On 13 Oct 2017, Yaozh.com (药智网) reported that Shanghai Pharm (2607.HK, NR)has likely teamed up with FountainVest Partners (方源资本) to fully acquireCardinal Health’s China operation at USD1bn (RMB6.6bn). Earlier in July, Reutersalso reported that the US’s Cardinal Health would like to sell its China operation inthe range of USD1.2bn to USD1.5bn. The latest bidding offer from ShanghaiPharm’s consortium has already reduced by USD500m.    Ranked #8 by distributor sales in China, Cardinal China’s annual revenue hitRMB25bn (USD3.8bn) in 2016. It operates over 16 distribution centres in 22 cities,with 28 direct-to-patient (DTP) drugstores. Cited by Yaozh.com, Shanghai Pharm iseyeing on Cardinal China’s key advantage on (1) 30 good DTP drugstore networkwith an annual sales at RMB600m to RMB700m, on each drugstore at RMB22msales which is 40 times higher than that from other pharmacy shops; and (2) itsheadquarter also based in Shanghai with variety of foreign branded medicines asdistribution sales. The same source also quoted that, post acquisition of CardinalChina, Shanghai Pharm has set its sales target to surpass China ResourcesPharma’s (3320.HK, NR) revenue sizes. Note that, certain provincial tender biddingand current policy appear to disfavor the foreign distributors in China.    At the same time, Yaozh.com reckoned that Sinopharm (1099.HK, BUY,TP:HKD47.70) and Shanghai Pharm will not have the interest to join the contest ofacquisition of Cardinal China. Moreover, the market expects other investors forthis deal to include (1) Warburg Pincus (美国华平投资) for its successful record inChina healthcare investment; and (2) Pacific Alliance Group (太盟投资集团) forbeing one of the largest diversified investment groups in Asia.    Our view: Positive to China’s main distributors (healthcare).    Consistent with the government policy, it aims to (1) reduce layers of distributorsalong the drug supply chain; and (2) scrap the mark-up sales from hospital’spharmacies to patients. Both the market and we see that “Two Invoice System”would likely disfavor those foreign distributors, despite of them being quality drugsuppliers. We reckon that, the local market leaders (such as Shanghai Pharm) willfurther expand the market share at the expense of (1) local sub-distributors andsmaller players; and (2) foreign distributors. As we flagged in our 27 May 2015report, DTP drugstore development would be consistent with national policy ofmore drug sales derived from retail pharmacies. These DTP pharmacies would havebetter knowledge of specialty drug prescription such as anti-cancer or strokemedicines, compared to the practice of normal retail drugstores.    Should we assume Cardinal China’s net margin in 2016 at the range between 1.5%and 1.8% versus Sinopharm’s 1.8%, the current offer price multiple would be 17.6xto 14.4x FY16 P/E respectively, versus HK sector median at 16.4x.    Stock impact: As we flagged in our 31 Aug 2017 report, we maintain our viewthat, “Two Invoice System” will increase the sales orders to main distributors fromsub-distributors, removing layers of distributors. Secondly, on the exit of foreigndistributors in China market, this will favour (1) the top three China maindistributors, namely Sinopharm, China Resources Pharma and Shanghai Pharm;and (2) #1 local marketer for foreign drugs (serving as a local agency), ChinaMedical System (867.HK, NR).

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