3-S Bio - Acquisition of the Company is Complete

3-S Bio ( Nasdaq - SSRX ) -- Buyout Price Increased to $16.70 a Share

3-S Bio (SSRX $16.20) said the buyout group attempting to purchase the company raised its offer from $15.40 a share to $16.70 a share.  No explanation for the 8% improvement was given.  A shareholder meeting is scheduled this month to vote on the proposal.  The price remains modest in relation to 3-S Bio's long term potential.  The company enjoys leading market shares with two fast growing drugs.  Additional products are in development.  The Chinese medical industry is poised to expand dramatically over the next decade.  And 3-S Bio has a joint venture in place with U.S. based Davita that could yield substantial benefits.  The private equity fund orchestrating the acquisition is connected with the Chinese government, though.  And the company's C.E.O. is part of the buyout group.  So alternative offers are unlikely.

( Click on Table to Enlarge )

3-S Bio ( Nasdaq - SSRX ) -- Hikes Expenses

3-S Bio (SSRX $14.90) reported better than expected Q4 revenues.  Despite price reductions mandated by the Chinese central government volume advanced 18% to $26.3 million.  Higher sales and marketing costs enabled the company to penetrate less populated areas.  They also blunted competitive inroads.  Market share for 3-S Bio's leading drugs was preserved in the 40% range.  Product development costs accelerated, as well.  The company signed a partnership with U.S. based Davita last year to establish a chain of dialysis centers in China.  3-S Bio will supply a large component of the drugs to that venture.  Development costs jumped to get those formulations approved and into production.  Earnings declined 33% due to the elevated spending, coming in at $.12 a share.

The acquisition of the company remains on track.  An offer was announced last September.  The purchasing group included 3-S Bio's chief executive, a large bank controlled by communist party members, and a hedge fund also run by communists.  In February an agreement was reached to purchase all the outstanding stock at $15.40 a share.  3-S Bio's shareholders must approve the transaction by a 2/3 margin.  A vote is expected in the second quarter.

The uptick in spending suggests the deal is likely to go through.  The Davita venture holds good potential in its present form.  That encompasses a small part of the total Chinese market.  The addition of state controlled entities could open up additional territories, generating a bid payday for the private equity group.  3-S Bio has plenty of cash on hand to fund operations.  So any new capital won't be sidetracked from the huge opportunity the Davita partnership affords.  Investments in other initiatives could be made through the private structure, as well.

The shares are trading close to the ultimate buyout price.  An upward revision to the price appears unlikely.  Aggressive holders are advised to close out positions and put the money to work in another Special Situation.

( Click on Table to Enlarge )

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. 

( Click on the Table to Enlarge )

3-S Bio ( Nasdaq SSRX ) -- Acquisition of the Company Remains Likely

3-S Bio (SSRX $13.25) reported excellent on target Q3 results.  The company accelerated research and marketing in the period.  That caused income to finish relatively flat with the prior year at $.22 a share.  Revenues improved 22% to $28.7 million.  Further margin compression is anticipated in upcoming quarters.  The Chinese government implemented a national health insurance program in 2010.  That legislation expanded the potential market.  But also gave the central authorities greater control over pricing.  One round of price reductions was implemented last year.  Another is slated for the first half of 2013.  Those will vary by product and they might be phased in.  The ultimate impact is expected to be in the 10% range.

Unit volume continues to expand.  3-S Bio expanded its marketing organization in 2012 to penetrate smaller cities and rural markets.  The company already had a leading market share for its principal products in the major population centers.  Those efforts promise to keep volume rising at above average rates well into the decade.  3-S Bio also tripled its production capacity in 2010.  The company still has ample room to expand within its current facilities.  That should reduce unit costs, helping offset the coming price reductions.

