pg.jrj.com.cnpg.jrj.com.cn/acc/Res/CN_RES/INVEST/2016/2/4/e792c895...2016/02/04 · market. Different age groups have different needs varying from skin rejuvenation and anti-aging,

Disclaimer & Disclosures This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it.

Issuer of report: The Hongkong and Shanghai Banking Corporation Limited

View HSBC Global Research at:

https://www.research.hsbc.com

China’s cosmetic surgery industry is set to double by 2019e

A simple procedure – the HA dermal filler injection – is growing faster than the industry’s average growth rate

We initiate on two leaders in the HA market, Bloomage and Shanghai Haohai, with Buy ratings

Looking good. The pursuit of physical beauty has become big business in China.

According to the China Association of Plastics and Aesthetics (CAPA), more than 7m

people, mostly young women, had cosmetic surgery in 2014, when the country’s

cosmetic surgery industry was valued at RMB400bn. CAPA expects China’s cosmetic

surgery industry to double to RMB800bn by 2019e, making it the third largest market in

the world. The big sellers are simple procedures that require no anaesthetic and can be

done during the office lunch break with no side effects.

No pain, you gain. The secret to the perfect look is a simple injection – the hyaluronic

acid (HA) dermal filler, which is regarded as safe, convenient and versatile. It can be used

to enhance facial contours, reduce wrinkles, hydrate and firm the skin. Margins are high

and most customers need to repeat treatments every year. China is a leading

manufacturer of HA – which occurs naturally in the human body but diminishes as people

age – and we expect HA dermal filler volume to increase more than 20% annually over

the next three years. Growth drivers include powerful marketing campaigns by industry

practitioners, tougher regulation and the influence of social media.

Domestic leaders. Bloomage (963 HK) and Shanghai Haohai (Haohai, 6826 HK) are the

first two domestic HA manufacturers to move into cosmetic surgery by launching HA

dermal filler products. Our proprietary survey of 50 hospitals in China shows that they are

the best-performing domestic brands. Bloomage has evolved into a full-fledged provider

of medical dermatology solutions. We forecast a 2015-17e recurring net profit CAGR of

23%, driven by the fast-growing HA filler segment, which should account for 46% of sales

by 2017e, from 36% in 2015. Haohai is a biomedical material manufacturer. We expect

recurring net profit to rise at a CAGR of 28% over 2015-17e, driven by the HA dermal filler

business, which should contribute 18% of sales in 2017e, from 12% in 2015.

Valuation. We initiate with Buy ratings on these stocks, based on strong growth

prospects and attractive valuation. Our target prices for Bloomage (TP HKD20, 19%

upside) and Haohai (TP HKD60, 30% upside) are both based on 24x 2016e recurring

EPS, a 10% premium to the industry average. We believe they deserve to trade at a

premium, given their growth profile and rich product pipelines which should support

long-term expansion. The TPs for Bloomage and Haohai imply PEG of 1.1 and 0.9,

respectively. No consensus forecasts are available. Downside risks include competition

from new entrants, pricing pressure and product safety issues.

4 February 2016

Yumeng Wang* Analyst The Hongkong and Shanghai Banking Corporation [email protected] +852 2996 6586

Zhijie Zhao* Analyst The Hongkong and Shanghai Banking Corporation [email protected] +852 2996 6591

* Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations

China Cosmetic Surgery EQUITIES MEDICAL EQUIPMENT

China Face value is rising: initiate on two domestic leaders

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EQUITIES MEDICAL EQUIPMENT

4 February 2016

2

Investment summary 3

Cosmetic surgery in China 11

HA injections close-up 17

Shanghai Haohai Biotech 25

Bloomage 38

Disclosure appendix 53

Disclaimer 55

Contents

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4 February 2016

Beauty and the East

In China, people seem to be more conscious of their looks than ever before. Apart from

conventional cosmetics, many are going a step further in search of physical perfection. It is not

uncommon for young women to approach a plastic surgeon and ask to be transformed, eg with

deep double-eyelids and V-line face. But this is no yuppie trend – more 30 and 40-somethings

want to look good too.

According to the China Association of Plastics and Aesthetics (CAPA), more than 7m Chinese

people, mostly women, had some form of cosmetic surgery in 2014. Around 60,000 of them

chose to visit Korea – Asia’s plastic surgery hot spot – a y-o-y increase of 45%. CAPA estimates

that China’s plastic surgery industry was valued at RMB400bn in 2014 and expects it to double

to RMB800bn by 2019, making China the third largest market after the US and Brazil.

What’s driving this is not just growing wealth. Social media – a powerful force in China – is piling

on the peer pressure through platforms like Wechat and Weibo. Beauty and cosmetic surgery

apps, which have millions of followers, encourage people to look at their own image with an

ever more critical eye. The tremendous popularity of the Korean pop and lifestyle culture, known

as Hallyu, is also quite literally changing the face of China’s younger generation.

China is, of course, not alone. A survey by the American Academy of Facial Plastic and

Reconstructive Surgery in 2014 showed that the rise of selfie was leading to an increase in

requests for cosmetic procedures. What’s interesting about the China market is that more

people prefer non-surgical procedures, which do not require full anaesthesia, rather than more-

complex invasive procedures.

This is why hyaluronic acid (HA) is such an important part of the story. HA is used in injections

for minimally-invasive procedures that have become the cosmetic surgery of choice because

they are regarded as safe and convenient. Thank rooster combs – that is where a lot of the stuff

originally comes from. This report takes a detailed look at the non-surgical cosmetic surgery

market in China, in particular HA injections.

Investment summary

China’s cosmetic surgery industry has grown into a RMB400bn market; it should double by 2019e

HA dermal filler injections, a type of non-surgical procedure, have become particularly popular

Initiate on two domestic leaders, Bloomage and Haohai, with Buy ratings

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Most popular surgical and non-surgical procedures in 2015

Type Procedure Surgical procedures Eyelid surgery Liposuction (commonly known as fat removal) Breast augmentation Fat grafting Rhinoplasty (commonly known as a nose job) Non-surgical procedures Botulinum Toxin (Botox) Hyaluronic acid Hair removal Chemical peel Laser skin resurfacingSource: International Society of Aesthetic Plastic Surgery (ISAPS)

China’s cosmetic surgery market

This industry, which barely existed in China 10 years ago, has a number of growth drivers, including:

Large customer base: There are over 330m women aged between 20 and 50 – the target

market. Different age groups have different needs varying from skin rejuvenation and

anti-aging, to face contouring. Men matter too – their share of the market has almost

doubled from 11% in 2014 to about 20% in 2015.

The younger generation: In the US, people over the age of 35 account for 80% of

non-surgical procedures, while in China, those below 35 are the main customers. They care

about their appearances and have money to spend on themselves.

Social networks redefine marketing: Marketing for cosmetic surgery used to rely on street

side billboards, newspaper ads or PC website searches. The popularity of Wechat and Weibo

has led to the rise of mobile marketing, making promotional messages more accessible to

young people. The latest apps such as SoYoung and Gengmei connect plastic surgeons,

patients and cosmetic surgery product manufacturers to create a digital community.

This young industry is still rough around the edges. The leading companies reckon about 80% of

China’s HA dermal filler market comprises smuggled and illegal products. There are also

50,000-100,000 beauty salons that are not qualified to perform medical procedures. The situation

should improve as the government tightens the regulation. The certified brands should benefit

from both the organic growth of the market and increased market share as unregulated

products disappear.

The HA dermal filler industry at a glance

In China, the most popular treatments are non-surgical procedures, especially injections, due to

the rapid recovery time and low risk of complications. Some people call them “lunch break

cosmetics” because the treatment can often be done in an hour, with few side effects. HA

dermal filler injections have become particularly popular because of their convenience, safety

record and versatility – a quick jab can rejuvenate skin, erase wrinkles and contour the face.

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Non-surgical procedures are growing faster than invasive procedures in China (2011)

Source: ISAPS

The industry works like this:

The three most important components are: the upstream manufacturers, the plastic surgery

hospitals and the promotion/advertising channels.

There are nine qualified HA dermal filler players in China – four international and five

domestic. Restylane, a Swedish company and the first mover in China, has the largest

market share, followed by Yvoire (Korea), BioHyalux (made by Bloomage) and Matrifill

(Haohai Biotec). The others have minimal share.

Barriers to entry: HA manufacturing is not rocket science, so more companies could enter the

market should they get approval from the China Food and Drug Administration (CFDA). But it is

a lengthy process and it takes more than product certification to get ahead of the game. The

true entry barriers, in our view, lie in building the brand name and customer loyalty.

Distribution channels: The most economically effective way is to use a mix of an in-house

sales team and distribution agencies. This creates a balanced coverage of plastic surgery

hospitals across China.

Pricing: Price of HA dermal filler varies, depending on the manufacturer’s and the hospital’s

marketing strategy. In the regulated market, HA dermal filler (1ml) costs on average

RMB3,000 to RMB4,000, but can go up to RMB6,000-7,000.

Given the prevalence of fakes, in October 2015, the China Food and Drug Administration

(CFDA) launched a six-month nationwide campaign to crack down on the unregistered HA

dermal filler industry, tightening regulations on the manufacturing and sale of the products.

34.5%

3.1%

13.1%

-5.4%-10%

0%

10%

20%

30%

40%

Non-surgical Surgical

yoy growth of number of aesthetic medical procedures

China Worldwide

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HA dermal filler industry structure

Source: HSBC

HA dermal filler product cycle

It is not all that hard to achieve annual sales of RMB100m if you find a group of distributors

to help penetrate into new hospitals, supported by an aggressive promotion campaign.

As the brands start to build, it takes more effort to increase hospital loyalty. Hospitals may

focus on 2-3 brands after trying a selection. This can be done by strengthening

relationships with opinion leaders.

Finally, the most important part of the equation is the customer. In an industry where fakes

and unlicensed products are common, we believe trust is everything.

We are optimistic about the prospects of the two companies we cover in this report, Bloomage and

Haohai. They already have established HA businesses – both raw materials and medical

products – but recently made the jump into the cosmetic surgery market, where margins and growth

are particularly strong. A survey we conducted, discussed below, supports our bullish view.

Proprietary study of the competitive environment

We surveyed 50 hospitals over China to study the market for HA dermal filler, including

penetration rate, recommendation rate, price, special offers and quality. We found that:

While Restylane and Yvoire, both foreign brands, still have the highest penetration rate,

domestic brands BioHyalux (made by Bloomage) and Matrifill (made by Haohai) are

catching up fast. They were available in more than 80% of the hospitals we surveyed.

Generally, the price difference between overseas and domestic brands is not very

significant when discounts are factored in. There is one major exception – Juverdem, a US

brand, is about three times more expensive than other products (Juverdem is made by the

same company that makes Botox).

One third of the hospitals think there is little difference in quality between international and

domestic brands; c40% recommended domestic brands as first choice.

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Haohai – 6826 HK, initiate Buy, TP HKD60

Haohai is a leading company in absorbable biomedical materials widely used in orthopaedics,

anti-adhesion and haemostasis, ophthalmology, wound care and dermatology. Haohai, a major

HA manufacturer since 2007, became the second domestic player to get HA dermal filler

approval in September 2013 and launched its brand Matrifill in 2014.

Haohai’s products

Biomedical products Brand names CFDA classification Orthopaedics HA injection Teng Chemical drug Chitosan injection Chitogel Class III medical deviceAnti-adhesion & haemostasis HA gel Teng, Qisheng, Jianhua Class III medical device Chitosan injection Chitogel Medical collagen sponge Qitebang Ophthalmology OVD Teng, Qisheng, Jianhua Class III medical device Lubricant eye drops Eyesucom Wound care and tissue filling rhEGF Healin Biological product HA dermal filler Matrifill Class III medical deviceSource: Company report

We expect Haohai’s net profit to increase at a CAGR of 28% during 2015-17e, largely in line

with revenue growth given stable margins. Our 2015-17 sales forecasts include:

Orthopaedics business: CAGR of 26%, driven by an ageing population, increasing product

penetration and the addition of a high average-selling price (ASP) injection product, Chitosan.

Anti-adhesion segment: 21% CAGR, driven by the easing of a capacity bottleneck and

improved market education.

Ophthalmology: OVD 14% CAGR, in line with the growth in cataract surgeries.

