Jintian Pharmaceutical Group, a Chinese pharmaceutical company, was performing reasonably well when CVC Asia Pacific invested in 2011, acquiring a 24.2 percent stake for around $80 million.
“The company was quite an established regional player with a sound financial track record and a very impressive growth profile,” Sunny Sun, senior managing director at CVC, tells PEI.
At the time, Jintian was generating revenues of about RMB 1 billion ($165 million; €121 million). However, looking at the business, CVC felt it had an opportunity to become a real regional leader.
“It was the largest privately-owned pharmaceutical retail company in Heilongjiang province only, and there are three provinces in Northeast China. So we thought it would be very important for the company to expand.”
But according to Sun, there was a real danger that the existing management might take the business in the wrong direction.
Happily – as demonstrated by the company’s $150 million IPO in Hong Kong last December, in which CVC sold about a third of its shareholding for a roughly 2x money-on-money multiple, according to market sources – CVC was able to steer them in a better direction. Here’s how.
1. BETTER GOVERNANCE
The first priority for CVC was to make sure it could push through changes despite only having a minority stake.
“At the time of the investment we had a number of agreements already with the company. First of all, a three-year business plan – so the general direction of the company and its growth path were very well elaborated already. Secondly, we had a set of minority rights agreed with the chairman – so veto rights on major operating and strategic issues.”
“On the governance side, I think our major improvement was on the board,” Sun adds. “The company was privately-owned and therefore every decision was easily made by the chairman.” Previously, there had been a board, but no independent financial investors. CVC managed to secure three board seats, despite being a minority shareholder.
The firm then implemented a system of four board meetings per year, plus a “sounding board” meeting each month. Previously, Jintian’s board members had met just twice a year.
“We had a sounding board meeting on a monthly basis with the chairman and chief financial officer, so we were constantly giving advice to the management. We viewed ourselves as an actively contributing minority shareholder – but we weren’t the management or there to do their job.”
2. IMPROVED SYSTEMS
One of the benefits of a global presence is having access to skilled people from across the globe. CVC made use of this by bringing the firm’s head of IT over from Europe.
“Our experience in Europe was certainly very helpful,” Sun says. “We brought in our head of IT in Europe to China, and he visited the company a few times [to have] discussions with the IT company in China that was going to implement the [new] system.”
Jintian implemented a new enterprise resource planning (ERP) system, which gave it more of a real-time view of its business processes. CVC was able to advise Jintian on how to use the system, as well as how to link up various parts of the business – including its almost 800 stores.
Moreover, CVC engaged advisory firm Ernst & Young to look at the company’s internal control procedures. This 12-month project resulted in better tracking of invoices at the retail store level, as well as better record-keeping of documents relating to government inspections – neither of which had been done properly beforehand.
“At first it was a little resisted by the management, but later much appreciated. They thought it was designed to monitor everyone, so took it emotionally – as if it was a trust issue. But it wasn’t; it was a standardisation [of processes] and documentation so that everyone, particularly the senior management, could have an overview of particular aspects of the business.”
The result? Jintian’s senior management was able to identify which products were generating the most revenue.
For example, in 2012, distribution of exclusive products contributed 20 percent of Jintian’s revenue. But before the new systems, it was difficult to pin down where the revenue was coming from, preventing the company from stocking the right products.
“The company has on average a [gross] profit of about 24 percent. This is achieved by constantly having an optimal product mix – particularly exclusive products nationally and regionally – and this part of the business contributes to a large part of the gross profit.”
3. EXPANDING GEOGRAPHICALLY
CVC certainly succeeded in driving Jintian’s regional expansion.
“The company today is the largest privately-owned pharmaceutical retail chain in Northeast China – in all three provinces by number of directly operated stores,” Sun says.
On entry, Jintian had 450 retail stores in Heilongjiang province. By the time of its IPO, it had also expanded into neighbouring Jilin and Liaoning provinces, increasing store numbers to 794.
Revenues also jumped 65 percent from 2010 to 2012, with the company growing 50 percent just in the first quarter of 2013.
Critically, CVC helped prevent management from going down a potentially dangerous path, Sun claims.
“We agreed with the chairman that we needed to be focused regionally. In China it is very easy for entrepreneurs to get carried away [and look] to become a national player; [to] go away from [their] home base and expand into the coastal or well-established cities.”
However, he argues, this would have changed the growth profile of the company, which in its own part of China enjoyed a very low cost structure.
For retail chains, labour and rent are the two biggest costs. And in Northeast China, the average cost of employing someone is around RMB 40,000 per year, compared to RMB 70,000 in Beijing, Shanghai and Guangzhou.
“If the company had not focused on Northeast China and being a regional leader, the cost base would have gone much higher and it would have lost one of its biggest competitive advantages.”
In December, Jintian was floated on the Hong Kong Stock Exchange, at a valuation of about $750 million. CVC and two other financial investors, DBS and SEAVI, sold 100 million shares. It had played a key role in the process, introducing Jintian to its IPO sponsor Morgan Stanley, as well as using the capital markets expertise of CVC’s Greater China chairman and investment banking veteran Francis Leung.
“The chairman was determined to list the business last year,” explains Sun. “One can debate whether December last year was the best timing, but in terms of the readiness of the business and the IPO preparation, I think it was a good decision and the right decision.”
CVC has already booked a 2x money-on-money multiple from the offering, market sources say (the firm declined to comment). And since it retains a 16.2 percent stake, it will no doubt hope for more upside to come.