SHANGHAI - Shanghai Pharmaceutical Holdings Co. Ltd is set for what could be the largest IPO by a pharmaceutical company ever, surpassing Ostuka Holding's $2.4 billion IPO from last year.

On May 6, SPH put on offer roughly 664 million of its shares on the Hong Kong Stock Exchange to local and global investors, representing approximately 25% of the enlarged issued share capital of the company; SPH already is listed domestically in Shanghai.

Of the 664 million H shares (plus 100 million shares for the over-allotment option), 95% were made available to global institutional investors May 6, while the remaining 5% will be offered to retail investors May 20.

According to the prospectus issued by the company, the indicative offer price range for the offering is from HK$21.80 to HK$26.00 per share.

If the offer price is fixed at HK$26.00 per share and the over-allotment option is exercised in full, the total net proceeds from the global offering will reach as high as HK$19,140.6 million ($2.46 billion).

This would make SPH's offering the largest ever for a pharmaceutical company, just two years after it became China's second-largest drug distributor (4.6% market share) and third-largest pharmaceutical company in terms of revenue.

SPH achieved those industry positions in 2009 on the back of mergers through absorption of Shanghai-listed pharmaceutical companies Shanghai Industrial Pharma and Zhongxi Pharmaceutical.

The company's offering, even if it is eventually not the biggest ever, will still be twice the size of its major competitor Sinopharm Group Co. Ltd.'s $1 billion IPO in 2009 ([A#2809120400]).

Although Sinopharm is the largest drug distributor in China, SPH is the only integrated Chinese pharmaceutical company that is both a leading distributor and manufacturer, and holds the top spot among distributors in eastern China, China's largest market.

According to the prospectus, SPH expects to raise at least HK$15.275 billion ($1.97 billion) at a mid-point indicative price of HK$23.90 per share from this listing.

The offering would be $0.77 billion in capitalization more than the previously expected IPO size of $1.2 billion, following the recent rebound in the company's shares in China to around RMB 20 per share from RMB 17.6.

Lead underwriters for the offering are Goldman Sachs, Deutsche Bank AG and Credit Suisse.

Trading in SPH shares in Shanghai was stopped April 28 and resumed only after the offering began May 6. On the first day of trading after the offering opened, SPH's stock was up 1.76% to RMB 20.27 in Shanghai.

The company has also secured four cornerstone investors, including Pfizer Inc., to purchase shares worth $550 million in total, according to the prospectus.

Temasek Holdings will invest $300 million, Malaysian conglomerate Guoco Group Ltd. plans to spend $150 million, while Pfizer and Bank of China Group Investment each plan to invest $50 million in the IPO, SPH said. The cornerstone investors have all agreed to not sell or transfer any applicable shares for at least 12 months after the listing date in Hong Kong.

Funds To Boost Distribution Expansion

SPH will spend about 40% of the net proceeds or about HK$6.11 billion to expand its distribution network, primarily in northern and southern China, the country's second- and fourth-largest pharma distribution markets.

SPH will also use the funds to boost expansion in its home base of eastern China, the largest market, where it is already the largest distributor and holds an 11% market share (Sinopharm is the third largest distributor in eastern China at 6.4%).

In particular, SPH says it will focus on distributors with niche market expertise - including over-the-counter drug distributors - or innovative business models to gain access to new business areas with significant growth potential.

In January, SPH acquired the third-largest distributor in Beijing - Citc Pharmaceutical, a unit of China Health System Ltd. - for RMB 2.3 billion - and Beijing Aixin Weiye Medicine Co. Ltd. at RMB 225 million in 2010 to expand its network in northern China.

The acquisition of Citic closed April 1 and SPH intends to use proceeds from the Hong Kong listing to pay the full purchase price for the acquisition of Citic and the financing cost for the relevant bridge loans, SPH said in the prospectus ('Shanghai Pharmaceutical To Acquire CITIC Pharmaceutical For RMB 4 Billion,' PharmAsia News, Jan. 14, 2011).

The company also acquired Guangzhou Zhongshan Pharma and Fujian Pharma last year to expand its footprint into southern China.

SPH plans to utilize 30% of its net proceeds from the Hong Kong listing to expand its pharmaceutical manufacturing businesses through acquisitions in China and globally, and integrate them with its current pharmaceutical business.

One area the company will focus on is acquiring or partnering with domestic pharma companies operating in low-wage areas of China that could help SPH manufacture low-margin, high-volume products listed on China's Essential Drug List. SPH believes such companies would also help its products better penetrate rural markets.

The company will also invest roughly 10% of the funding for R&D, information technology systems and working capital.

Roughly 70% of SPH's self-manufactured drugs are on the National Essential Drugs List and 60% are on the National Medical Insurance Drugs Catalog, which means SPH has significant risk exposure to government price controls, analysts note. It has 53 major products and plans to add another six products through acquisition of the antibiotics business of Shanghai Pharmaceutical (Group).

The group controls 39.91% of SPH now and will command 27.05% after the Hong Kong offering; the Shanghai government will continue to control a majority stake in the company after the secondary listing.