HA dermal filler: we expect this new business to have annual growth of 90% in 2016e and

30% in 2017e, driven by increasing penetration and new product launches.

Haohai’s revenue mix change

Source: Company reports, HSBC estimates

Our TP of HKD60 is based on 24x 2016e PE, a 10% premium to comparable companies,

implying 0.9 PEG, given a 28% earnings CAGR for 2015-17e. We believe Haohai deserves to

trade at a premium, given: 1) its high growth visibility supported by the fast-growing

orhthopaedics, ophthalmology and cosmetic surgery sector; 2) R&D pipeline and potential M&A

to support long-term growth. Catalysts include the announcement of strong HA dermal filler

sales in 2015 and the launch of new products in 2016.

-

200

400

600

800

1,000

1,200

2012 2013 2014 2015E 2016E 2017EOrthopaedics Anti-adhesion and hemostasis Ophthalmology Wound care and tissue filling

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Downside risks

1) Competition from new entrants and substitute products; 2) pricing pressure on its drug and

dermal filler products, and 3) product safety issues.

Haohai earnings forecasts

Revenue breakdown (RMBm) 2012 2013 2014 2015e 2016e 2017eOrthopaedics 123 199 237 297 381 472y-o-y 61.4% 19.1% 25.4% 28.3% 23.8%Anti-adhesion and haemostasis 122 140 155 184 224 270y-o-y 14.9% 11.0% 18.5% 21.4% 20.8%Ophthalmology 51 53 67 79 97 119y-o-y 4.1% 26.8% 18.5% 22.3% 22.9%HA dermal filler - - 26 80 152 198y-o-y 212.9% 90.0% 30.0%Total revenue 303 401 516 676 894 1,105y-o-y 32.3% 28.6% 31.1% 32.3% 23.5% Gross profit 253 346 450 586 767 941Gross margin 83.4% 86.3% 87.2% 86.7% 85.7% 85.1% Selling expense (73) (143) (187) (223) (295) (365)% of revenue 23.9% 35.7% 36.3% 33.0% 33.0% 33.0%Admin expense (36) (34) (49) (61) (76) (88)% of revenue 12.0% 8.5% 9.5% 9.0% 8.5% 8.0%R&D expense (18) (24) (26) (37) (49) (61)% of revenue 5.8% 5.9% 5.1% 5.5% 5.5% 5.5% Tax (19) (25) (32) (48) (60) (72)Tax rate 14.6% 15.0% 14.9% 15.0% 15.0% 15.0% Reported net profit 114 142 184 271 339 410y-o-y 24.2% 29.7% 47.7% 25.0% 21.0% Recurring net profit 114 142 184 252 339 410y-o-y 0.0% 24.2% 29.7% 37.1% 34.7% 21.0%Net margin 37.6% 35.3% 35.6% 37.2% 37.9% 37.1%Source: Company reports, HSBC estimates

Bloomage – 963 HK, initiate Buy, TP HKD20

Bloomage is the world's largest manufacturer of HA raw materials. It has broadened its

business by moving downstream; in 2012, Bloomage became the first domestic company to

launch HA dermal filler products in China, later adding HA hydro lifting injections and HA

skincare products. We expect Bloomage to launch new models of HA injections in 2016-17 and

Botox in 2018.

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Bloomage’s percentage of revenue from HA end products to rise to 46% by 2017e


Bloomage: major products and pipeline

Product Indication Type Year of launchHA injection - Low molecule weight Dermal filler Dermatology 2012HA injection - High molecule weight Dermal filler Dermatology 2015HA hydro lifting injection Skin rejuvenation Dermatology 2015HA skin care products Daily skin care Dermatology 2014HA injection for ophthalmology use OVD Ophthalmology 2012HA injection for orthopaedics use Knee pain Orthopaedics 2014 Pipeline Third-generation HA dermal filler Dermal filler Dermatology 2H16/2017Botulinum toxin Dermatology 2018Source: Company data, HSBC

We believe recurring net profit will increase at a CAGR 23% over 2015-17e, driven by strong

top-line growth. Our sales forecasts include:

HA raw materials: 13% CAGR, driven by expanding capacity and increasing portion of

medical and cosmetic grade raw materials.

HA dermal filler/injections: 30% CAGR, driven by the launch of high-molecule dermal filler

products and the popularity of hydro-lifting treatment.

Other revenue: includes orthopaedics/ophthalmology products and imported brands, to be

launched in 2H16/2017.

0

200

400

600

800

1,000

2012 2013 2014 2015E 2016E 2017E

Bloomage revenue breakdown

HA raw materials HA end product

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Bloomage earnings forecast

RMBm 2012 2013 2014 2015e 2016e 2017eHA raw materials 266 288 321 398 454 513y-o-y 8.4% 11.4% 24.0% 14.0% 13.0%HA dermal filler/injection 9 87 159 222 289 375y-o-y 82.8% 40.0% 30.0% 30.0%Others 1 5 20 60Total revenue 275 375 481 625 763 948y-o-y 36.4% 28.3% 30.0% 22.0% 24.3% Gross profit 191 300 375 471 573 707Gross margin 69.3% 79.9% 78.0% 75.2% 75.2% 74.5% Selling expense (33) (59) (75) (94) (114) (142)% of revenue 12.1% 15.6% 15.5% 15.0% 15.0% 15.0%Admin expense (26) (59) (78) (91) (111) (138)% of revenue 9.4% 15.7% 16.1% 14.5% 14.5% 14.5%Finance costs (9) (10) (10) (14) (29) (21)% of revenue 3.3% 2.7% 2.0% 2.3% 3.8% 2.3%Share-based compensation (18) (57) (27) (24) (22) (19)% of revenue 6.6% 15.3% 5.5% 3.8% 2.8% 2.0%Amortization expense (20) (20) (20)Other expense (30) Tax (23) (31) (36) (45) (65) (84)Tax rate 20.1% 24.9% 18.2% 21.0% 21.0% 21.0% Net profit 89 94 162 168 245 317y-o-y 5.7% 71.7% 3.5% 46.0% 29.6%Net margin 32.5% 25.2% 33.7% 26.8% 32.1% 33.5%Adjusted net profit 105 140 183 229 282 344y-o-y 33.9% 30.7% 25.0% 23.0% 22.0%Net margin 38.1% 37.4% 38.1% 36.6% 37.0% 36.3%Source: Company reports, HSBC estimates

Our TP of HKD20 is based on 24x 2016e PE, a 10% premium to comparable companies,

implying 1.1 PEG, given a 23% earnings CAGR for 2015-17e. We believe Bloomage deserves

to trade at a premium because: 1) It has evolved into a comprehensive dermatology provider

with a rich pipeline; 2) the company is efficient in generating a high ROE of 18-20% in 2015-17e.

Catalysts include the rapid ramp-up of hydro-lifting injections and new product launches.

Downside risks: 1) Increasing competition in dermal filler space; 2) margin pressure from

decreasing gross margin of both raw materials and end products, and 3) product safety issues.

How we are different from the market

We conducted a telephone survey of 50 plastic surgery hospitals across China to gather

first-hand information on the competitive environment for HA dermal fillers. We found that

most hospitals carry 2-4 brands of HA dermal fillers. Although Restylane and Yvoire still

account for the largest market share, domestic brands BioHyalux, manufactured by

Bloomage, and Matrifill, made by Haohai, are catching up quickly.

Many investors are concerned about competition as there are already nine companies in the

market and more could follow. However, we are not overly concerned. First, we believe there is

ample room in the market for growth. Manufacturers are focused on reaching the untapped

market rather than fighting each other. About 80% of China’s HA dermal filler market comprises

smuggled and illegal products. This should not last as the regulator, the China Food and Drug

Administration, is making great efforts to raise quality standards and eliminate unqualified

operators across all healthcare subsectors. Second, competition is not necessarily bad. It takes

more than one player to educate a market which is still in its infancy. The growing popularity of

HA dermal filler injections illustrates the power of promotion.

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Looking good

The pursuit of beauty has become a lifestyle choice in China. There is an enormous interest in

the way bodies look: we paint them, keep them in shape through exercise and diet, and, if we

are still dissatisfied, head off to the cosmetic surgeon. Like it or not, men and women are under

increasing pressure to live to some ideal standard of beauty.

According to CAPA, China’s plastic surgery industry was valued at RMB400bn in 2014 and is

expected to double to RMB800bn by 2019, making it the third largest market in the world. But this is

just the beginning of China’s beauty story. The room for growth is enormous. As the table shows,

the cosmetic procedure per capita number in China is still much lower than in developed markets.

China’s procedure per capita is still lower than peers

Source: ISAPS

A few years ago, cosmetic surgery in China was limited to the realm of film stars. Social media

and the Internet have changed that. For example, SoYoung and Gengmei, two apps available

on the Apple and Android platform since 2013, bombard people with beauty tips, trends and

cosmetic surgery advice. They are rated 13th and 15th, respectively, in the Apple Store free-app

China rankings in the healthcare and fitness category. They both had around 10m active users

at the end of 2015, up from less than 1m in 2014.

13.2

11.6

10.0

7.8 7.3 7.4

0.8 0.4

0

2

4

6

8

10

12

14

Korea Italy US Taiwan Brazil Japan China India

No. of procedures per 1,000 population, 2011

Cosmetic surgery in China

The country has become one of the world’s largest cosmetic surgery markets

The huge customer base and the spending power of the younger generation are driving rapid growth

A more regulated market should benefit the certified brands and manufacturers

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Apple Store free-app ranking, China, to date

App name App store ranks in healthcare & fitness Active usersSoYoung 13 c.10mGengmei 15 c.10mSource: Apple Store

The different procedures

The market can be divided into two categories – invasive procedures and non-surgical

procedures. The first typically involves full incisions and anaesthesia; common procedures

include eyelid surgery, liposuction, breast augmentation and rhinoplasty. The second non-

surgical procedures can remove wrinkles and improve skin tone, firmness and hydration. Many

involve only a simple injection.

According to an international survey on aesthetic/cosmetic procedures in 2014, Botulinum

Toxin – better known as Botox – is the most popular global non-surgical procedure (4.8m

cases), followed by HA injections (2.7m). Common treatments include:

Botox injections which can prevent wrinkles.

Hyaluronic acid (HA) dermal filler which can rejuvenate facial contours, reduce wrinkles and

improve hydration and firmness of the skin.

Removing unwanted hair by exposure to a laser that destroys the hair follicle.

Chemical peel which is a body treatment used to improve the texture of the skin.

Laser skin resurfacing which uses a laser to improve the appearance of skin or treat minor

facial flaws by removing layers of skin.

World-wide top 5 non-surgical procedures

Source: ISAPS, HSBC

China’s pursuit of beauty

Demand is robust across different age groups. People in their early 20s are more interested in

facial contouring, the need for breast augmentation surges for women post-lactation and, as

people enter middle age, anti-aging procedures become popular. There are over 330m females

in China aged between 20 and 50; fewer than 8m had cosmetic surgery last year. There are

0 1,000 2,000 3,000 4,000 5,000 6,000

Laser Skin Resurfacing

Chemical peel

Hair removal

Hyaluronic acid

Botulinum Toxin

Number of nonsurgical procedures ('000)

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215m women in the 20-29 age groups, the demographic that dominates the market (see table

on next page). The China market has certain distinct characteristics:

Facial contouring: There is strong demand for facial contouring that improves the shape of

features such as the nose, chin or ears (westerners tend to have more facial definition due to

the bone structure).

The younger generation: In the US, people over the age of 35 account for 80% of non-surgical

procedures, while in China, those below 35 are the main customers. They care about their

appearances and have money to spend on themselves.

First-tier cities: The most active markets for plastic surgeries are the first-tier and top second-tier

cities – i.e. Shanghai, Beijing, Chengdu, Wuhan, Guangzhou and Shenzhen (source: SoYoung app).

Male customers: The pursuit of beauty is not limited by gender. Although the majority of

customers are women, male accounted for about 20% of the procedures last year, up from 11%

in 2014 (source: Gengmei app). Rhinoplasty, dermal treatment and hair transplants are popular

among men.

Procedures: Non-surgical procedures, especially injections, are more popular than invasive

procedures, given the faster recovery time and lower risk of complications.

