PW Medtech's Buying Spree: Diversification Or Insider Story?

Key takeaways:

• After buying a related peer in November, PW Medtech acquired a human tissue regeneration and repair product developer last week at a high premium
• The company’s performance has been affected by the pandemic, and it may hope the new acquisitions will lower such risk through diversification

By Jony Ho

Medical device maker PW Medtech Group Ltd. (1358.HK) has struggled lately, dragged down by pandemic-related disruptions. Perhaps seeking to lower that risk, the company has made two large acquisitions since late November, both with some intriguing elements.

The company is mainly engaged in the research and development, manufacture and sale of high-end infusion devices, intravenous indwelling needle products and insulin needles. Such devices are widely used in hospitals, which has spurred strong growth for PW Medtech in recent years as more people seek such medical care with China’s improving living standards. But such products have also seen weaker demand during the pandemic as many people remain stuck at home during local lockdowns and avoid hospitals to reduce the risk of infection.

PW Medtech has been a big beneficiary of China’s national policy, including the latest update to its “Regulation on the Supervision and Administration of Medical Devices” last June to support medical device innovation and accelerate localization. A study concluded that China’s low-value medical consumables have grown at a compound rate of nearly 20% in the past few years, and the market will reach 92.73 billion yuan ($14.5 billion) this year, with huge room for more growth.

Against that complex backdrop, PW Medtech has made two acquisitions in the last few weeks. The first saw it acquire 51% of in Sichuan Ruijian, a medical device company, for $99.46 million last Nov. 30. After completion of that transaction, Lepu Medical (300003.SZ) still holds 18% equity interest in Sichuan Ruijian.  

Since Lepu Medical’s de facto controller Pu Zhongjie is the spouse of PW Medtech Chairman Zhang Yue’e, the acquisition is considered a connected transaction.

Despite that, the acquisition target does seem to have solid potential as the only hemodialysis company in China with its own R&D, design and manufacturing of spinning and back-end assembly lines. That gives it a low-cost advantage and has also allowed it to sell to fast-growing markets in Southeast Asia, South America and Africa – channels that could help PW Medtech develop its own international markets.

Sichuan Ruijian reported an unaudited net profit before taxes of 73.88 million yuan in 2020, up 80% year-on-year, according to financial data provided by PT Medtech. The acquisition valued Sichuan Ruijian at a price-to-earnings (P/E) ratio of about 17.5 times, which looks reasonable given its strong growth.

Puzzling acquisition

While the Sichuan Ruijin acquisition looks good, PW Medtech’s other recent acquisition is more puzzling. On Jan. 5, it announced its acquisition for 580 million yuan of 58.2% of Beijing Ruijian, a human tissue regeneration and repair products developer, providing damaged human tissue and organ repair materials used for treatment of burns, as well as for soft tissue regeneration and in plastic surgery. The area is relatively far removed from PW Medtech’s current business, and the move is seen as an entry into the regenerative medical biomaterials industry.

The market for such products has big potential and has been considered a valuable area for investment in recent years, laying the groundwork for new growth in the coming years, PW Medtech said.

Unlike Sichuan Ruijian, PW Medtech did not disclose any connected transaction in the Beijing Ruijian deal. But it’s interesting to note that despite the “great potential” described by PW Medtech in its announcement, Beijing Ruijian lost nearly 20 million yuan in 2019 and 2020 combined, and had total assets of just over 58 million yuan at the end of 2020, down 8.3% year-over-year, with 9.27 million yuan in liabilities.

So, what exactly motivated PW Medtech to acquire less than 60% of Beijing Ruijian’s shares for 580 million yuan, representing a high premium for a company that isn’t profitable and is also outside its core business?

It’s also worth noting is that both of PW Medtech’s new acquisitions were founded in 2013 and purchased quite close in time to each other, and that both share the “Ruijian” name in Mandarin, though with slightly different Chinese characters. While background information about the two companies is scarce, dealing between related companies is relatively common in China, even though it’s unclear if that’s the case with Beijing Ruijian.

All that said, we’ll move into PW Medtech’s financial statements to try to understand its motivation behind these acquisitions. The pandemic has put a major damper on demand for the company’s products over the last two years due to lockdowns and regional travel restrictions. PW Medtech has been hit especially hard due to big disruptions in hospitals in its main sales areas such as Beijing, Hubei and northeast China’s Heilongjiang province.

The group’s revenue fell by 31.7% in 2020, and its gross profit also dropped by 33.1%. Excluding an exceptional gain of 590 million yuan from the sale of an equity interest in an associated company, net profit was approximately 44 million yuan that year, a significant drop by nearly half from 2019.

The company’s situation improved in the first half of 2021 as China brought its epidemic largely under control, with revenue and gross profit rebounding by more than 30%. But then the Covid-19 Delta variant appeared in Nanjing and spread to more than 20 provinces and cities. As that happened and the more contagious Omicron variant started to appear at the end of last year, travel restrictions were once again imposed in many places, once again threatening the company’s business in the second half of last year

Against such a backdrop, an expansion of its product portfolio and distribution network through acquisitions may help to diversify to protect against such risk. For example, a new outbreak may not affect the company’s revenue as much following the acquisitions because its sales will be more diverse geographically.

Valuation not low

PW Medtech’s shares rose to a six-year high of HK$1.67 ($0.21) in mid-July, but then moved steadily downward in the second half of the year as business risks mounted. The stock closed at HK$0.97 on Monday down more than 40% from its high, after also falling about 1% the day after the announcement of the acquisition of Beijing Ruijian.

Excluding one-time income of 730 million yuan from the sale of an associate, PW Medtech made a net profit of approximately 30 million yuan in the first half of last year. In an optimistic scenario we can assume the second half will perform similarly, giving the company a full year profit of 60 million yuan and forecast P/E ratio of 22 times.

Looking at other Hong Kong-listed medical device makers, SSY Group (2005.HK) and Weigao Group (1066.HK) have P/E ratios of 16.5 times and 17.9 times; A-share listed industry leaders, CR Double-Crane (600062.CN) and Kelun Pharma (002422.CN), have P/E ratios of 13.6 times and 23.5 times, showing that PW Medtech’s valuation isn’t low.

With the latest two deals now finalized, all eyes will move to the group’s future financial statements to see if these new businesses can churn out new gold for the company.