C & O PHARMACEUTICAL - Not particularly exciting (DMG)

REJECT OFFER

Price S$0.475

Offer S$0.50

Target S$0.55

Offer price is moderately attractive. We have always maintained our view that C&O’s extensive distribution network makes it an attractive M&A partner for a pharmaceutical company looking to penetrate the China market. Shionogi, a Japanese pharmaceutical manufacturer, will purchase a 24.17% stake in C&O from Leo Star and Mr Gao Bin, at S$0.50/share. At completion, Shionogi (together with Sumitomo, C&O’s substantial shareholder) will hold 53.17% of C&O, triggering a GO for the rest of the shares it does not own. The GO will be at S$0.50/share. This translates into a P/E of 12x our FY12F earnings, a 10% upside from the stock’s price before it was halted. The offer price is also at a premium of 4.0% to 22.8% over the 1-month, 3-month, 6-month and 12-month VWAP of the shares. This is not particularly exciting, considering that Sihuan (a pharmaceutical company with operations in China) was de-listed in 2009 at a much higher premium over the VWAP of its shares.

Outlook is more stable in FY12. We had lowered our TP to S$0.45 in our 16 May report, on the back of weaker than expected quarterly earnings and possibly flat YoY FY11 earnings, due to the uncertain operating environment then. Going forward, C&O is seeing a pick-up in restocking activities by customers and we expect earnings growth to be stable in FY12. Contribution from its new products is also likely from 2HFY12. On top of that, management aims to double revenue from its C&O-branded products over the next four years (currently ~32% of Group revenue) as it continues to develop new products.

C&O is worth more. While C&O is much smaller than regional peers in terms of revenue generated and market capitalisation, its margins are more than double that of its peers. Based on relative valuation, the target P/E for C&O would be 13.4x (a discount to current peer average of 35x). Applying that to our FY12F earnings, we have a fair value of S$0.55. We urge shareholders not to accept the offer at S$0.50/share