There are over 330m women in China aged between 20 and 50

Source: National Bureau of Statistics

Customers below 35 years old account for the majority of all aesthetic medical procedures

Source: HSBC, Gengmei China Plastic Surgery White Paper

010203040506070

0-45-1011-1415-1920-2425-2930-3435-3940-4445-4950-5455-5960-6465-6970-7475-79

China female population (mn)

0%

20%

40%

60%

80%

100%Customer distribution

>35 yeas old 30-35 years old 25-30 years old <25 years old

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The percentage of male customers is increasing

Source: Gengmei China Plastic Surgery White Paper, 2015

Non-surgical procedures grow faster than invasive procedures in China (2011)

Source: ISAPS

Change is on the way

Cracking down on the unregulated market

In China, only 20% of the HA injections use products approved by the CFDA; the rest either

involve fakes (60%) or are smuggled from Europe and Korea (20%). The market at the medical

level is very fragmented. There are around 500 public hospitals in China that have aesthetic

medical departments and another 500 private hospitals that offer cosmetic surgery. There are

also 3,000 certified private clinics. It is estimated that there are unqualified 50,000-100,000

beauty salons that perform various types of cosmetic surgery.

When people take medication they generally look for authorized products at certified hospitals

and clinics. However, when it comes to beauty, many appear to be willing to take risks with

products that do not meet the strict CFDA standards. Price is another factor. A 1ml HA dermal

filler injection costs around RMB3,000-6,000 in hospitals, while an unauthorised beauty salon

may charge only RMB1,000.

We expect the unregulated market to shrink gradually as the government cracks down on illegal

products and premises. In 2012, the National Health and Family Planning Commission (NHFPC)

stepped up monitoring of all aspects of the industry (institutions, practitioners, procedures,

advertising). In 2014, China Association of Plastics and Aesthetics (CAPA) launched a trial

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2014 2015Male Female

34.5%

3.1%

13.1%

-5.4%-10%

0%

10%

20%

30%

40%

Non-invasive Invasive

yoy growth of number of aesthetic medical procedures

China Worldwide

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4 February 2016

evaluation programme in seven provinces which should be rolled out nationwide by 2017. In October

2015, the CFDA initiated a six-month nationwide campaign to crack down on the unregistered HA

dermal filler industry, tightening regulations on the manufacturing and sale of the products.

At the same time, the CFDA is raising the quality standards for medical devices, especially

Class III devices that are invasive or are implanted into the human body. In early January 2016,

the CFDA rejected 420 applications for medical devices, including some of the most well-known

international brands.

Fake products still dominate the market

Source: HSBC estimates

Composition of aesthetic medical institutes

Source: HSBC

Sales and marketing

Hospitals are spending heavily on advertising to market their cosmetic surgery services.

According to Lidu Aesthetics Hospital and Sino-Kor Aesthetics Hospital, which are both listed

and disclose financial information, 30-40% of their revenue goes on sales and marketing, mostly

on advertising. This includes:

Offline advertising on buses, subway systems and billboards.

Companies pay search engines like Baidu for a good position on search result pages.

For example, if you type “Zhengrong” (plastic surgery in Chinese) in Baidu’s search box, the

first four links take you to cosmetic surgery hospitals: Fuhua, Weizi, Shuguang and Mylike.

20%

20%60%

Certified products

Smuggled products

Fake products

500 5003,000

50-100k

Aesthetic medicaldepartments of public

hospitals

Aesthetic medical privatehospital chain and regionallarge-scale private hospitals

Qualified private clinics Unqualified beauty salon

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Mobile advertising: Wechat, with 600m active users, has become the go-to app for mobile

marketing and advertising. For example, major HA injection brands, domestic and foreign,

have opened official accounts on Wechat to promote their products.

Apps like Gengmei and SoYoung are more ambitious. By launching websites, mobile

applications and WeChat accounts, they have connected plastic surgeons, patients and

cosmetic surgery product manufacturers to create a digital community. They have forums

where patients can share their plastic surgery experiences. The apps also direct traffic to

plastic surgeons and hospitals.

Sales and marketing is a significant cost for cosmetic surgery hospitals

Source: Company reports, HSBC

The rise of blockbuster products and an industry leader

Case study: Allergan

Although the market is fragmented, it has the potential to groom blockbuster products and

create industry giants. The best-known company is Allergan, headquartered in Dublin, Ireland,

which is a global pharmaceutical company focused on eye care, neurosciences, medical

dermatology, cosmetic surgery, breast enhancement, obesity intervention and urologics. Its

most famous product is Botox, a bacterial toxin originally used for ophthalmology and later to

erase wrinkles. In 2001, the sales of Botox had barely passed USD3m. By 2002, Allergan

gained FDA approval to market Botox as a product that reduces the appearance of frown lines.

By 2013, sales were nearing USD2bn and contribute to one third of Allergan’s revenue. In

November 2015, Pfizer, the US pharma giant, announced a merger with Allergan at USD160bn.

Botox has grown into a blockbuster product in the medical and cosmetic space

Source: Allergan annual reports

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

Lidu Sino-Kor

Sales and marketing expense %, 2014

0%

2%

4%

6%

8%

10%

12%

14%

0

500

1,000

1,500

2,000

2,500

2009 2010 2011 2012 2013

Botox revenue (USDm) yoy

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4 February 2016

A versatile product

Hyaluronic acid (HA) is an anionic, nonsulfated glycosaminoglycan, a type of molecule

composed partly of sugars. HA is actually a natural structural component of skin, present in the

connective tissues throughout the human body. The magic of HA lies in its ability to retain

moisture. It is considered to have a greater capacity to hold moisture than any other natural or

synthetic polymer. One gram of HA is able to hold up to 6 litres of water, according to the

International Journal of Toxicology. HA is found in: 1) dermis, helping skin retain its moisture;

2) joints, serving as a lubricant and as a cushion; and 3) eyes, providing cushioning and

maintaining the shape of the eyeball.

HA, both the raw material and the finished product, can be categorised into four types:

Food: HA can be added to ordinary foods and beverages as additives, or made into

nutrition supplements.

Cosmetics: HA is widely used in cosmetic products as a moisturizer, anti-aging agent, or to

modify the viscosity of formula and create a nice sensory feeling when applied to skin.

Eye drops: HA is widely used for eye drops. It can also be used for post-operative

anti-adhesion products to lower the risks of infection and bleeding.

Injections: Injection grade HA can be used: 1) as a cushioning agent to ease joint pain and

to treat arthritis; 2) in eye surgery during intraocular lens implantation; and 3) as a dermal

filler to reduce facial wrinkles and for facial reconstruction.

Manufacturing techniques

There are two major manufacturing methods for HA, one is extraction from rooster combs, one

of the world’s richest sources of HA, and the other is microbial fermentation using bacterial

strains. Both technologies produce polydisperse high molecular weight HA for biomedical and

cosmetic applications. Both methods have been widely used at industry-scale, and they each

have their pros and cons.

Extraction protocols have been improved over the years, but still suffer from low yields, due

to the intrinsic low concentration of HA in the tissue, and from high polydispersity of polymer

products due to both the natural polydispersity of hyaluronan and to the uncontrolled

HA injections close-up

HA dermal filler injections are popular due to their clinical convenience, safety and versatility

Four brands – Restylane (Sweden), Yvoire (Korea), BioHyalux (China) and Matrifill (China) – dominate the market

Good relationships with hospitals, brand strength and new product launches are the key to future success

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degradation during extraction. As in any process for the production of therapeutic

compounds from animal sources, there is a potential risk of contamination with proteins and

viruses, but this can be minimized by using tissues from healthy animals and extensive

purification. To date, animal waste is still the most important source for the industrial

manufacturing of HA for medical application. Pharmacia (Sweden), Pfizer (US), and

Diosynth (The Netherlands) were among the first companies that produced HA from animal

waste on an industrial scale.

Bacterial fermentation produces HA with high molecular weight and purity, but risk of

contamination with bacterial endotoxins, proteins, nucleic acids, and heavy metals exists.

Production of HA by fermentation of streptococci strains is a mature technology, affording

high molecular weight and highly pure polymers suitable for medical, pharmaceutical and

cosmetic applications. Companies that produce HA through fermentation are Q-Med

(Sweden), Lifecore Biomedical (US), and Genzyme (US).

Dermal filler products

HA dermal filler

Naturally occurring hyaluronic acid (HA) in the body is gradually lost due to sun exposure,

hormonal changes and ageing. This results in wrinkles and loss of elasticity. HA gel used for

cosmetic injections is formulated to last longer. The gel is metabolized by the body into water

after around 6-18 months (depending on the type of gel and the metabolic rate of the individual).

HA dermal filler can be applied to various parts of the face and serves different purposes:

Rejuvenating facial contours to reverse the hollows and wrinkles that come with age. HA

dermal filler can be used to fill: 1) the hollowness under eyes to improve tired looking eyes;

2) furrows around the nose due to sagging cheeks; 3) lines running down from the corners

of the mouth; 4) hollow cheeks and temples.

Augmenting facial features. HA dermal fillers can be used on the: 1) nose for a straighter

profile; 2) chin to correct short chins; 3) lips to enhance thin lips; 4) cheeks to create

youthful roundness.

Improving firmness and skin texture. Using a special intradermal injecting technique, skin

hydration can be improved.

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4 February 2016

Common applications of dermal filler

Source: Bloomage website

HA injections are gaining popularity in China as well as other parts of the world. According to

International Society of Aesthetic Plastic Surgery (ISAPS) data, the number of HA injections

performed worldwide increased at CAGR of 12.7% over 2010-14. In China, the number of PC

website searches for key words “HA injections” have increased over four times since 2011, as

compared to two times for “plastic surgery” based on Baidu Index, a keyword search tool.

The searches for HA dermal filler increased faster than that for plastic surgery on Baidu

Source: Baidu Index

Botulinum toxin

Botulinum toxin, better known as Botox, is a neurotoxic protein produced by the bacterium

clostridium botulinum. It is a natural, purified protein that blocks the transmission of nerve

impulses to a spasm muscle, allowing the muscle to relax. Botox is widely used for cosmetic

use: It is injected into the muscle to smooth out the wrinkles and slim the face. It is a quick,

simple and effective solution to reduce frown lines, crow's feet and forehead lines. However,

Botox can only diminish wrinkles that are caused by muscle action. The results of Botox

treatment can be seen within days and usually last for 3-4 months for wrinkle reduction.

Currently, only the branded Botox and generic product Hengli (manufactured by Lanzhou

Institute of Biological Products) are available in the market. We expect Bloomage to introduce

Korea-made botulinum toxin to China in 2018.

0

2,000

4,000

6,000

8,000

10,000

HA dermal filler Plastic surgery

Baidu Index for key word searches

2011 2016

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HA plus other ingredients

Sometimes HA is made into dermal filler with other ingredients, such as cellulose and collagen,

to achieve long-lasting effect. Such products include Bonita and EME (manufactured by Imeik)

and Artecoll (manufactured by Netherland-based Hafod Bioscience). Generally, a pure HA

dermal filler will be naturally metabolized by the body in 6-12 months, while EME and Bonita can

last for over a year and Artecoll even longer. They last longer in the human body given the

added ingredients are harder to absorb. However, the risk of adverse reactions also increases

for these ingredients as they are more likely to cause allergic reactions.

Other HA dermal filler products

Brand name (EN) Brand name (CN) Other ingredients Manufacturer MNC/Domestic Approval timeEME 逸美 Cellulose Imeik China Oct-09Bonita 宝尼达 Polyvinyl alcohol (PVA) Imeik China Oct-12Artecoll 爱贝芙 Collagen, Polymethyl methacrylate

(PMMA) Hafod Bioscience Netherlands May-02

Source: Company data, HSBC

HA’s other applications: Hydro-lifting treatments

Hydro lift is a novel approach to facial rejuvenation and treating dry crepe skin. This involves

using HA fillers and Botox placed perpendicularly to the long wrinkles of the mid-face allowing

for a tightening and hydrating effect. The hydro-lifting technique was first introduced in Korea

and is customized for East Asian customers. Research shows that Asian skins tend to be more

sensitive to environmental pollution, certain chemicals and in some cases, humidity. Data from

Euromonitor shows that Chinese customers spend more on facial moisturizer and face masks

than other cosmetics purchases.

