Phoenix Healthcare Group (1515.HK) The largest private hospital group in China with a unique business model; Initiate at LT BUY

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1 20 January 2014 Last Closing: HK$11.98 Upside: +16% Target Price: HK$13.90 Healthcare Sector Phoenix Healthcare Group (1515.HK) The largest private hospital group in China with a unique business model; Initiate at LT BUY Financial highlights RMB ' E 2014E 2015E 2016E Rev enue 394, , ,032 1,038,757 1,285,849 1,847,845 2,097,546 Net profit 42,812 48, , , , , ,023 Diluted EPS (RMB) Rev enue (YOY%) 29% 49% 37% 24% 44% 14% Net profit (YOY%) 12% 110% 2% 89% 33% 24% Diluted EPS (YOY%) 12% 110% -1% 41% 33% 24% Rev enue v s. consensus 7% 9% 29% 19% Net profit vs. consensus -1% 5% 11% 11% Diluted EPS v s. consensus 15% 7% 11% 10% P/E 132.8x 118.1x 56.2x 56.7x 40.2x 30.3x 24.5x P/B 25.0x 8.1x 12.0x 3.2x 4.1x 3.8x 3.5x EV/EBITDA 80.2x 58.4x 33.0x 31.6x 21.1x 15.2x 12.7x Div idend y ield (%) 0.0% 0.0% 0.0% 0.0% 0.7% 1.0% 1.2% estimates (Priced on 1/17/2013) We are initiating coverage on Phoenix Healthcare Group (PHG) with a LT Buy rating and a TP of HK$13.90: PHG is one of the largest private hospital groups in China in terms of bed counts and patient visits. Its business model includes: 1) running its private hospital, 2) managing 3rd-party hospitals/clinics and 3) procuring drugs/devices/consumables for hospitals/clinics under its management. As an early entrant in the private hospital space, PHG has proven success by quickly expanding its network via the invest-operate-transfer (IOT) model where PHG gets managerial rights after a fixed amount of investment. Hospitals also saw improvements under PHG s management. Its procurement business benefits from increasing economies of scale. With the private hospital sector encouraged by the Chinese government, coupled with PHG s experience and track record, we believe PHG has a competitive edge in future network expansion. Unique business model facilitates extracting the most with the least input: Under its IOT model, PHG invests a certain amount (which is much less than acquiring a hospital) and receives the managerial rights. PHG will then earn a management fee as a % of the hospital s top-line and profit before tax. This model does not change the not-for-profit nature for public hospitals which the government would prefer. Moreover, PHG procures drugs, devices and consumables to sell to hospitals it operates, capturing another revenue stream and leveraging the economies of scale from both organic (patient volume) and inorganic (new hospitals/clinics) growth. Three key scenarios: We have identified three scenarios: i) no IOT addition, ii) one IOT addition and iii) two IOT additions before Our base case assumes PHG to add one IOT hospital in 2014 which will be accretive starting In our model, this IOT addition boosts PHG s 15E and 16E EPS by 21% and 29%, respectively. Valuation: Our probability-weighted DCF derived PT of HK$13.90 implies 2014E PEG of 1.27x, in-line with the industry average of 1.34x. Concerns/Risks: 1) next price cuts may impact supply chain margins, 2) staff cost increase, 3) geographical concentration, & 4) risks related to potential new services Download our reports from Bloomberg: BOCM enter UP MP OP Initiation of coverage SELL Neutral Stock LT BUY BUY The largest private hospital group in China, according to Frost and Sullivan. The government is supportive of the private hospital sector. IOT model allows for lower investment outlay than acquiring, while capturing much of the value chain; and leveraging the economies of scale from both organic and inorganic growth. Our probability-weighted DCF derived TP of HK$13.90 implies 2014E PEG of 1.3x, inline with industry average of 1.3x. Stock data 52-week high week low Market capitalization (US$mn) 1,284 Number of shares (mn) month average daily volume (mn) month performance (%) 0% 50-day moving average day moving average day relative strength index 47 Source: Company data, Bloomberg Performance chart HSI 1515-HK /29/13 12/29/13 Source: Company data, Bloomberg Christopher Lui Christopher.lui@bocomgroup.com Tel: (852)

2 TABLE OF CONTENTS 1) Financial summary ) Company Snapshot ) Investment positives ) Investment concerns and risks ) Valuation ) Financial analysis and forecasts ) Company analysis ) Industry overview ) Competitive analysis ) Financial models Download our reports from Bloomberg: BOCM enter 2