Pfizer Investment Adds Further Weight

Adding momentum to its IPO, SPH recently unveiled a non-binding memorandum of understanding with Pfizer to explore various business opportunities, including the potential to jointly register, commercialize and distribute in China an innovative compound from Pfizer (Also see "Pfizer Looks To Team Up With Shanghai Pharmaceutical To Co-develop And Commercialize Pfizer Products In China" - Scrip, 21 April, 2011.).

In its prospectus, SPH adds a bit more color, identifying the potential compound as an "innovative urology drug developed by Pfizer."

Interestingly, Pfizer recently said it would exit urology and several other areas of research it viewed as greater risk or less productive to focus on core areas such as oncology. The U.S. company has said it would consider divesting, partnering or spinning out research assets that are deemed to be non-priorities (Also see "Reading Into Pfizer's Changes: First Steps For New CEO" - Pink Sheet, 7 February, 2011.).

Under the MOU, Pfizer and SPH will also look to strengthen an existing agreement to promote Pfizer's pneumococcal conjugate vaccine Prevnar-7 to lower-tier cities in China, and will explore additional areas of collaboration including R&D and distribution arrangements.

The parties intend to negotiate terms and conditions and potentially enter into definitive agreements within six months of signing the MOU, the prospectus reveals. Although the MOU is non-binding, Pfizer's decision to become a cornerstone investor in SPH likely bodes well.

SPH is already the largest distributor for Pfizer's products in China. With the $50 million cornerstone investment, Pfizer would own 2.22% of SPH's H shares (0.61% of combined H shares and A shares) at the midpoint offer price, if the over-allotment option is not exercised.

SPH says it will use some of the new proceeds to develop marketing, promotion and sales services for multinational companies, in addition to pure distribution.

These services may include market intelligence and competitive landscape analysis as well as product registration, according to a stock market filing SPH made April 18. SPH says it may also be in the market to acquire a local pharmaceutical marketing company.

SPH said April 12 that it would distribute drugs, medical devices, consumables and vaccines worth more than $20 billion for its 69 MNC clients in 2011, which accounts for 60% of its distribution business in China.

Among global top 50 pharma, a total of 33 companies are doing business with SPH, the company told PharmAsia News in an earlier interview.

The company also owns 30% of joint venture companies with Bristol-Myers Squibb Co. and Roche, respectively.

Shanghai Squibb, the JV with BMS, was formed in 1982 with an initial term of 50 years for the manufacture of over 30 products including hepatitis B treatment Baraclude (entecavir) and cholesterol-lowering drug Pravachol (pravastatin).

Shanghai Roche was formed in 1994 also on a 50-year contract for the marketing and manufacturing of Roche's 15 products in China including MabThera (rituximab) for treating chronic lymphocytic leukemia, and Xeloda (capecitibine) for treating advanced or recurrent gastric cancer.

Government Policy Intends To Foster Big Three

China has roughly 10,000 distributors, and the top three account for only 20% of the market; in the U.S., the top three distributors account for about 90% of the market. Despite leading the industry, Sinopharm's market share in 2009 stood at only 12.4% nationally, with SPH in the second slot at 4.6%.

Consolidation is on the way, with a major push from the Chinese government. In particular, SPH's expansion plans should get a boost from the National Plan for Development of the Pharmaceutical Distribution Industry (2011-2015) that China's Ministry of Commerce released May 5.

Under the plan, the ministry outlined its intention to consolidate the industry by 2015 to one to three large distributors with more than RMB 100 billion in annual revenue. Further, at a regional level, the ministry plans to form 20 regional distributors with RMB 10 billion in annual revenue by 2015.

To that end, all the top distributors in China are eager to raise funds to make acquisitions. SPH's main rival Sinopharm announced May 4 that it planned to issue 3-year, annual paid, fixed-rate, corporate debt of total principal RMB 5 billion.

Of that, the first RMB 2 billion will be issued on May 12 and the remaining RMB 3 billion will be issued by 2012. The company also just raised $440 million from a secondary offering in Hong Kong.

Analysts say that Sinopharm may have a slight leg up on SPH in the consolidation wars in part because it already has the largest footprint among distributors, although both are expected to be among the Big 3. Sinopharm is also partly owned by China's central government, whereas SPH and the other expected powerhouse, China Resources Medications Group Ltd., are partly owned by regional governments (Also see "China Distributor Consolidation Heats Up: Sinopharm Looks To Raise $440 Million Ahead Of Shanghai Pharma IPO" - Scrip, 27 April, 2011.).

The government's plan also revealed that the ministry expects the sales of top 100 distributors to account for 85% of the market in 2015, reaching 1.2 trillion in size, up from 773 billion in 2009.

The success of the development plan also hinges on more consolidation in the market, including upstream - the pharmaceutical industry, which is largely fragmented - and downstream - i.e., retail pharmacies - Richard Yeh, Hong Kong-based analyst at Citi, wrote in a May 5 note.

Consolidation will fuel a more efficient drug supply system, according to Yeh. "It could lower the overall drug distribution margin (currently stands at 7%) as we believe that long term drug distribution margin will likely be in-line with that of developed markets (3%-4%)."

- Dai Jialing (j.dai@elsvier.com)

With Pfizer As Cornerstone Investor, Will Shanghai Pharmaceutical Be Largest Pharma IPO Ever?

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