Chinese people spend more on facial moisturisers and face masks

Source: Euromonitor

HA injection players in the market

Competition is increasing. By 2012, the only brand in the China market was Sweden’s Restylane; in

the next four years, another four foreign brands and four domestic brands were approved.

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

China

US

Facial moisturiseres Anti-aging Face masks Liquid/cream/gel/bar cleasners Toners Others

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4 February 2016

Number of HA dermal filler approvals

Source: HSBC, CFDA

CFDA-approved HA dermal filler

Brand name (EN) Brand name (CN) Manufacturer MNC/Domestic Approval timeHA injection Restylane 瑞蓝 Q-Med AB Sweden Dec-08BioHyalux 润百颜 Bloomage China Jul-12Yvoire 伊婉 LG Life Science Korea Jul-13Matrifill 海薇 Haohai Biotec China Sep-13Shuyan 舒颜 SL Pharma China Feb-14Facille 法思丽 SciVision Taiwan Apr-14Elravie 艾莉薇 Humedix Korea Jan-15Juvederm 乔雅登 Allergan US May-15Singfiller 欣菲聆 Hangzhou Xiehe China Jul-15Source: HSBC, CFDA

Our proprietary research on different brands of HA dermal filler

We surveyed 50 hospitals in 15+ cities in China, including Beijing, Guangzhou, Shanghai,

Shenzhen, Changsha, Chongqing, Suzhou, Yantai and Zhengzhou, Nanjing. We focused on

four brands: Restylane (瑞蓝), Yvoire (伊婉), BioHyalux (润百颜), and Matrifill (海薇). This is

what we found:

Which HA brand do you carry in your hospital?

Restylane, the most mature HA injection product, has a penetration rate of 100%, followed by

Korean brand Yvoire. Domestic brands BioHyalux and Matrifill are becoming increasingly

accessible at 60-70%. Juverdem, a high-end product, was used in nine of the 50 hospitals.

-1

1

3

5

7

9

11

13

15

Before 2012 2012 2013 2014 2015

Number of HA dermal fillers in the market

Restylane

Bloomage

YVOIREMatrifill

ShuyanFacille

JuverdemElravie

Singfiller

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Restylane and Yvoire have the highest penetration rate, followed by BioHyalux and Matrifill

Source: HSBC

Which brand would you recommend to customers?

Hospitals generally make one or two recommendations. Of the 50 hospitals we surveyed, more

than half recommended Restylane and Yvoire due to their reputation and track record of good

quality. BioHyalux was first choice in 14 hospitals and Matrifill to 12. All nine hospitals which

carry Juverdem made it their first choice.

Restylane and Yvoire are still the first choice for majority of the hospitals

Source: HSBC

What is the price of HA dermal filler

The price difference between overseas and domestic brands is not significant, factoring in

discounts. The exception is Juverdem, which is about three times more expensive than the others.

0%10%20%30%40%50%60%70%80%90%

100%

Juverdem Restylane YVOIRE BioHyalux Matrifil

Penetration rate out of 50 hospitals

0%10%20%30%40%50%60%70%80%90%

100%


Recommendation rate out of 50 hospitals

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4 February 2016

Pricing differentiation is not too significant, except for Juverdem

Source: HSBC

Which brands are offering discounts right now?

Restylane and Yvoire are offering more discounts than domestic brands. This is mainly because

hospitals are trying to close the price gap between overseas and domestic brands.

Restylane and Yvoire are offering more discounts than domestic brands

Source: HSBC

Do you think foreign brands are better quality than domestic brands?

Two thirds of the hospitals think foreign brands are superior to domestic brands in terms of

efficacy and recovery time.

12000

29001200 1800 1500

13k

4.3k

3k 3k 3k

15k

6.8k8k 7.8k

6.8k

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000


Price range of five major HA dermall fillers (High, Median and Low from top to bottom)

05

101520253035404550


Number of special offers among 50 hospitals

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Majority think foreign brands are better quality than domestic brands

Source: HSBC

The competitiveness of domestic brands

The low entry barrier and intense competition are the major concerns for investors. We think both

are overblown. Although making HA is not rocket science, it takes 3-4 years to register products

with the CFDA. That is a very long time in a fast-growing industry. Late entrants will likely face

tougher environment with first movers already building out their relationships with hospitals.

We believe the demand is strong and there is ample room for more growth. The fact that the

industry has a huge problem with smuggled and illegal products should ultimately benefit the

established manufacturers. The CFDA is making great efforts to raise quality standards and

eliminate unqualified players across healthcare subsectors. Also, competition is not necessarily bad.

It takes more than one player to educate the market which is still at early stage of development.

We think domestic companies can remain competitive in this market, particularly Bloomage and

Haohai. They are managing their sales and marketing channels effectively and have gone

further downstream by creating a rich product pipeline.

68%

32%

Is MNC brand better than domestic brand

Yes

No

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4 February 2016

A leading biomedical material company

Haohai is a leading absorbable biomedical materials company. Its focus is on medical sodium

hyaluronate, medical chitosan and medical collagen, materials widely used in a variety of

surgeries including orthopaedics, anti-adhesion and haemostasis, ophthalmology, wound care

and dermatology.

Haohai 1H15 revenue breakdown

Source: Company reports

Haohai manufactures 14 biomedical products, of which three are classified as pharma products

and 11 as Class III medical devices, invasive medical devices with the highest quality standards.

The products include:

Orthopaedic intra-articular viscosupplement to treat degenerative arthritis.

Anti-adhesion products that prevent tissue and organ adhesion resulting from trauma and

injuries in surgical operations.

Ophthalmic viscoelastic device (OVD) products which are required for cataract surgeries

and can be used in other eye surgeries.

Recombinant human epidermal growth factor (rhEGF) for burn repair and diabetic foot ulcer,

etc. Haohai entered the cosmetic surgery market in 2014 by launching its branded HA

dermal filler product, Matrifill.

45%

28%

12%

5%10%

Orthopedics

Anti-adhesion and hemostasis

Ophthalmology

Wound care

Dermal filler

Shanghai Haohai Biotech

Haohai specialises in absorbable biomedical materials – HA, medical chitosan and medical collagen

It entered the HA dermal filler market in 2014 and is expanding the business rapidly

Initiate with a Buy rating and TP of HKD60

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Haohai’s products

TA Biomedical products Brand names CFDA classification Orthopaedics HA injection Teng Chemical drug Chitosan injection Chitogel Class III medical deviceAnti-adhesion & haemostasis HA gel Teng, Qisheng, Jianhua Class III medical device Chitosan injection Chitogel Class III medical device Medical collagen sponge Qitebang Class III medical deviceOphthalmology OVD Teng, Qisheng, Jianhua Class III medical device Lubricant eye drops Eyesucom Class III medical deviceWound care and tissue filling rhEGF Healin Biological product HA dermal filler Matrifill Class III medical deviceSource: Company report

Supportive policy environment

Pharmaceutical products in China need to go through a tender process to penetrate into public

hospitals. These happen every 2-3 years on a provincial level. This provides a great opportunity for

new products to gain market share but can also put pressure on prices. While for medical devices,

tender is also mandatory but mostly conducted on a hospital level. This would give manufacturers

slightly more bargaining power to negotiate a price they feel comfortable with, whilst in a provincial

tender, the price cut is sometimes compulsory and there is no room for negotiation.

Class III medical devices accounted for 58% of revenue in 1H15. The outlook for this revenue

stream is positive, given:

The State Council is determined to cut drug sales from 40% of public hospital revenues to

30% by 2017. As a result, we believe hospitals will increase sales of medical devices.

While the tender progress is standard for drug and price cuts have become common, the

tender for medical devices, in particular Haohai’s products, is mostly led by hospitals as

opposed to provincial government office. We have observed minimal price cut for Haohai’s

product offerings in the past few years.

China has introduced a number of initiatives which favour domestic medical devices,

squeezing the market share of foreign companies. Haohai, as a major beneficiary, has

increased its market share significantly.

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4 February 2016

Viscosupplement market share: Haohai vs. B&L Freda

OVD market share: Haohai vs. AMO Uppsala

Source: SME Research Source: SME Research

Ageing population: Orthopaedics and ophthalmology to benefit

An ageing society is defined as a population which has 7% of people over the age of 65. China

reached this milestone in the late 1990s. The rate has continued to rise as average life

expectancy has increased. According to NBS, by 2020, 14.5% of the population will be over 65,

rising to above 30% by 2050. And there has been a sharp increase in the percentage of people

“turning grey” between 2014 and 2017.

3-year average growth of ageing population

65+ age group as a percentage of the population

Source: National Bureau of Statistics, HSBC Source: Source: National Bureau of Statistics, HSBC

Orthopaedics – Viscosupplement

It is estimated that 68% of the aged population have arthritis, a degenerative and painful disease.

Fluids in the articular cavity – the area around the joint – that lubricate the movement of the articular

(known as synovia), and HA constitutes around 30% of the synovia. The concentration and

molecule size of HA in synovia deteriorates as people age and can lead to osteoarthritis, a more

serious condition.

Intra-articular HA/medical chitosan injections into light and medium-stage osteoarthritic patients

provide additional synovia and can reduce pain and delay the progression of the disease.

In 2000, the American Rheumatism Association (ACR) identified intra-articular HA injections as

the first-line treatment for osteoarthritis.

The viscosupplement market has grown at a 29% CAGR, from RMB900m in 2011 to RMB2.5bn

in 2015. We expect volume growth to increase at a CAGR of over 20% in the near term given

the relatively low penetration of the products. Japan’s viscosupplement market was around 40m

0%

10%

20%

30%

40%

50%

60%

2008 2013Haohai B&L Fredia

0%

10%

20%

30%

40%

50%

2008 2013

Haohai AMO Uppsala

3.8%

4.8%

0%

1%

2%

3%

4%

5%

6%

1993 2001 2009 2017e 2025e 2033e 2041e 2049e0%

5%

10%

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20%

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30%

35%

1990 1997 2004 2011 2018 2025 2032 2039 2046

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4 February 2016

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units in 2013, indicating a penetration rate of about 70% for people over 50; in China, the

market was 10m, a penetration rate below 3%.

Viscosupplement market has been growing rapidly

Penetration rate for viscosupplement is still low in China

Source: SME Research Source: HSBC research

The launch of high-end products

Haohai’s orthopaedic segment includes HA and medical chitosan orthopaedic intra-articular

viscosupplement (OIVS) products, with the brand names 'Teng' and 'Chitogel', respectively. The

former is classified as a pharma product, while the latter as medical device. According to SME

Research, Haohai is the second largest manufacturer of OIVS in China, with around 29%

revenue market share in 2013.

Haohai has cost advantage compared to competitors

Haohai is leading in market share in the oligopoly market of viscosupplement

Source: Company data, HSBC Source: SME Research

With lower prices for pharmaceutical products becoming a common industry theme, we

expect a price cut of around 10% for HA injections. Some of this pricing pressure will be

absorbed by the distributors. Also, Haohai has an exclusive specification of 3ml HA injection

which its competitors do not have, increasing the product’s pricing power. We expect HA to

grow at a CAGR of 22% in terms of volume over 2015-17 and 16% in value due to the

potential price cut from the forthcoming drug tenders in 1H16.

We expect Chitogel to become the key growth driver of Haohai’s orthopaedics business.

Chitogel has an effective duration of 6-12 months compared with six months for HA-based

OIVS. Chitogel-based OIVS require only three injections in each treatment cycle; HA-based

OIVS require five within a month. Also, Chitogel has anti-inflammatory function which HA

injection does not have. Chitogel is an exclusive product and we expect it to face less

pricing pressure.

0

1

2

3

2011 2012 2013 2014 2015Viscosupplement market size, China (Rmb bn)

29%

0%

20%

40%

60%

80%

Japan China

Penetration rate (population aged 50+)

0

200

400

600

800

1,000

Haohai B&L Freda Jingfeng SelikagakuTreatment cost (Rmb)

29%

30%

24%

17%Haohai

B&L Freda

Jingfeng

Selikagaku

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4 February 2016

We expect Haohai’s orthopaedics business to grow at 26% CAGR in 2015-17e


Ophthalmology

Ophthalmic viscoelastic devices (OVDs) are fundamental tools in modern cataract surgery. It acts

as a cushion or support to maintain a deep anterior chamber, allowing faster and safer eye

surgery, with reduced damage to the corneal endothelial cell and surrounding intraocular tissue.

