China Drugstore Chain Nepstar Sees Acquisition Opportunities Emerging From Economic Crisis

BEIJING - As a financial maelstrom churns across the West and threatens China's economic growth rates, China Nepstar Chain Drugstore sees a rainbow of opportunity; small private pharmacies tossed about in the current storm could become takeover targets, according to Nepstar officials.

"2009 will be marked by a rather difficult economic climate worldwide and in China," said Lucia Qian, director of investor relations at Nepstar. "Yet Nepstar will continue to expand in 2009."

Backed by strong earnings growth over the last three years, Nepstar has already launched an aggressive series of acquisitions; in the first three quarters of 2008, the company swallowed up 126 privately operated drugstores, even as it opened 555 new stores.

Nepstar is already China's largest pharmacy chain in terms of directly operated stores, but aims to continue its fast-paced merger drive.

"Acquisitions are key to Nepstar's future, and we are constantly looking at new opportunities," said Qian.

The economic slowdown is likely to boost the pool of independent pharmacies ripe for acquisition, she added.

And while the credit crunch might make some small rivals more vulnerable, Nepstar has a substantial arsenal of cash to finance future takeovers.

"Nepstar now has RMB 1.4 billion in cash and cash equivalents," said Qian, and part of that is already earmarked to be channeled into mergers.

Earlier this decade, Nepstar's declining fortunes might have made the company itself appear open to a takeover.

Nepstar posted a net loss in income in 2003, 2004 and 2005, but engineered a turnaround the following year. The company reported net profits of RMB 13.6 million in 2006, and RMB 148.1 million in 2007.

Nepstar's biggest competitors today are the pharmacies operated by China's government-run hospitals. "Hospital pharmacies still dominate the market," said Qian.

Yet some of the public health officials and experts currently drafting China's sweeping health system reforms have proposed limiting or even phasing out these hospital pharmacies, which now provide one of the only channels for state-run medical centers to generate a profit (Also see "China’s Half Trillion Dollar Economic Stimulus Plan To Boost Healthcare Sector" - Scrip, 14 Nov, 2008.).

There have been proposals, Qian said, to separate these hospitals' provision of both the prescription and dispensing of medicines. If government-operated hospitals eventually lose their pharmacies in the years ahead, she added, this would open a huge market share of drug sales to private companies including Nepstar.

Another plank of health system reforms is likely to benefit the company over the shorter-term future. "The government is trying to expand coverage under the national insurance system," the Nepstar executive said (Also see "China Set To Launch Sweeping Health System Reforms, Aimed In Part At Reversing Stratified Access To Medicine, Hospitals, Insurance" - Scrip, 30 Oct, 2008.).

"This will channel more drug consumption outside of hospitals," she added.

Most individual purchases of medicine are currently paid out-of-pocket, and consumers facing troubled economic times could limit their spending.

Widening the proportion of Chinese citizens covered under one of the country's insurance schemes, on the other hand, will lead to expanded drug sales, Qian said.

Health system reforms already in progress and still being worked out will ultimately boost private providers of pharmaceuticals, and will bolster Nepstar's expansion.

The company, whose 2,600-plus stores are now concentrated in China's wealthiest cities along the eastern and southern coasts, is now aiming to expand inland.

"It is quite likely," Qian predicted, "that Nepstar will aim its expansion at new provinces beyond the coastal areas."

While Nepstar touts expansion efforts, it is not immune to the economic downturn. The drugstore chain recently reduced its personnel head count per store 11.7 percent and is trying to renegotiate the terms of store leases to cut costs (Also see "China Nepstar Downsizes, Cuts Store Personnel by 11.7%, To Weather Global Crisis and China’s Economic Slowdown" - Scrip, 1 Dec, 2008.).

- Kevin Holden ([email protected])