3 1) Financial summary Figure 1: Financial summary Income Statement RMB ' H12 2H H13 2H13E 2013E 2014E 2015E 2016E Total Revenue 394, , , , , , ,065 1,038,757 1,285,849 1,847,845 2,097,546 Gross profit 92, ,749 75, , ,804 87, , , , , ,354 SG&A expenses (26,497) (32,752) (19,161) (30,751) (49,912) (29,854) (82,781) (112,635) (87,438) (125,653) (142,633) EBITDA 85, ,071 91, , , , , , , , ,911 Operating income (EBIT) 66,424 89,997 55,910 78, ,892 57,570 52, , , , ,721 Finance costs (2,634) (18,169) (10,691) (13,094) (23,785) (11,294) (14,358) (25,652) Profit Before Taxes 65,032 78,718 61,579 85, ,278 70,161 77, , , , ,983 Tax Rate 25% 26% 25% 25% 25% 25% 25% 25% 25% 25% 25% Net Income 42,812 48,130 38,827 62, ,088 50,354 53, , , , ,023 Diluted EPS Diluted Weighted Av erage Shares 602, , , , , , , , , , ,763 Margins H12 2H H13 2H13E 2013E 2014E 2015E 2016E Gross margin 23.6% 24.1% 23.3% 25.1% 24.4% 20.8% 21.9% 21.4% 23.4% 22.6% 25.2% SG&A 6.7% 6.4% 6.0% 7.0% 6.6% 7.1% 13.4% 10.8% 6.8% 6.8% 6.8% EBITDA 21.6% 23.0% 28.4% 26.6% 27.3% 24.0% 18.6% 20.8% 25.2% 24.3% 25.7% Operating (EBIT) margin 16.9% 17.7% 17.4% 18.1% 17.8% 13.7% 8.5% 10.6% 16.6% 15.8% 18.4% Profit before tax margin 16.5% 15.5% 19.2% 19.6% 19.4% 16.7% 12.6% 14.3% 21.6% 19.8% 21.4% Net margin 10.9% 9.4% 12.1% 14.3% 13.3% 12.0% 8.6% 10.0% 15.2% 14.0% 15.3% YOY% H12 2H H13 2H13E 2013E 2014E 2015E 2016E Total Revenue 29% 49% 31% 42% 37% 24% 44% 14% Gross profit 32% 51% 16% 23% 21% 35% 39% 27% EBITDA 37% 77% 10% -1% 4% 50% 39% 20% Operating income (EBIT) 35% 50% 3% -34% -18% 94% 37% 32% Profit Before Tax es 21% 87% 14% -9% 1% 88% 32% 23% Net Income 12% 110% 30% -15% 2% 89% 33% 24% Diluted EPS 12% 110% 30% -20% -1% 41% 33% 24% Diluted Weighted Av erage Shares 0% 0% 0% 8% 3% 34% 0% 0% Balance Sheet RMB ' H12 2H H13 2H13E 2013E 2014E 2015E 2016E Inv entories - Total 22,267 23,200 35,073 30,249 63,301 63,301 55, ,962 72,081 Trade receivables 20,100 23,845 83, , , , , , ,411 Cash and ST Inv estments 321, , , ,246 1,270,081 1,270, , ,005 1,416,040 Total Current Assets 409, , , ,549 1,807,958 1,807,958 1,435,878 1,829,163 1,979,068 Property. Plant & Equipment - Net 91,527 94, , , , , , , ,529 Total Non-current Asset 254, , , , , , , , ,656 Total Assets 664,310 1,134,678 1,020,860 1,184,400 2,459,915 2,459,915 2,388,561 2,761,918 2,897,724 ST Borrowings 0 200,000 5,803 6,274 6,274 6, Total Current Liabilities 144, , , , , , , , ,350 LT Borrow ings 200, , , , , Total Non-current Liabilities 212,589 10, , , , ,788 13,462 13,462 13,462 Total Liabilities 357, , , , , , , , ,812 Equity attributable to equity holders of the company 283, , , ,126 1,852,609 1,852,609 1,989,731 2,171,446 2,396,162 Capital 130, , , ,404,483 1,404,483 1,404,483 1,404,483 1,404,483 Retained Earnings 48,464 95, , , , , , , ,015 Non-controlling interest 23, ,160 92,502 94,564 99,907 99, , , ,750 Total Equity 306, , , ,690 1,952,516 1,952,516 2,102,141 2,298,482 2,538,912 Total Liabilities & Shareholders' Equity 664,310 1,134,678 1,020,860 1,184,400 2,459,915 2,459,915 2,388,561 2,761,918 2,897,724 Cash Flow Statement RMB ' H12 2H H13 2H13E 2013E 2014E 2015E 2016E Net Income/Starting Line 65,032 78,718 61,579 85, ,278 70,161 77, , , , ,983 Depreciation & Amortization 17,573 20,184 18,932 17,232 36,164 19,142 23,077 42,219 46,453 84,602 91,709 Operating profit before change in working capital 84, ,108 88, , ,265 97, , , , , ,911 Funds from/for Other Operating Activities (3,506) (27,839) 2,262 (8,513) (6,251) (1,599) (285,079) (286,678) 83,737 (242,157) 188,094 Income taxes paid (11,040) (20,917) (13,788) (13,807) (27,595) (23,852) (6,187) (30,039) (63,119) (76,975) (105,834) Cash from Operating Activities 70,057 62,352 76,522 89, ,419 72,065 (172,808) (100,743) 344, , ,172 Purchases of PP&E (17,157) (34,347) (14,793) (13,322) (28,115) (6,664) (31,863) (38,527) (347,179) (64,675) (77,609) Cash from Investing Activities (328,099) (36,120) (94,476) (7,724) (102,200) (58,076) 58, (347,179) (64,675) (77,609) Interest Paid (Cash Flow ) (2,409) (18,858) (11,719) (12,163) (23,882) (10,111) (15,541) (25,652) Cash from Financing Activities 298, ,081 (251,719) (30,364) (282,083) 1,598 1,234,179 1,235,777 (288,629) (77,243) (95,527) Net Change in Cash 39, ,313 (269,673) 51,809 (217,864) 15,122 1,120,488 1,135,610 (291,619) (11,458) 449,036 Net Cash - Ending Balance 74, ,988 61,315 51, , ,246 1,248,734 1,248, , ,658 1,394,693 estimates Download our reports from Bloomberg: BOCM enter 3