Cataracts are associated with ageing (they affect 60-70% of people aged 50-60 and 80% aged

over 70 in China). They cause cloudy patches in the eye lens that make it hard to see. It has led

to 50% of the blindness cases in China, according to WHO. WHO estimates that the number of

cataract patient increases by 400,000 each year.

According to the National Healthcare and Family Planning Commission (NHFPC), the number of

cataract surgeries performed increased at a 17% CAGR from 2011 to 2014. We expect this

market to continue to grow at a similar rate, given China’s CSR (cataract surgical rate = cataract

operations per million population per year) is still very low, at around 1,400 compared to an

average of 3,000 in developing countries and above 9,000 in developed countries.

The number of cataract surgeries has increased significantly in China…

… but the cataract surgical rate is still low

Source: NHFPC Source: NHFPC

Haohai is the largest manufacturer of OVD products in China, with a market share of 40% in

2013. We expect Haohai’s ophthalmology segment to grow mostly in line with the OVD

market growth at a 15% CAGR over 2015-17.

Haohai also launched Eyesucom, a lubricant eye drop in 2014, used to protect eyes from

tear deficiency from ophthalmic surgery. Eyesucom is the only chitosan-based Class III

medical device in China for eye protection. We expect Eyesucom to leverage the

distribution channel of OVD and established physician relationship. We expect Eyesucom to

record sales of RMB10m/20m in 2016/17e.

0%

20%

40%

60%

80%

100%

0

100

200

300

400

500

2012 2013 2014 2015E 2016E 2017E

Haohai's viscosupplement revenue (RMBm)

HA Chitogel yoy

0

400

800

1200

1600

2011 2012 2013 2014

No. of cataract surgery (m)

17%

0

2,000

4,000

6,000

8,000

10,000

China Developingcountries

Developedcountries

CSR

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Haohai is the largest player of OVD market We expect Haohai’s OVD products to grow at 14% in 2015-17e

Source: SME Research Source: Company reports, HSBC estimates

Anti-adhesion to benefit from continuous market education and capacity expansion

Most surgeries cause adhesion – band of scar tissue that binds two parts of tissue not normally

joined. Post-operative adhesion can lead to complications such as chronic abdominal-pelvic

pain, secondary infertility, an increase in bowel obstruction risk and more complexity for future

surgery, including longer surgery times and an increase in morbidity.

Surgeons have been exploring multiple strategies to prevent post-operative adhesion, including

using minimally invasive surgery techniques and accurate haemostasis. Above all,

biodegradable barriers put in between the adjacent serosal surfaces are proven highly effective

in lowering the risks of adhesion, infection and bleeding. They have gained popularity in clinical

practice globally and in China, particularly for gynecological and abdominal surgeries, in recent

years as a result of continued promotion and educational efforts of major anti-adhesion product

manufacturers.

The post-operative anti-adhesion market has grown four-fold, from RMB368m in 2008 to RMB1.5bn

in 2013, a CAGR of 32.7%. The growth was due to: 1) increasing number of operations; according

to the NHFPC, there were 36.9m operations in 2012, a CAGR of 9.8% over 2006-12; 2) increasing

awareness of the benefits of using post-operative anti-adhesion products.

Fast-growing anti-adhesion market Chitosan and HA are the most commonly used anti-adhesive material

Source: SME Research Source: SME Research

Haohai is the largest player in anti-adhesion market, accounting for 50% of the market share. Its

product offerings include HA gel, chitosan injection and medical collagen sponge. We expect

Haohai’s anti-adhesion segment to grow at 21% CAGR in 2015-17e, mainly driven by organic

growth of the market and the removal of a manufacturing capacity bottleneck. Prior to the

42%

17%

16%

8%

17%Haohai

AMO Uppsala

B&L Freda

LG

Others 0%

5%

10%

15%

20%

25%

30%

0

40

80

120

2012 2013 2014 2015E 2016E 2017E

OVD revenue (RMBm) yoy

0

1

2

3

2011 2012 2013 2014 2015Anti-adhesion market size (RMBbn)

26%

45%

37%

18%

Market share by product

Chitosan

HA

Other

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4 February 2016

capacity expansion in 4Q13, the company produced chitosan-based anti-adhesion products in

Qisheng factory, Shanghai, which had limited capacity. This made it difficult to increase

Chitosan-based anti-adhesion product sales and has hurt Haohai's market share.

The production line had utilization rates of 96% in 2011 and 137.7% in 2012. Haohai suspended

the manufacturing to upgrade the facility in 1Q13. The new facility, which began operations in

February 2014, increased capacity for chitosan-based anti-adhesion products by 133% – from

1.93m units a year to 4.5m units a year. Similarly, medical collagen sponge capacity was only

50,000 pieces a year at the old factory. This has expanded to 300,000 at the new facility.

Young and fast-growing dermal filler player

Haohai became the second domestic player to get HA dermal filler approval in September 2013

and launched Matrifill in early 2014. Haohai had conducted multi-centre clinical trials of 500

cases for Matrifill in Nangfang Hospital, Peking University Third Hospital and Shanghai Ninth

People’s Hospital, comparing the effects of Matrifill with the effects of Restylane, the world's

leading brand from Sweden.

Matrifill is the only product on the market that has conducted a head-to-head comparison with

Restylane. Haohai also obtained CE (EU medical device approval) certification for Matrifill in

2012. In our proprietary survey, Matrifill is used in 39 out of the 50 hospitals we contacted.

Matrifill data

Brand name Matrifill Specification 0.5ml, 0.75ml, 1ml, 1.5ml, 2mlYear of market entry 2014Distribution model Direct sales and distribution network Sales team 50-60Hospital purchase price (RMB) c1,600Retail price (RMB) c3,000-6,000Source: Company data, HSBC

Matrifill

Source: Company website

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We expect Matrifill to record sales of RMB80m in 2015, up from RMB26m in 2014. The rapid

growth is due to:

Ample room in the market and a young product cycle: Although nine products have CFDA

approval and the entry barrier for new products is not very high, the market for regulated HA

dermal filler is still large and we expect Matrifill to benefit from increasing penetration and

strengthening relationships with the hospitals in 2016. Matrifill’s second year performance

was in line with that of Bloomage’s BioHyalux at the same stage.

Sales team: A team of 50 sells Matrifill to hospitals, manages the distribution network and

handles sales and marketing for the brand. In 2015, the company launched a series of

marketing campaigns with 40 plastic surgery institutions throughout China.

HA dermal filler has become the strategic focus for Haohai. However, a single product is not

sufficient to build a reputation in the cosmetic surgery industry. Haohai plans to launch two more

products, Janlane and QST gel, in early 2016 and 2017, respectively. Janlane is a longer-acting

filler for facial contouring and QST gel is an advanced option for facial wrinkle treatments. We

expect Matrifill’s growth momentum to continue in 2016-17, with Janlane starting to contribute to

revenue in 2017e.

We expect the HA dermal filler segment to maintain high growth


Financial analysis

We expect Haohai’s net profit to grow at a 28% CAGR over 2015-17, largely in line with revenue

growth, given the stable margin from the improving product mix. Our other 2015-17 sales

forecasts include:

Ortho business to grow at 26% CAGR, driven by ageing population, increasing penetration

and addition of high ASP products for Chitosan injections.

Anti-adhesion segment: 21% CAGR, driven by the removal of the capacity bottleneck and

continued market education.

Ophthalmology segment: 14% CAGR, excluding lubricant eye drops, in line with the growth

of number of cataract surgeries.

HA dermal filler: annual growth of 90% in 2016e and 30% in 2017e, driven by increasing

penetration and new product launches.

0

50

100

150

200

250

2014 2015E 2016E 2017E

Haohai HA dermal filler revenue (RMBm)

Matrifill Janlane

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4 February 2016

Haohai earnings forecasts

Revenue breakdown (RMBm) 2012 2013 2014 2015e 2016e 2017eOrthopaedics 123 199 237 297 381 472y-o-y 61.4% 19.1% 25.4% 28.3% 23.8%Anti-adhesion and haemostasis 122 140 155 184 224 270y-o-y 14.9% 11.0% 18.5% 21.4% 20.8%Ophthalmology 51 53 67 79 97 119y-o-y 4.1% 26.8% 18.5% 22.3% 22.9%HA dermal filler - - 26 80 152 198y-o-y 212.9% 90.0% 30.0%Total revenue 303 401 516 676 894 1,105y-o-y 32.3% 28.6% 31.1% 32.3% 23.5% Gross profit 253 346 450 586 767 941Gross margin 83.4% 86.3% 87.2% 86.7% 85.7% 85.1% Selling expense (73) (143) (187) (223) (295) (365)% of revenue 23.9% 35.7% 36.3% 33.0% 33.0% 33.0%Admin expense (36) (34) (49) (61) (76) (88)% of revenue 12.0% 8.5% 9.5% 9.0% 8.5% 8.0%R&D expense (18) (24) (26) (37) (49) (61)% of revenue 5.8% 5.9% 5.1% 5.5% 5.5% 5.5% Tax (19) (25) (32) (48) (60) (72)Tax rate 14.6% 15.0% 14.9% 15.0% 15.0% 15.0% Reported net profit 114 142 184 271 339 410y-o-y 24.2% 29.7% 47.7% 25.0% 21.0% Recurring net profit 114 142 184 252 339 410y-o-y 0.0% 24.2% 29.7% 37.1% 34.7% 21.0%Net margin 37.6% 35.3% 35.6% 37.2% 37.9% 37.1%Source: Company reports, HSBC estimates. The difference between reported net income and recurring net income in 2015 is due to cRMB23m one-off exchange gains

Balance sheet and cash flow analysis

Haohai has a very healthy cash flow after raising RMB1.8bn from its IPO in April 2015. The

large amount of cash flow from investing activities in 2015 is mainly due to the purchase of term

deposits. We estimate it had cash and cash equivalents of cRMB2.2bn at end-2015e. We

expect this to be used to fund capex for new facilities and potential M&A. We expect Haohai’s

capex for 2015-17e to amount to RMB500m to fund capacity expansion at Shanghai Likangrui,

Minhang and Haohai Biological. We expect Haohai to remain unleveraged given the recent IPO.

Cash flow analysis

RMBm 2012 2013 2014 2015e 2016e 2017eCash and cash equivalents 161 197 181 2,198 2,284 2,535Cash flow from operating activities 118 147 142 270 241 402Cash flow from investing activities (84) (111) (88) (1,576) (155) (152)Cash flow from financing activities - - (70) 1,823 - -Capex (65) (124) (94) (100) (200) (200)Source: Company reports, HSBC estimates

Balance sheet analysis

RMBm 2012 2013 2014 2015e 2016e 2017ePP&E 146 271 352 419 573 715Current assets 245 297 347 2,394 2,574 2,856Cash and cash equivalents 161 197 181 2,198 2,284 2,535Total assets 448 621 752 2,852 3,186 3,609Gross debt 0 0 0 0 0 0Source: Company reports, HSBC estimates

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Valuation and risks

We initiate coverage with a Buy rating and a TP of HKD60. Our TP is based on 24x 2016e PE,

a 10% premium to comparable companies, implying 0.9 PEG, given a 28% earnings CAGR for

2015-17e. We believe Haohai deserves to trade at a premium, given: 1) its high growth visibility

supported by the fast-growing orhthopaedics, ophthalmology and cosmetic surgery sector; 2)

R&D pipeline and potential M&A to support long-term growth. Catalysts include the

announcement of strong HA dermal filler sales in 2015 and the launch of new products in 2016.