3-S Bio's CEO is leading an investor group to take the company private at $15.00 a share.  An committee comprised of outside directors is evaluating the proposal.  3-S Bio still holds approximately $6.00 a share in cash, following the write-down of an R&D investment.  Other bids are possible.  But the current deal appears likely to proceed in light of the CEO's involvement.

( Click on Table to Enlarge )

 

3-S Bio ( Nasdaq - SSRX ) -- Receives Buy-Out Offer

3-S Bio (SSRX $13.50) appears on track to produce excellent Q3 results.  The long term outlook remains favorable, as well.  Finances are robust, moreover.  The company holds approximately $7.00 a share in cash.  3-S Bio's chief executive in combination with a local private equity firm recently submitted an offer to purchase the entire company for $15.00 a share in cash.  Several other U.S. listed Chinese companies recently have made plans to go private, as well.  Numerous China based companies have blown up during the past three years due to accounting fraud and other irregularities.  That's caused the value of Chinese shares in general to trade at reduced valuations. 

The American short selling community has investigated 3-S Bio on several occasions.  Nothing out of the ordinary has ever been discovered.  The company is run by U.S. trained scientists.  It's products compete on the world stage.  A major American dialysis company, Davita, recently formed a joint venture with 3-S Bio to take advantage of the high potential Chinese health care market. 

The price being offered appears low.  After the company's cash is backed out the deal values the ongoing business at 8x earnings.  In light of 3-S Bio's growth potential and high likelihood of success a significantly higher multiple appears justified.  Since the company's CEO is part of the buy-out group it's unlikely competing offers will emerge.  Existing shareholders might insist on a higher price.  It's uncertain if the buyers will agree to that, however. 

Financing appears to be in place.  The transaction looks like it has a high probably of going through.  Current holders might want to wait and see if a better price emerges.  The stock still has 10% to go to reach the stated buy-out price.  Investors realistically can hold off to earn that arbitrage income, as well.  More aggressive investors can sell the shares now and reinvest in another Special Situation.

( Click on Table to Enlarge )

3-S Bio ( Nasdaq - SSRX ) -- Sales Force Drives Growth

3-S Bio (SSRX $11.25) reported excellent better than expected Q2 results.  Product prices were similar to the year ago period.  Unit growth propelled sales higher by 31% to $28.1 million.  Earnings advanced 38% to $.29 a share.  3-S Bio's leading product maintained its market share at 40%-43%, suggesting robust expansion by the industry overall.  A new product was purchased in the quarter, which will head into general distribution in the September period.  Another product entered Phase 3 clinical trials.  Exports rose 85% and represented 5% of sales.  Volume gains are likely to continue in upcoming quarters as the big increase in sales reps added in 2010 and 2011 continue to improve performance.  More hiring is underway.  The sales force probably will keep growing at least at a 5%-10% pace.  We have raised our 2012 earnings estimate by a nickel to $.95 a share to reflect the sturdy Q2 showing.

Government mandated reimbursement cuts are likely in the September quarter.  China implemented a wide ranging health plan in 2010.  A key trade off for industry participants has been a big increase in the number of people covered in exchange for lower prices.  Another round of price reductions is expected.  The specifics will vary depending on a variety of factors.  But 3-S Bio anticipates an average hit of 10%-20%. 

Manufacturing margins currently are nearly 90%.  That's typical of drug companies around the world.  3-S Bio expanded capacity threefold in 2010 to meet the expected rise in demand the new health care envisioned.  The company still is operating at 50%-60% of capacity.  While margins will be impacted by the upcoming price reductions, rising volume promises to offset the full effect.  More efficient sales operations could alleviate the pressure on margins, as well.  And 3-S Bio is actively seeking additional products to feed through its distribution network.  Meantime, exports to emerging markets like Turkey and Egypt are growing quickly due to the products' efficacy and relatively low price points compared to American and European offerings.

