Developing World Healthcare Blog

The Public/Private Disconnect Goes Global: Part 2

As discussed in last month’s post, the stated reason for WuXi’s management team to pursue a privatization was the market’s negative reaction to the company’s year-end 2014 earnings results released in early March 2015. The shares declined by a total of 15% in the ten days following the announcement. Last month’s discussion focused on the public-private disconnect related to investment spending (in general) while this month’s discussion focuses on the domestic/foreign angle. To set the stage, we should point out that WuXi’s research coverage featured a mix of US-based CRO analysts, and HK-based China healthcare analysts. The differences in their perspectives is at the heart of the domestic/foreign disconnect.

WuXi’s 2015 Plans Were Not Well Received

WuXi’s fourth quarter results, revenue +21% and EPS +4%, were consistent with expectations. The real surprise was the 2015 outlook: EPS guidance of $1.73-1.78 fell short of estimates that were as high as $2.15. During their conference call presentation, management outlined a significant increase in expenses to pursue several new businesses -- genomics, China healthcare initiatives, e-commerce, and cell therapy (an existing business.) These new businesses, which reduced EPS by $0.02 in 2014, would reduce 2015 EPS by $0.26 (roughly 13%.) The losses would decline by half in 2016, and disappear in 2017.

Management made its case for 2015’s large investments by highlighting their “good” track record of “planting seeds” in new businesses that ultimately added to revenue and profitability (notably small molecule manufacturing and biologics.) In addition, they stressed the significant opportunities in the context of the China market. The following quote from WuXi’s Chairman and CEO is a good summary of their argument:

“WuXi is uniquely positioned to serve as a gateway to China for western innovations and innovators. We have built world class and end-to-end capabilities in five major platforms: genomics, small molecules, biologics, medical device, and cell therapies. We have extensive knowledge of both western innovations through our work with 2,000 customers and of China that has enormous and rapidly expanding medical needs.”

 

Ambitious Expansion Plans in China Healthcare Drew Scrutiny

The genomics, e-commerce, and cell therapy plans didn’t draw much scrutiny from the analysts. The China healthcare initiatives, which include developing and offering clinical screening tests for cancer and rare diseases, and executive health checks, is where the domestic/international disconnect became apparent. There were questions about (insurance) reimbursement for new tests (a reasonable concern in the US context.) Management responded that they didn’t expect to “get a lot of reimbursement” because most similar tests in China are paid for out-of-pocket by patients (unlike the US.)

A second valid area of inquiry (also from a U.S. analyst) focused on the broader issue of expansion beyond the historical client base of pharma and biotech companies. Management acknowledged the risks, and noted that the new markets are very under-served with minimal competition (we concur.) Unfortunately, the response included the statement, “So, once we have a product, and – then we’ll figure out how to sell.” The honesty is commendable, but lack of detail doesn’t enhance P/E multiples.

 

The Path from Public to Private Cleared Relatively Quickly

According to the merger proxy, events unfolded quickly in the wake of the earnings release. Discussions between WuXi’s Chairman/CEO and Ally Bridge started two weeks later. Singapore’s Temasek joined the process in April. The buyout group presented its $46/ADS offer to the Board of Directors in late April – seven weeks after the earnings release.

The deal was not controversial (unlike the Charles River merger.) There were not any competing bids. Proxy advisers ISS and Glass Lewis recommended votes in favor, and shareholders went along willingly. WuXi remains in expansion mode since the deal closed. They have acquired a German CRO that focuses on proteins, and opened a branch in Seoul, South Korea. Further, there are reports of plans to list the biologics business on the Hong Kong exchange at a value of as much as US$1.5 billion (45% of the company’s going-private value.)

 

So What’s the Point Here? 

It’s too early to conclude that WuXi’s privatization represents a “missed opportunity” for the public markets. Many things could go wrong. The new businesses could fail to meet expectations. The reported listing of the biologics business may not proceed. That said, the company’s leading position in China, and the government’s desire to move the life sciences sector “upmarket” globally tilt the odds in the company’s favor. WuXi likely will return to the public markets somewhere and in some form. We think the current owners will have done quite well by then.