Comparable companies

BBG Name Industry Price Mkt Cap (USDm)

ADT (USDm)

PE(x) PE(x) 2015-17e EPS

2016e PE/CAG

R

PB(x)

2015 2016 CAGR PEG 20146826 HK Haohai Biomedical 46.00 944 0.7 24.9 18.4 27.6 0.7 9.3963 HK Bloomage Biomedical 16.76 755 1.7 25.3 20.3 23.0 0.9 8.14548 JP Seikagaku Biomedical 1837.00 896 3.1 27.2 31.5 9.1 3.5 1.4ANIK US Anika

Therapeutics Biomedical

37.67 551 0.6 19.7 23.8 -3.6 2.81177 HK Sino

Biopharm Pharmaceuticals

5.41 5,143 15.8 21.9 18.3 18.0 1.0 5.31093 HK CSPC Pharmaceuticals 6.51 4,935 13.3 23.2 18.6 24.4 0.8 4.61530 HK 3SBio Inc Biologics 9.89 3,190 8.8 34.9 26.1 29.6 0.9 4.82186 HK Luye Pharmaceuticals 6.55 2,790 8.9 22.7 18.7 22.5 0.8 4.41513 HK Livzon Pharmaceutical 36.15 2,247 1.2 19.4 16.6 17.2 1.0 3.8Average 24.2 21.9 16.7 1.3 3.9Source: Bloomberg for all other companies, HSBC estimates for Haohai and Bloomage only. Prices as of 2 Feb

Downside risks

1) Competition from new entrants: The biodegradable medical device segment is a competitive

market, with a much shorter product registration process than the drug segment. This lowers the

entry barrier. The emergence of new competitors and aggressive marketing by existing

companies could result in a loss of market share for Haohai.

2) Pricing pressure: HA OIVS and rhEGF (46.1% of Haohai’s 2014 aggregate revenue) are

registered as drugs and are listed on the National Drug Reimbursement List (NDRL), prices of

which are decided by tender. Price erosion associated with provincial drug tenders could result

in slower revenue growth and have a negative impact on the margins of these two products.

3) Product safety issues: If any of Haohai’s products show side effects in clinical use, it may

damage Haohai’s reputation.

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4 February 2016

Company profile

Company history

Year Events 2007 Haohai Limited was established in Shanghai, China PRC Gained control of Songjiang Factory, which manufactures HA and rhEGF products Acquired Shanghai Jianhua Consolidated Shanghai Qisheng2010 Haohai Limited was converted into a joint stock limited company and renamed to Shanghai Haohai Biological

Technology Co., Ltd. Shanghai Likangrui was acquired by the company, for expanding product of ferings (fibrin sealant) in anti-

adhesion and haemostasis 2011 The company was entrusted by STCSM to sponsor the establishment of the Shanghai Strategic Alliance for

Innovation of Medical Absorbable Biomaterial 2014 The company was approved by STCSM to establish the Shanghai Engineering and Research Center of

Medical Absorbable Biomaterial 2015 Haohai went IPO in Hong Kong Stock Exchange on 30 April 2015

The company made an investment for 60% shareholding in Shanghai Baiyue by capital injection. The company acquired 38% stake in Henan Universe.


Shareholder structure

Haohai is a privately owned company. The largest share is owned by the founder Wei Jiang and

his wife Ms. Jie You. The management team owns c10% of the equity interest.

Haohai shareholder structure

Source: Company reports

Extensive sales network

Haohai has an extensive distribution network in China, consisting of over 1,300 distributors,

covering over 4,700 hospitals, representing over 90% and 40% of the Class III and Class II

hospitals in China, respectively. The company also maintains an in-house sales force to market

and sell medical device products to Class III hospitals in first and second tier cities.

Manufacturing facilities

Haohai has three production facilities in Shanghai – Haohai Biological, Shanghai Jianhua and

Shanghai Qisheng – with a total gross floor area of 29,000 square metres and nine production lines.

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In 2014, the company completed facility upgrades at all three facilities, which substantially

increased the designed production capacity of HA, chitosan and rhEGF. The capacity of HA at

Haohai Biological increased by 270% from 1.35m units to 5m units; HA/chitosan injections at

Shanghai Qisheng increased by 130% to 4.5m units.

The company will continue to increase capacity. It is constructing two new production

facilities – Shanghai Likangrui and Minhang – and further upgrading existing facilities at Haohai

Biological. Total capex through 2017 is estimated to be RMB630m. On completion in 2017, the

total annual production capacity of HA-based and chitosan-based products will be increased

from 9.5m units to 20m units.

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4 February 2016

Financials & valuation: Shanghai Haohai Biological Buy Financial statements Year to 12/2014a 12/2015e 12/2016e 12/2017e

Profit & loss summary (CNYm)

Revenue 516 676 894 1,105EBITDA 185 262 343 424Depreciation & amortisation -20 -33 -46 -57Operating profit/EBIT 164 229 298 366Net interest 4 24 45 48PBT 216 319 399 482HSBC PBT 216 319 399 482Taxation -32 -48 -60 -72Net profit 184 271 339 410HSBC net profit 184 252 339 410Cash flow summary (CNYm)

Cash flow from operations 142 270 241 402Capex -94 -100 -200 -200Cash flow from investment -88 -1,576 -155 -152Dividends 0 0 0 0Change in net debt 16 -2,017 -86 -250FCF equity 58 138 128 200Balance sheet summary (CNYm)

Intangible fixed assets 20 9 8 7Tangible fixed assets 384 450 604 746Current assets 369 2,415 2,596 2,877Cash & others 181 2,198 2,284 2,535Total assets 773 2,874 3,207 3,630Operating liabilities 157 163 158 170Gross debt 0 0 0 0Net debt -181 -2,198 -2,284 -2,535Shareholders' funds 594 2,688 3,027 3,437Invested capital 435 512 765 925

Ratio, growth and per share analysis Year to 12/2014a 12/2015e 12/2016e 12/2017e

Y-o-y % change

Revenue 28.6 31.1 32.3 23.5EBITDA 29.5 41.6 31.2 23.4Operating profit 21.9 39.0 30.2 23.1PBT 29.5 48.0 25.0 21.0HSBC EPS 29.7 37.1 34.7 21.0Ratios (%)

Revenue/IC (x) 1.3 1.4 1.4 1.3ROIC 35.4 41.0 39.6 36.9ROE 32.6 15.3 11.9 12.7ROA 25.9 14.9 11.1 12.0EBITDA margin 35.8 38.7 38.4 38.3Operating profit margin 31.9 33.8 33.3 33.2EBITDA/net interest (x) Net debt/equity -30.5 -81.8 -75.5 -73.8Net debt/EBITDA (x) -1.0 -8.4 -6.7 -6.0CF from operations/net debt Per share data (CNY)

EPS Rep (diluted) 1.14 1.69 2.11 2.56HSBC EPS (diluted) 1.14 1.57 2.11 2.56DPS 0.00 0.00 0.00 0.00Book value 3.70 16.75 18.86 21.42

Key forecast drivers Year to 12/2014a 12/2015e 12/2016e 12/2017e

Orthopaedics 237 297 381 472Anti-adhesion 155 184 224 270Ophthalmology 67 79 97 119Wound care and tissue filling 57 116 193 244

Valuation data Year to 12/2014a 12/2015e 12/2016e 12/2017e

EV/sales 2.7 -0.9 -0.8 -0.9EV/EBITDA 7.4 -2.5 -2.1 -2.3EV/IC 3.2 -1.3 -1.0 -1.1PE* 34.0 24.8 18.4 15.2PB 10.5 2.3 2.1 1.8FCF yield (%) 3.7 8.9 8.3 12.8Dividend yield (%) 0.0 0.0 0.0 0.0

* Based on HSBC EPS (diluted)

Issuer information Share price (HKD) 46.00 Free float 100%Target price (HKD) 60.00 Sector BiotechnologyReuters (Equity) 6826.HK Country Hong KongBloomberg (Equity) 6826 HK Analyst Yumeng WangMarket cap (USDm) 236 Contact +852 2996 6586

Price relative

Source: HSBC

Note: Priced at close of 02 Feb 2016

38.00

43.00

48.00

53.00

58.00

63.00

68.00

38.00

43.00

48.00

53.00

58.00

63.00

68.00

2014 2015 2016 2017Shanghai Haohai Biologica Rel to HANG SENG INDEX

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An integrated dermal solution provider

Bloomage has been the world’s largest HA raw material manufacturer since 2012. In the last

three years, it has evolved into an integrated HA product provider by entering the dermal filler

market and become a full-fledged medical dermatology product provider. In 2012, Bloomage

became the first domestic company to launch HA dermal filler products in the market. It later

added HA hydro lifting injection and HA skin care products in its dermatology product offerings.

We expect Bloomage to introduce new types of HA injections in 2016-17, followed by botulinum

toxin (Botox) treatments in 2018.

Bloomage’s percentage of revenue from HA end product to rise to 46% by 2017e


0

200

400

600

800

1,000

2012 2013 2014 2015E 2016E 2017E

Bloomage revenue breakdown

HA raw materials HA end product

Bloomage

Bloomage, the largest HA raw material manufacturer in the world, has expanded into HA finished products, including dermal fillers

It has become a full-fledged provider of dermatology services, with a rich product pipeline

Initiate with a Buy rating and TP of HKD20

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4 February 2016

Bloomage: major products and pipeline

Product Indication Type Year of launchHA injection - Low molecule weight Dermal filler Dermatology 2012HA injection - High molecule weight Dermal filler Dermatology 2015HA hydro lifting injection Skin rejuvenation Dermatology 2015HA skin care products Daily skin care Dermatology 2014HA injection for ophthalmology use OVD Ophthalmology 2012HA injection for orthopaedics use Knee pain Orthopaedics 2014 Pipeline Third-generation HA dermal filler Dermal filler Dermatology 2H16/2017Botulinum toxin Dermatology 2018Source: Company data, HSBC

Largest HA raw materials provider

Bloomage is by far the world’s largest HA raw material manufacturer and has a dominant position in

China. It makes raw materials for food, cosmetics and medical grade HA products. The medical

category has the highest profitability (>90% gross margin) and ASP, followed by cosmetics and

food. Although growth in global HA raw material consumption has fallen to the low-teens, we

believe Bloomage is well positioned to deliver above-industry average growth, given: Economies of scale: In 2014, Bloomage expanded its HA raw material production capacity

to 200 tonnes, from 60 tonnes. Comparable global and domestic players generally only

have capacity of about 30 tonnes.

Cost advantage: Bloomage uses the fermentation method to produce HA, the most mature

industrial manufacturing technique. Its expression level can reach 10g/litre, higher than the

industry average of 7g/litre, making Bloomage c30% more cost effective than competitors.

Prominent customer profile. Over the past 20 years, Bloomage has built long-term

relationships with more than 650 customers in over 40 countries. It provides HA raw

materials for prominent global companies, including AMO and Bausch & Lomb (medical),

Amway and Schiff (food), and Estee Lauder, L’OREAL and Unilever (cosmetics).

Increasing portion of medical grade HA sales: We believe Bloomage will increase the

revenue contribution from medical grade raw materials in order to mitigate the margin pressure

on cosmetic and food grade products caused by intensified competition. As a result, we expect

the HA raw materials gross margin to fall from 72% in 2014 to 66% in 2017e.

The global HA market is expected to grow at a CAGR of 8-10% over 2015-17e, according to

management. We expect Bloomage’s HA raw materials business to grow at 13% CAGR over

the same period.

HA raw materials comparison

Grade Technology barrier

% of Bloomage HA raw material

revenue

Unit price (RMB/kg)

GM Bloomage's market share Sales growth forecast

(2014-17e) Domestic GlobalFood grade Low 6% 1,000-5,000 10-15% n/a n/a c10%Cosmetic grade Medium 65-68% 8,000-20,000 60-70% 60% 30% 10-15%Medical grade High 25-28% 200,000 90%+ 90% 15% >20%Source: Company reports, HSBC estimates

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Bloomage’s HA raw materials revenue breakdown (2014)

ASP variance is great among HA raw materials

Source: HSBC estimates Source: HSBC

We expect Bloomage HA raw materials to maintain steady growth at 13% CAGR in 2015-17e


A first-mover in domestic HA dermal filler

In 2012, Bloomage became the first domestic company to get CFDA approval for HA dermal

filler. BioHyalux’s sales increased from less than RMB10m in to over RMB200m in 2015,

according to our estimates. The success can be attributed to several factors:

First mover advantage

Bloomage was the first domestic company to launch pure HA dermal filler. At the time, most

hospitals only stocked one dermal filler brand, Restylane (some also had EME). BioHyalux

sales rose to RMB80m in the second year after launch.

