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.

( Click on Table to Enlarge )



3-S Bio ( Nasdaq - SSRX ) -- Potential Price Reductions in China

3-S Bio (SSRX $9.75) appears on track to report excellent on target Q4 results.  The outlook for 2012 is a little uncertain, however, due to the likelihood of new price regulations by the Chinese government.  The last time that happened a modest cut was implemented but 3-S Bio benefited from a significant expansion in coverage.  Technically speaking, most of China's population now is covered by the national health insurance law.  But a large percentage still aren't taking full advantage of that for one reason or another.  Lack of awareness, bureaucratic inertia, and de facto quotas are primarily responsible.  Another round of price cuts is possible.  But those are likely to be paired with measures to achieve higher unit volume volume.  Margins may narrow a shade but overall profitably is unlikely to be affected.  3-S Bio has products that are capable of competing on the international stage without government support.  It's a high quality operation that promises to thrive over the long haul as China becomes a fully modernized society.  Trading at 11x our estimate of 2012 earnings these  shares offer substantial appreciation potential.

( Click on Table to Enlarge )



3S Bio ( Nasdaq - SSRX ) -- Clear Sailing

3S Bio (SSRX $12.00) reported excellent on target Q3 results.  Earnings advanced 53% to $.23 a share.  Sales improved 33% to $63.0 million.  3S Bio is a leading Chinese biopharamceutical producer.  Its two lead products are internally developed improvements on TPO, the breakthrough product invented by Amgen three decades ago.  Those products account for approximately 90% of total sales.  Applications are primarily in cancer treatment and dialysis, same as the original.  3S Bio is the leading provider in China because the company performed the necessary clinical trials there, and developed an effective direct sales force.  Last year 3S Bio quadrupled the size of its manufacturing facilities.  The expansion was certified by government inspectors early in 2011.  Depreciation charges and start-up costs impacted earnings in Q1.  Rising volume overtook those costs in the June period.  Further gains were realized in the latest period.

New products are in the pipeline.  3S Bio bought the Chinese rights to several candidates last year.  Clinical trials are underway.  Approvals could start to be obtained in 2014.  Meantime, the company has expanded its sales efforts in China.  The new health law curtailed prices somewhat in 2010.  But it also broadened the potential market.  The population in China is aging, reinforcing the trend.  3S Bio has begun to pursue international markets more aggressively, as well.  The company is addressing emerging markets like Turkey and Egypt with its low cost high performing products.  Exports represented 4% of the total in Q3, up 57% from the year ago quarter.

Fourth quarter results usually decline on a sequential basis.  A strong performance is likely all the same.  We estimate full year earnings will reach $.75 a share (+34%) on sales of $80 million (+26%).  R&D costs should expand in 2012 as the company's new products enter bigger rounds of clinical testing.  Gross margins might improve, though, as greater manufacturing efficiencies are realized.  3S Bio still is operating at less than 50% of capacity.  There aren't any upcoming reimbursement issues on the table, but another reduction might be enforced at some point as volume continues to build.  We estimate 2012 income will advance 20%-27% to $.90-$.95 a share on sales of $100-$105 million (+25%-31%).  New products could amplify performance over the long haul.  3S Bio is run by U.S. trained scientists and is well equipped to operate on the world stage without the state's helping hand.  As it becomes more entrenched Western drug companies might view it as an attractive distribution partner.

( Click on Table to Enlarge )



3S Bio ( Nasdaq - SSRX ) -- Follow-up Report

3S Bio (SSRX $18.00) reported excellent on target Q1 results.  Sales advanced 28% to $18.1 million.  The rising Chinese currency accounted for 5% of that increase.  If the RMB keeps advancing against the U.S. Dollar further translation benefits will accrue.  Earnings dipped to $.15 a share.  Higher depreciation charges on the company's new manufacturing facility impacted profit margins.  That plant quadrupled 3S Bio's capacity, of which 30%-35% currently is being used.  The company also increased wages, hired more sales people, and lifted R&D spending on new drugs.  3S Bio additionally laid the groundwork to increase export operations, targeting emerging markets like Malaysia, Turkey, South Africa, and Egypt.  The company will take on Western pharmaceutical makers with lower cost alternatives.  3S Bio is one of the few companies in China that already has the ability to compete head to head with Western corporations on the world stage.  The combination of top notch science and low costs promise to fuel growth even after the government protections that help run of the mill Chinese companies fade over time.

Our 2011 estimates are unchanged.  Earnings could reach $.75 a share on sales of $80 million.  Margins should improve in upcoming periods as volume increases and costs stabilize.

( Click on Table to Enlarge )



3S Bio ( Nasdaq - SSRX ) -- Follow-up Report

3S Bio (SSRX $15.25) reported better than anticipated Q4 results.  Sales advanced 40% to $15.3 million.  The company's two main recombinant DNA drugs led the charge, growing 40% and 53% respectively.  Those products accounted for 91% of total revenue for both the quarter and the full year.  Higher marketing and R&D costs prevented income from advancing as quickly as sales.  In fact, earnings declined 50% to $.08 a share in the period.  Most of the shortfall stemmed from a one time payment to acquire the Chinese rights to sell a promising anti-rejection drug being developed in Canada.  3S Bio also made an equity investment in the developer, and will finance a Phase III clinical trial in China later in 2011.

