal circumstances.  The company holds $7.00 a share in cash.  It earns about $1.00 a share.  It has a leading position in a high growth industry, suggesting a P/E multiple of 18x-25x plus the cash value.

That valuation might be too high considering 3-S Bio is subject to price controls.  The Chinese government sets the price 3-S Bio can sell its products at.  Those prices have been regularly lowered in the past.  And another round of cuts is slated for 2013.  3-S Bio already prices its products well below the legal maximum.  So it won't have to go down as much percentage wise as the new rules suggest.  But there will be some pressure on margins over the next few quarters.  3-S Bio expanded capacity 200% a few years ago.  So margins are likely to rebound in the future as volume expands.  Income growth may moderate in 2013 but the long term outlook remains positive.

3-S Bio also is engaged in a joint venture with U.S. based Davita, the world's leading dialysis provider.  3-S Bio will deliver some of the drugs used by Davita in China.  The U.S. company is creating a national network of dialysis centers.  While the Central Government could harass 3-S Bio if it turns down the buyout offer, doing so might raise concerns at Davita.  That might be especially true if the government singled out 3-S Bio for special treatment.

The chief executive officer is in an awkward position.  Right now he is part of the buyout group.  But he still has a fiduciary responsibility to his existing shareholders.  How everything plays out remains to be seen.  Our guess is that the share price will hold up even if the deal falls through. 

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