67%

27%

6%Medical grade

Cosmetic grade

Food grade

200

30-608-20 2-4

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100

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250

Injectiongrade

Eye dropgrade

Cosmeticgrade

Food grade

HA raw materials ASP ('000 RMB/kg)

0%

5%

10%

15%

20%

25%

30%

-

100

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300

400

500

600

2014 2015E 2016E 2017E

Bloomage HA raw mateirals (RMBm)

Medical Cosmetic Food yoy

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4 February 2016

Summary of BioHyalux data

Brand name BioHyalux Specification HA injection - Low molecule weight HA injection - High molecule weightYear of market entry 2013Distribution model Direct sales and distributor Sales team 120Covered hospital 110 public hospitals, 450 private plastic surgery hospital chain, 180 private clinicsHospital purchase price (RMB) 1,600-1,800Retail price (RMB) 3,000-6,000Source: Company reports, HSBC

Good hospital penetration rate

Bloomage has a dedicated sales team of 120, one of the largest in the domestic market. The

team covers 110 of the 500 public hospitals with aesthetic medical departments, 450 of the 500

aesthetic medical private hospitals and 180 of the smaller qualified private clinics.

Bloomage’s hospital coverage


Versatile marketing strategies

As opposed to the traditional way of bombarding customers with advertisements, Bloomage has

adopted more versatile marketing strategies, including:

Professional image. Back in 2013, when most industry practitioners had not realized the

importance of educating customers, Bloomage launched a well-designed independent

website to introduce BioHyalux.

Special offer: Bloomage carried out a promotional campaign in MyLike Plastic Surgery

Hospitals in 2013 and early 2014. Anyone could walk in and ask for a 0.5mg HA filler try-out

by paying a RMB500 injection fee.

Working with opinion leaders: In June 2013, Bloomage collaborated with HuaMei

Cosmetic Surgery Hospital to co-host an Asia facial augmentation seminar to coincide with

the launch of BioHyalux in southern China. At the end of 2013, Bloomage collaborated with

Navy General Hospital to establish a professional medical cosmetology platform,

"RunHaiYan" (润海颜), to provide cosmetic services to customers.

Embedded movie advertising: In the movie, The Truth About Beauty (整容日记), released

on 4 April 2014, a group of women talked about cosmetic surgery in front of a PC showing

the BioHyalux website.

0

500

1000

1500

2000

2500

3000

3500

Public hospitals Aesthetic medical private hospitalchain

Private clinics at smaller scaleCovered Uncovered

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Bloomage has built a professional image in cosmetic surgery


Now that BioHyalux has a good hospital distribution network in place, we expect sales of

Bloomage’s HA injection products to grow at 30% CAGR in 2015-17e, driven by: 1) increasing

penetration into uncovered areas, especially private clinics; 2) new dermal filler series: in 2014,

Bloomage launched a new product for enhanced facial contouring; 3) Bloomage is the first

domestic company to introduce hydro-lifting HA injection treatment. Bloomage acts as an agent

to sell imported hydro-lifting machines.

We expect Bloomage’s HA dermal filler/injection to grow at 30% CAGR over 2015-17e


HA products: more than just dermal filler

Bloomage has made good use of its fully-fledged HA raw materials product line to launch

various other related products:

Skin care products

Bloomage has launched a series of skin care products including creams, face masks, serums

and toners. They are mostly available in plastic surgery hospitals to help post-surgery recovery.

We believe this is a more efficient entry point than the fast moving consumer goods market.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

-

50

100

150

200

250

300

350

400

2012 2013 2014 2015E 2016E 2017E

BioHylux revenue (RMBm) yoy

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4 February 2016

Bloomage’s skin care products


Orthopaedics and ophthalmology

Bloomage was granted its OVD approval in 2012 and knee lubricant approval in 2014. These

categories have addressable markets of RMB1bn and RMB2.5bn, respectively. Although

orthopaedics and ophthalmology are not Bloomage’s traditional strength, we believe this is a good

move, given the size of the market, fast growth and benign competitive environment. For now,

Bloomage will use distributors to penetrate hospitals. We expect orthopaedics and ophthalmology

products to contribute combined revenue of RMB50m by 2017e.

Pipeline provides long-term visibility

Last year, Bloomage formed two strategic agreements with overseas brands to expand its

product line:

May 2015: Bloomage invested EUR59m for a 33% equity interest in Vivacy Lab, a

France-based HA laboratory. Vivacy is a fast-growing European-based HA dermal filler

provider with: 1) third-generation HA dermal filler cross-linking technology; 2) a rich product

pipeline including: anti-aging, ophthalmology, rheumatology and gynecology products;

3) a strong sales team covering over 70 countries. Bloomage has gained the exclusive

rights to sell Vivacy Lab’s products in Asia Pacific. We expect Bloomage to get CFDA

approval for Vivacy’s dermal filler products over 2H16/2017.

July 2015: Bloomage formed a strategic cooperation with the South Korean biotech

company Medytox to establish a JV (Medyloom) that aims to develop botulinum toxin

(Botox) business in China. Medytox is the fourth company in the world to have developed

botulinum toxin since Botox’s patent expired in 2014. It has a 40% market share in Korea.

The JV hopes botulinum toxin will get CFDA approval by 2018.

Bloomage has laid the foundations to grow into a comprehensive dermatology solution provider.

After the success of its low-weight molecule BioHyalux in 2013-14, growth in 2015-16 should

come from high-weight molecule BioHyalux and HA injections for hydro-lifting treatments.

Beyond 2017, the expected launch of high-end products from collaboration with overseas

companies, Vivacy’s dermal filler and Medytox’s botulinum toxin and dermal filler, should

provide long-term earnings visibility.

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Bloomage has a roadmap for HA and dermatology products

Source: Company reports, HSBC. Notes: The products in grey are products to be launched soon.

Financial analysis

Revenue forecasts

We believe recurring net profit will increase at a CAGR 23% over 2015-17e, driven by strong

top-line growth. Our sales forecasts include:

HA raw materials: 13% CAGR, driven by expanding capacity and increasing portion of

medical and cosmetic grade raw materials.

HA dermal filler/injections: 30% CAGR, driven by the launch of high-molecule dermal filler

products and the popularity of hydro-lifting treatment.

Other revenue: includes orthopaedics/ophthalmology products and imported brands, to be

launched in 2H16/2017.

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4 February 2016

Bloomage earnings forecast

RMBm 2012 2013 2014 2015e 2016e 2017eHA raw materials 266 288 321 398 454 513y-o-y 8.4% 11.4% 24.0% 14.0% 13.0%HA dermal filler/injection 9 87 159 222 289 375y-o-y 82.8% 40.0% 30.0% 30.0%Others 1 5 20 60Total revenue 275 375 481 625 763 948y-o-y 36.4% 28.3% 30.0% 22.0% 24.3% Gross profit 191 300 375 471 573 707Gross margin 69.3% 79.9% 78.0% 75.2% 75.2% 74.5% Selling expense (33) (59) (75) (94) (114) (142)% of revenue 12.1% 15.6% 15.5% 15.0% 15.0% 15.0%Admin expense (26) (59) (78) (91) (111) (138)% of revenue 9.4% 15.7% 16.1% 14.5% 14.5% 14.5%Finance costs (9) (10) (10) (14) (29) (21)% of revenue 3.3% 2.7% 2.0% 2.3% 3.8% 2.3%Share-based compensation (18) (57) (27) (24) (22) (19)% of revenue 6.6% 15.3% 5.5% 3.8% 2.8% 2.0%Amortization expense (20) (20) (20)Other expense (30) Tax (23) (31) (36) (45) (65) (84)Tax rate 20.1% 24.9% 18.2% 21.0% 21.0% 21.0% Net profit 89 94 162 168 245 317y-o-y 5.7% 71.7% 3.5% 46.0% 29.6%Net margin 32.5% 25.2% 33.7% 26.8% 32.1% 33.5%Adjusted net profit 105 140 183 229 282 344y-o-y 33.9% 30.7% 25.0% 23.0% 22.0%Net margin 38.1% 37.4% 38.1% 36.6% 37.0% 36.3%Source: Company reports, HSBC estimates

Expense analysis

We expect gross margin to fall to 74.5% by 2017, due to price cuts affecting HA raw materials

and HA end products as a result of increasing competition. We expect the selling expense ratio

and admin expense ratio to remain steady at c15% and c14.5% over 2015-17e, respectively.

Our forecasts for other expenses include:

Share-based compensation: RMB24m in 2015, RMB22m in 2016, RMB19m in 2017 from

the options and warrants issued to the management team.

A non-recurring expense of cRMB20m in 2015 from transaction fees for issuing convertible

bonds to GIC and conducting due diligence on the acquisition of Vivacy.

The acquisition of Vivacy is likely to result in amortization expense of RMB20m a year over

2015-17.

The issuance of share-based compensation to the management team in 2016 is likely to

record a one-time loss of RMB10m in 2015.

Finance cost should increase from the issuance of RMB220m loan and RMB465m

convertible bonds to finance M&A.

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Management share incentive scheme

No. of shares Exercise price Share price Option life2012 share options 12.48m shares HKD4.422 HKD4.3 3.25yrs2013 share options 9.96m shares HkKD16.652 HKD15.8&17.22 3-4.5yrs2013 warrants 16.6m shares HkKD16.652 HKD17.22 3-4.5yrs2014 share-based payment transaction settled by controlling shareholder

9.96m shares HKD5.8 HKD18.96 5yrs


Dilutive effect on number of shares

At current price levels, we expect the dilution from convertible bonds and 2013 warrants to start

to kick in. We expect the diluted number of shares to potentially increase to 404m in 2016/17,

from the issuance of 9.687m shares to management team in January 2016, 16.6m exercisable

warrants (all shall be exercisable by 30 October 2017) and 16.1m convertible bonds issued to

GIC (exercise price at HKD17.2).

Net profit adjustments

To better understand Bloomage’s recurring operational status, we have calculated an adjusted

net profit by taking out: 1) share-based compensation; 2) intangible amortization expense from

acquisition of Vivacy; 3) transaction fees; 4) finance costs on bank loans and convertible bonds;

and 5) profits from investments in Vivacy.

Net profit analysis

RMB 2014 2015e 2016e 2017eEPS basic 0.488 0.478 0.678 0.875EPS diluted 0.473 0.425 0.605 0.781Adjusted EPS basic 0.000 0.652 0.781 0.953Adjusted EPS diluted 0.000 0.566 0.697 0.850Source: Company reports, HSBC estimates

Balance sheet and cash flow analysis

Bloomage has a healthy operating cash flow. We expect its capex to remain steady at RMB80m

per year in 2015-17e. The substantial increase in cash inflow from financing activities in 2015 is

mainly due to the issuance of equities of HKD193m and convertible bonds of HKD465m to GIC

in November 2015 and RMB220m new bank loans to fund the deal with Vivacy. The substantial

increase in cash outflow from financing activities is mainly due to the increase in restricted cash

and the EUR59m acquisition of 33.41% of Vivacy. We expect gross debt to gradually decrease

as Bloomage pays off the bank loans and GIC may convert bonds into equities. We expect

Bloomage to remain in a net debt position.

Cash flow analysis

RMBm 2012 2013 2014 2015e 2016e 2017eCash and cash equivalents 121 205 204 697 667 780 Cash flow from operating activities 84 155 137 190 284 378 Cash flow from investing activities (140) (168) (71) (644) (80) (80)Cash flow from financing activities (11) 63 (48) 733 (234) (186)Capex (47) (114) (118) (80) (80) (80)Source: Company reports, HSBC estimates

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Balance sheet analysis

RMBm 2012 2013 2014 2015e 2016e 2017ePP&E 151 266 376 422 465 505 Current assets 259 432 516 1,050 1,053 1,303 Cash and cash equivalents 121 205 204 697 667 780 Total assets 474 768 965 1,912 1,937 2,205 Gross debt 0 36 0 592 372 200 Net debt (121) (169) (204) (105) (295) (580)Source: Company reports, HSBC estimates

Valuation and risks

We initiate coverage with a Buy rating and a TP of HKD20. Our TP is based on 24x 2016e PE,

a 10% premium to comparable companies, implying 1.1 PEG, given a 23% earnings CAGR for

2015-17e. We believe Bloomage deserves to trade at a premium because: 1) It has evolved into

a comprehensive dermatology provider with a rich pipeline; 2) the company is efficient in

generating a high ROE of 18-20% in 2015-17e. Catalysts include the rapid ramp-up of

hydro-lifting injections and new product launches.