We have reduced our 2013 earnings estimate by a dime to $1.05 a share.  That figure assumes the upcoming reimbursement changes will approach the high end of the range.  A somewhat stronger performance is possible if the cuts prove less severe than expected.  Downside risk remains modest.  The stock trades close to book value ($9.45 a share).  Cash and equivalents total $124 million ($5.62 a share).  The Chinese population is aging quickly, suggesting above average industry growth for an extended time.  A joint venture with U.S. based Davita to run a network of kidney dialysis centers promises further leverage.  That project is slated to start rolling out next year. 

( Click on Table to Enlarge )

3-S Bio ( Nasdaq - SSRX ) -- No Government Reimbursement Ruling Yet

3-S Bio (SSRX $12.00) appears on track to report excellent on target Q2 results.  The Chinese drug provider still is operating on the government's old price list, so margins probably widened in the period.  Volume has been expanding, producing economies of scale at 3-S Bio's manufacturing facility.  That plant still is operating at approximately 50% of capacity, so further leverage is likely.  The central government is expected to slash reimbursement by 10% or so when new regulations are implemented.  Adoption of national health insurance expanded the market dramatically in 2010.  Reduced prices are on way the government hopes to make the program affordable.  Meantime, export sales continue to rise quickly.  A joint venture with U.S. based Davita is on schedule.  That deal promises to leverage 2013 performance.  Our estimates already reflect a price cut for the current year.  So a somewhat stronger showing is possible if the new scheme isn't adopted soon.

( Click on Table to Enlarge )



3-S Bio ( Nasdaq - SSRX ) -- Unit Volume Rises, Costs Decline

3-S Bio (SSRX $13.25) reported excellent on target Q1 results.  Sales climbed 24% to $23.4 million.  Earnings surged 53% to $.23 a share.  Selling prices were generally unchanged compared to the December period, although they did decline 3%-5% from the year ago quarter.  Volume remained robust despite the fact prices probably will be forced lower by new Government regulations.  Those have not be formalized yet but are expected to go into effect in Q2.  In theory, customers could have waited for the prices to fall before purchasing in Q1.  China established its own health reform law in 2010, expanding coverage to most of the country.  The quid pro quo with the health care community has been one of greater volume in exchange for lower prices.  The upcoming round could see 3-S Bio impacted by 5%-10%.

Margins held up well after prices were reduced last year.  3-S Bio built a series of new manufacturing facilities which came on stream in 2011.  Modernized equipment and procedures enabled the company to cut production costs directly.  Depreciation expense jumped in the short run, though, since the new facilities were 4x larger than the former site.  The company now has ramped up volume sufficiently to achieve 50% capacity utilization rates.  Further cost reductions are possible, suggesting overall margins will remain attractive despite the Government's upcoming price cuts.

Marketing efforts are accelerating.  3-S Bio plans to boost its distribution channel by 20%-25% this year, with an emphasis on penetrating second tier hospitals.  Those customers are exhibiting the fastest growth as the health law kicks in.  The company also recently formed a joint venture with U.S. based Davita to set up a chain of dialysis centers in two Chinese provinces.  That deal is likely to begin contributing early next year.  New products are in the pipeline, moreover.  And export operations are picking up momentum.  A new version of the company's top selling drug will enter clinical trials this year.  Other trials are approaching the finish line.  Those include products licensed from international companies for sale in China.  3-S Bio's new facilities also are being fine tuned to make generic biological drugs.  Those are off patent biotech products that offer huge potential but even western companies find challenging to make.  Exports remain focused at high population mid range countries like Egypt and Turkey which need high quality products at affordable prices. 

Our estimates are unchanged.  A stronger performance is possible if the next round of Government price reductions come in at the low end of the anticipated range.  The long term outlook remains bright.  3-S Bio is well positioned to expand in China without government help.  Its world class scientific talent promises to attract additional foreign partnerships.  Finances are solid.  And for a bunch of scientists, the management has a proven track record when it comes to marketing pharmaceuticals.

( Click on Table to Enlarge )