Growth in the core business remains vibrant.  A new manufacturing facility came on line in 2010, expanding capacity by 300%.  The government's new national health insurance law is boosting patient coverage.  And while price controls limit 3S Bio's revenue potential, those regulations are accompanied by approved supplier lists that reduce competition, as well.  Several new products are in the pipeline, which could leverage performance in future years.  Cash reserves exceed $100 million.  So additional deals with non-Chinese drug companies are a possibility.

We estimate sales will improve 26% in 2011 to $80 million.  Earnings could rise 34% to $.75 a share as volume builds at the new facility and R&D costs level off as a percentage o sales.  3S Bio remains well positioned to thrive in China's still evolving health care industry.  The company is preparing to expand outside the country, as well, which should demonstrate it's ability to compete without government protection. 

( Click on Table to Enlarge )



3S Bio ( Nasdaq - SSRX ) - Follow-up Report

3S Bio (SSRX $14.50) is on track to produce excellent on target Q4 results.  The Chinese government issued a revised set of reimbursement prices for certain drugs this week.  That's part of the national health care law that went into effect in 2009.  3S Bio's two main products were not affected by the change.  The drugs that were impacted suffered an approximate 20% price reduction.  The government insurance program accounts for most of the Chinese market.  Coincident with the government's updated price list was a plan to expand health care spending by 25% next year, to boost the number of people covered and provide more comprehensive treatment.  3S Bio remains vulnerable to future government price mandates, although the company's bargaining position is pretty strong in that its lead product (TPAIO) does not face any direct competition.  Use of that product currently is restricted to "work related injuries," even though its primary application is in chemotherapy.  The company presently serves only 5%-10% of the potential market.  And that potential market is thought to be just a third or less of what it might be, since a large number of prospective patients are never treated.  It's possible that labeling could change for the better if a lower pricing schedule is handed down.

Another new product recently was added to the R&D pipeline.  That licensed drug treats gout, a fairly common affliction in China, and currently is in Phase II clinical trials.  More international partnerships could emerge.  We continue to estimate 2010 earnings will finish around $.65 a share.  Next year $.75 a share remains a realistic target.

( Click on table to enlarge. )

3S Bio ( Nasdaq - SSRX )

3S Bio (SSRX $16.00) is a leading Chinese provider of genetically engineered pharmaceuticals.  The company's two lead products were developed internally and currently hold the largest share of their respective markets.  EPIAO is an injectible version of EPO, the drug that put Amgen on the map in the 1990s.  It's used to stimulate red blood cell production to treat anemia, primarily in post surgical and cancer applications.  That line accounts for 60% of sales and has a 42% share of the Chinese market.  TPIAO treats chemotherapy induced platelet deficiencies and represents 30% of sales with a dominant market share.  Foreign compeition was blocked out of China while TPAIO went through the evaluation stage, but those restrictions were lifted earlier in 2010.  3S Bio also markets three older products through its direct sales force.  Two additional products have been licensed from foreign drug companies.  Those drugs are in clinical trials and probably won't be introduced for 2-3 years, assuming approval is obtained.

Demand is growing at a fast pace.  China implemented a comprehensive health care reform law in 2009, which expanded coverage to most of the country's population.  Economic stimulus funding has generated further impetus.  Proliferation of advanced medical technology is increasing the number of procedures performed.  And the basic need for treatment is rising due to the rapidly aging Chinese population.  The entire medical industry is expanding at a 10%-15% annual rate.  3S Bio is growing even more quickly, in the 25%-30% area, due to its focus on the high end of the market and a superior sales force.

We estimate 2010 sales will rise 25%-30% to $58-$60 million.  Earnings are likely to end relatively flat with those of the prior year at $.65-$.70 a share due to a higher tax rate and greater R&D spending.  Next year sales could reach $75 million as 3S Bio's two lead products retain their leading positions in China's fast growing pharmaceutical industry.  Income could attain $.75-$.80 a share, depending on how well margins hold up.  3S Bio recently doubled production capacity, which will cause unit costs to increase until volume catches up.  Further hikes in R&D spending are possible, too.

The long term outlook is bright.  3S Bio is managed by American trained scientists who enjoy a stellar reputation among foreign executives.  Its proven track record could lead to increasingly large joint venture relationships.  Finances are robust, with $109 million in the bank and no debt.  New products already in the pipeline have the potential to amplify performance dramatically.  In 2-3 years the current line-up could yield sales of $125 million, and earnings of $1.40 a share.  New products and joint ventures could generate substantial leverage beyond that.   Applying a P/E multiple of 25x suggests a target price of $35 a share, potential appreciation of 120% from the current quote.  3S Bio represents a high potential acquisition candidate, moreover, so a higher valuation is possible.

(Click on table to enlarge)