Comparable companies

BBG Name Industry Price Mkt Cap (USDm)

ADT (USDm)

PE(x) PE(x) 2015-17e EPS

2016e PE/CAG

R

PB(x)

2015 2016 CAGR PEG 20146826 HK Haohai Biomedical 46.00 944 0.7 24.9 18.4 27.6 0.7 9.3963 HK Bloomage Biomedical 16.76 755 1.7 25.3 20.3 23.0 0.9 8.14548 JP Seikagaku Biomedical 1837.00 896 3.1 27.2 31.5 9.1 3.5 1.4ANIK US Anika

Therapeutics Biomedical

37.67 551 0.6 19.7 23.8 -3.6 2.81177 HK Sino

Biopharm Pharmaceuticals

5.41 5,143 15.8 21.9 18.3 18.0 1.0 5.31093 HK CSPC Pharmaceuticals 6.51 4,935 13.3 23.2 18.6 24.4 0.8 4.61530 HK 3SBio Inc Biologics 9.89 3,190 8.8 34.9 26.1 29.6 0.9 4.82186 HK Luye Pharmaceuticals 6.55 2,790 8.9 22.7 18.7 22.5 0.8 4.41513 HK Livzon Pharmaceutical 36.15 2,247 1.2 19.4 16.6 17.2 1.0 3.8Average 24.2 21.9 16.7 1.3 3.9Source: Bloomberg for all other companies, HSBC estimates for Haohai and Bloomage only. Prices as of 2 Feb

Bloomage 12-month forward PE band (based on HSBC adjusted basic EPS)

Source: Company, HSBC estimates, Wind

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Downside risks

1) Increasing competition in the HA dermal filler market: There are nine companies in this

market and a number of others are awaiting CFDA approval. If the incumbents increase their

marketing efforts or new entrants launch high-quality products, Bloomage may face market

share pressure.

2) Margin pressure: Gross margin decreased from 82% in 2009 to 78% in 2014 due to

decreasing ASPs for HA raw materials. If the prices drop more significantly than expected for

HA raw materials and end products, Bloomage may face a sharper reduction in gross margin.

3) Product safety issues: if any Bloomage products show side effects in clinical use, it may

damage the company’s reputation.

Company profile

Bloomage, based in Beijing, is the leading global HA manufacturer. It IPO’d in Hong Kong in

2008 and has since 2012 transformed itself into an integrated HA manufacturer providing both

raw materials and end products.

Ms. Yan Zhao is the founder and chairman of Bloomage. She remains the biggest shareholder

of the company with 51% stake. Other key management personnel hold 2.85% equity interest.

In November 2015, Bloomage issued HKD194m of equities and HKD465m of convertible bonds

to GIC. To date, GIC holds 4.5% of Bloomage’s issued shares.

Shareholder structure

Source: Company data, HSBC

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Financials & valuation: Bloomage BioTechnology Buy Financial statements Year to 12/2014a 12/2015e 12/2016e 12/2017e

Profit & loss summary (CNYm)

Revenue 481 625 763 948EBITDA 208 275 345 426Depreciation & amortisation -15 -55 -58 -62Operating profit/EBIT 192 220 286 364Net interest -1 -4 -19 -11PBT 198 212 310 402HSBC PBT 198 212 310 402Taxation -36 -45 -65 -84Net profit 162 168 245 317HSBC net profit 183 229 282 344Cash flow summary (CNYm)

Cash flow from operations 137 190 284 378Capex -118 -80 -80 -80Cash flow from investment -71 -644 -80 -80Dividends -15 -14 -14 -14Change in net debt -36 99 -190 -284FCF equity -18 146 180 250Balance sheet summary (CNYm)

Intangible fixed assets 1 81 61 41Tangible fixed assets 448 481 523 561Current assets 516 1,050 1,053 1,303Cash & others 204 697 667 780Total assets 965 1,612 1,637 1,905Operating liabilities 157 386 142 244Gross debt 43 635 415 243Net debt -161 -62 -252 -537Shareholders' funds 752 1,094 1,356 1,687Invested capital 605 529 828 882

Ratio, growth and per share analysis Year to 12/2014a 12/2015e 12/2016e 12/2017e

Y-o-y % change

Revenue 28.3 30.0 22.0 24.3EBITDA 53.0 32.4 25.3 23.6Operating profit 58.1 14.4 30.1 27.3PBT 57.5 7.2 46.0 29.6HSBC EPS 30.7 25.0 23.0 22.0Ratios (%)

Revenue/IC (x) 0.9 1.1 1.1 1.1ROIC 30.9 33.6 35.8 35.6ROE 27.8 24.8 23.0 22.6ROA 18.8 13.3 16.0 18.4EBITDA margin 43.2 44.0 45.2 44.9Operating profit margin 40.0 35.2 37.5 38.4EBITDA/net interest (x) 282.6 62.5 17.9 37.2Net debt/equity -21.4 -5.7 -18.6 -31.8Net debt/EBITDA (x) -0.8 -0.2 -0.7 -1.3CF from operations/net debt Per share data (CNY)

EPS Rep (diluted) 0.40 0.41 0.61 0.78HSBC EPS (diluted) 0.45 0.57 0.70 0.85DPS 0.03 5.00 5.00 5.00Book value 2.14 3.12 3.86 4.80

Key forecast drivers Year to 12/2014a 12/2015e 12/2016e 12/2017e

HA raw materials 321 398 454 513HA dermal filler 160 222 289 375

Valuation data Year to 12/2014a 12/2015e 12/2016e 12/2017e

EV/sales 10.0 7.9 6.2 4.7EV/EBITDA 23.2 17.9 13.7 10.4EV/IC 8.0 9.3 5.7 5.0PE* 31.3 25.0 20.3 16.7PB 6.6 4.5 3.7 2.9FCF yield (%) -0.4 2.9 3.6 5.0Dividend yield (%) 0.2 35.3 35.3 35.3

* Based on HSBC EPS (diluted)

Issuer information Share price (HKD) 16.76 Free float 100%Target price (HKD) 20.00 Sector ChemicalsReuters (Equity) 0963.HK Country Hong KongBloomberg (Equity) 963 HK Analyst Yumeng WangMarket cap (USDm) 756 Contact +852 2996 6586

Price relative

Source: HSBC

Note: Priced at close of 02 Feb 2016

7.90

12.90

17.90

22.90

27.90

7.90

12.90

17.90

22.90

27.90

2014 2015 2016 2017Bloomage BioTechnology Co Rel to HANG SENG INDEX

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Notes

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Notes

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Notes

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4 February 2016

Disclosure appendix

Analyst Certification

The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the

opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their

personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific

recommendation(s) or views contained in this research report: Yumeng Wang and Zhijie Zhao

Important disclosures

Equities: Stock ratings and basis for financial analysis

HSBC believes an investor's decision to buy or sell a stock should depend on individual circumstances such as the investor's

existing holdings, risk tolerance and other considerations and that investors utilise various disciplines and investment horizons

when making investment decisions. Ratings should not be used or relied on in isolation as investment advice. Different

securities firms use a variety of ratings terms as well as different rating systems to describe their recommendations and

therefore investors should carefully read the definitions of the ratings used in each research report. Further, investors should

carefully read the entire research report and not infer its contents from the rating because research reports contain more

complete information concerning the analysts' views and the basis for the rating.

From 23rd March 2015 HSBC has assigned ratings on the following basis:

The target price is based on the analyst’s assessment of the stock’s actual current value, although we expect it to take six to 12

months for the market price to reflect this. When the target price is more than 20% above the current share price, the stock will

be classified as a Buy; when it is between 5% and 20% above the current share price, the stock may be classified as a Buy or a

Hold; when it is between 5% below and 5% above the current share price, the stock will be classified as a Hold; when it is

between 5% and 20% below the current share price, the stock may be classified as a Hold or a Reduce; and when it is more

than 20% below the current share price, the stock will be classified as a Reduce.

Our ratings are re-calibrated against these bands at the time of any 'material change' (initiation or resumption of coverage,

change in target price or estimates).

Upside/Downside is the percentage difference between the target price and the share price.

Prior to this date, HSBC’s rating structure was applied on the following basis:

For each stock we set a required rate of return calculated from the cost of equity for that stock’s domestic or, as appropriate,

regional market established by our strategy team. The target price for a stock represented the value the analyst expected the

stock to reach over our performance horizon. The performance horizon was 12 months. For a stock to be classified as

Overweight, the potential return, which equals the percentage difference between the current share price and the target price,

including the forecast dividend yield when indicated, had to exceed the required return by at least 5 percentage points over the

succeeding 12 months (or 10 percentage points for a stock classified as Volatile*). For a stock to be classified as Underweight,

the stock was expected to underperform its required return by at least 5 percentage points over the succeeding 12 months (or

10 percentage points for a stock classified as Volatile*). Stocks between these bands were classified as Neutral.

*A stock was classified as volatile if its historical volatility had exceeded 40%, if the stock had been listed for less than 12

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stocks which we did not consider volatile may in fact also have behaved in such a way. Historical volatility was defined as the

past month's average of the daily 365-day moving average volatilities. In order to avoid misleadingly frequent changes in rating,

however, volatility had to move 2.5 percentage points past the 40% benchmark in either direction for a stock's status to change.

Rating distribution for long-term investment opportunities

As of 03 February 2016, the distribution of all ratings published is as follows: Buy 47% (29% of these provided with Investment Banking Services)

Hold 39% (27% of these provided with Investment Banking Services)

Sell 14% (18% of these provided with Investment Banking Services)

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For the purposes of the distribution above the following mapping structure is used during the transition from the previous to

current rating models: under our previous model, Overweight = Buy, Neutral = Hold and Underweight = Sell; under our current

model Buy = Buy, Hold = Hold and Reduce = Sell. For rating definitions under both models, please see “Stock ratings and basis

for financial analysis” above.

HSBC & Analyst disclosures

None of the below disclosures applies to any of the stocks featured in this report.

1 HSBC has managed or co-managed a public offering of securities for this company within the past 12 months.

2 HSBC expects to receive or intends to seek compensation for investment banking services from this company in the next 3 months.

3 At the time of publication of this report, HSBC Securities (USA) Inc. is a Market Maker in securities issued by this company.

4 As of 31 December 2015 HSBC beneficially owned 1% or more of a class of common equity securities of this company.

5 As of 31 December 2015, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of investment banking services.

6 As of 31 December 2015, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of non-investment banking securities-related services.

7 As of 31 December 2015, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of non-securities services.

8 A covering analyst/s has received compensation from this company in the past 12 months.

9 A covering analyst/s or a member of his/her household has a financial interest in the securities of this company, as detailed below.

10 A covering analyst/s or a member of his/her household is an officer, director or supervisory board member of this company, as detailed below.

11 At the time of publication of this report, HSBC is a non-US Market Maker in securities issued by this company and/or in securities in respect of this company

HSBC and its affiliates will from time to time sell to and buy from customers the securities/instruments, both equity and debt

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Whether, or in what time frame, an update of this analysis will be published is not determined in advance.

Economic sanctions imposed by the EU and OFAC prohibit transacting or dealing in new debt or equity of Russian SSI entities.

This report does not constitute advice in relation to any securities issued by Russian SSI entities on or after July 16 2014 and as

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Additional disclosures

1 This report is dated as at 04 February 2016.

2 All market data included in this report are dated as at close 02 February 2016, unless otherwise indicated in the report.

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[495505]

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Europe

Dr Stephen McGarry +44 20 7991 3164 [email protected]

Julie Mead +44 20 7991 9643 [email protected]

Jan Keppeler, CFA +49 211 910 2446 [email protected]

Richard Latz +49 211 910 1074 [email protected]

Asia Girish Bakhru, CFA +91 22 2268 1638 [email protected]

Damayanti Kerai +91 22 3396 0692 [email protected]

Zhijie Zhao +852 2996 6591 [email protected]

Yumeng Wang +852 2996 6586 [email protected]

Global Healthcare Research Team

Documents

pg.jrj.com.cnpg.jrj.com.cn/acc/Res/CN_RES/INVEST/2016/2/4/e792c895...2016/02/04 · market. Different age groups have different needs varying from skin rejuvenation and anti-aging,