Neusoft Medical Sets Sights Again on HK IPO, With Business Risks in Focus

Key Takeaways:

• Neusoft Medical has taken several twists and turns on the IPO road, reversing out of an earlier bid to join Shanghai’s STAR Market and now making a third attempt to list shares in Hong Kong
• The company’s business picture is dotted with risks from falling R&D spending in relation to revenue, rapidly rising sales costs, and a reliance on distributors

By Ellie Si

Neusoft Medical Systems Co. Ltd., a Chinese provider of imaging machines and services for the healthcare industry, is hoping to finally see its way clear to a Hong Kong IPO after several false starts on the way to a share listing.

The company once sought to list in Shanghai and made two unsuccessful attempts last year to join the main board of the Hong Kong Stock Exchange (0388.HK). Now mounting another listing bid with investment banks CICC and Goldman Sachs as joint sponsors, could this be third time lucky for China’s biggest exporter of computed tomography (CT) scanning systems?

Founded in 1998, Neusoft Medical supplies devices and services including magnetic resonance imaging (MRI) equipment and ultrasound scanners, as well as the CT machines that use computer-enhanced X-rays to screen for health issues. A study by research firm Frost & Sullivan, cited in its prospectus, found Neusoft Medical is China’s largest domestic manufacturer of CT machines, with an 11.5% market share as of last year, based on the total number of installed systems.

As of end-June, Neusoft had installed more than 44,000 medical imaging devices worldwide. It also built China’s first platform for medical devices as a service (MDaaS), with more than 5,100 imaging scanning machines currently connected to the system. Neusoft Medical has two other business lines: device services and training, and in vitro diagnostic devices and reagents, involved in the process of testing biological samples taken from the body.

Although a domestic force in the clinical scanning market, Neusoft Medical has taken a winding road to becoming a publicly listed company. The company had filed to IPO on Shanghai’s Nasdaq-style STAR Market in June 2020, but voluntarily withdrew its application a few months later after a listing hearing on the Shanghai Stock Exchange. By 2021, Neusoft Medical had set its sights on the Hong Kong market, but applications in May and December last year proved unsuccessful.

Neusoft Medical, once a subsidiary of Shanghai-listed Neusoft Corporation (600718.SH), was spun off in 2016 and was no longer consolidated into the corporation’s financial statements. But Neusoft Corporation remains the largest shareholder of the medical device maker, with a stake of just under 30%.

The one-time parent company operates across a wide spectrum with businesses involved in smart cities, healthcare, smart car connectivity, enterprise digital transformation and international software services. It has a current market capitalization of about 13 billion yuan ($187 million).

Neusoft Corporation has created a network of spin-offs from its business empire that include Neusoft Education Technology (9616.HK), listed in Hong Kong in September 2020, and Neusoft Xikang, Viewhigh Technology and Neusoft Reach Automotive Technology, all of which are preparing applications or have filed for listing.

Declining ratio of R&D to revenue

The financials in the prospectus present a positive image, with rising revenue and profit graphs. Revenue grew from 1.9 billion yuan in 2019 to 2.8 billion yuan last year, while net profit increased from 87.66 million yuan to 312 million in the same period. In the first half of this year alone, turnover reached 1.5 billion yuan, with net profit soaring 133% from the year-earlier period to 225 million yuan.

But in close-up, a more mixed picture emerges.

In fact, Neusoft Medical’s profits have not derived in the main from its core business operations, but from other income and gains, including government grants, interest generated from revenue contracts, bank and other interest income, and foreign exchange gains. As shown in the prospectus, the company’s other income and gains more than doubled from 132 million yuan in 2019 to 289 million yuan in 2021. If these gains are excluded, actual profits are quite limited and even slip into loss territory.

In the medical device business, research and development capability can be the key to competitiveness.

More than 80% of China’s medical imaging equipment market is dominated by foreign players such as General Electric, Siemens and Philips, according to a report by Changjiang Securities. Chinese companies including Neusoft have gradually taken over the market for low-end products, but they have been less successful in penetrating the high-end market, hampered by weakness in R&D.

Indeed, Neusoft’s R&D expenditure as a percentage of revenue has been falling over the last three financial years, from just over 21% in 2019, to around 15% the following year and 13% in 2021. The figure continued to fall to around 11% in the first half of this year, sowing doubt about the industry leader’s progress in building crucial R&D capability.

While the proportion of R&D expenditure declined, Neusoft’s sales and distribution costs grew rapidly, from 333 million yuan in 2019 to 479 million yuan in 2021, a jump of more than 40%, with the proportion related to distributor sales rising from just over 60% to 70%.

Bribery scandals cast shadow

The company faces risks from exposure to third parties. As medical technology is expensive, it is common practice in the industry for customers to pay in installments to spread the cost. But payment difficulties can leave Neusoft Medical with late or unpaid invoices.

The company’s trade receivables and notes receivable hovered between 1.25 billion yuan and 1.43 billion yuan in the past three years. Turnover days for accounts receivable, although shortened, still stretched to 175 days by the first half of 2022, much higher than the 66 days of its listed counterpart, Shanghai United Imaging Healthcare (688271.SH).

Meanwhile, scandals in which dealers use bribes to secure medical equipment sales are not uncommon. Public documents in a Chinese legal database include a case in which an official at a county hospital in Sichuan was offered up to 1.8 million yuan to favor Neusoft Medical products in a tender for CT equipment worth 9 million yuan. There have been Neusoft-related convictions for bribery or bribe-taking in Jiangsu, Shaanxi, Guangxi, Jilin, Sichuan and other provinces.

Aside from multinationals, competition from Chinese rivals may also be heating up in the market for CT and other medical imagery machinery.

Shanghai United Imaging Healthcare is among the strongest competitors. The company was listed on Shanghai’s STAR Market in August this year, with a total market capitalization of over 100 billion yuan, with its forecast price-to-earnings (P/E) ratio as high as 73 times.

Assuming Neusoft Medical’s second-half profit is in the same ballpark as first-half earnings, the company’s market capitalization will stand at 37.3 billion yuan at the same P/E ratio. However, given the current sluggish conditions in the Hong Kong stock market and the general premium of A-shares over Hong Kong stocks, the company would not easily be priced at that level if its listing application is accepted.

In addition, newcomers are nipping at Neusoft Medical’s heels. Unicorn companies such as MinFound Medical System and Shenzhen Anke Hi-Tech havefiled for listings in Shanghai and Shenzhen respectively. If they are successful, market competition would rise to another level. How will Neusoft Medical respond to the challenge? Investors will have to wait and see what picture emerges.