4 2) Company Snapshot Phoenix Hospital Group (PHG) is the largest private hospital group in China measured by the number of beds (3,322 beds) and patient visits (3mn) in 2012, according to Frost and Sullivan. Headquartered in Beijing, Phoenix has a network that includes 11 general hospitals, 1 traditional Chinese medicine (TCM) hospital and 28 community clinics. Figure 2: Three business models Business model 2012 Sales YOY% % of sales Gross margin General hospital revenue 403,109 24% 53% 18.4% Services provided at Jian Gong Hospital Hospital management fees 40, % 5% 69.3% Management fees collected from IOT hospitals and clinics Supply chain revenue 314,646 89% 42% 26.3% PHG supplies pharmaceuticals, medical devices and medical consumables to its in-network hospitals and clinics Total 758,032 49% 100% 24.4% The company has three revenue streams: 1) General hospital revenue this is the revenue of the hospitals/clinics PHG owns, which currently is just Jian Gong Hospital. 2) Hospital management fees under its IOT ( invest-operate-transfer ) hospitals/clinics, PHG takes management and incentive fees from a certain percentage of the hospitals/clinics sales and profit before tax or bottom line (if profitable). However, if the hospital/clinic is not profitable, PHG will need to compensate the hospital to make it break even using PHG s own funds. 3) Supply chain revenue PHG assists in procuring drugs/devices for its Jian Gong Hospital and IOT hospitals/clinics. This model provides economies of scale as PHG has more bargaining power with suppliers as its network grows. Figure 3: Sales; sales growth; and key sales margins Revenue (RMBmn) and growth Margins 2,000,000 Total Revenue YOY% 60% 50% Gross margin Operating margin Net margin 1,500,000 1,000, ,000 50% 40% 30% 20% 10% 40% 30% 20% 10% E 2014E 2015E 0% 0% E 2014E 2015E Download our reports from Bloomberg: BOCM enter 4

5 3) Investment positives The largest Private Hospital Group in China PHG is the largest private hospital group in China measured by the number of beds in operation (3,322 by 1H13) and patient visits (3mn), according to Frost and Sullivan. Through its direct ownership and the IOT model, PHG manages and operates a network of 11 general hospitals, one traditional Chinese medicine (TCM) hospital and 28 community clinics. Figure 4: Top five private hospital groups by # of beds, and # of patient visits (2012): Top five private hospital groups in terms of number of beds in operation (2012) Top five private hospital groups in terms of patient visits (2012) Hospital group # of beds in operation Hospital group # of patient visits (mn) Phoenix Healthcare Group 3,194 Phoenix Healthcare Group 3.05 Dongguan Kanghua 2,500 Dongguan Kanghua 2.22 Dongguan Donghua 1,800 Jinling Pharmaceutical 1.62 Jinling Pharmaceutical 1,700 Dongguan Donghua 1.54 Nanjing Tongren 600 Nanjing Tongren 1.30 Source: Company as to the figures of the company only, Frost and Sullivan, BOCOM Int l Figure 5: Hospitals operated/managed by PHG (2012): Hospital Direct/IOT Grade # of hospitals # of clinics # of beds Patient visits ('000) Outpatient ('000) Inpatient ('000) Jian Gong Direct ownership II Yan Hua IOT III Jing Mei IOT 1 III, 7 I , Mentougou IOT II Mentougou TCM IOT II ,322 3,050 2, Medical Insurance Designated Medical Institutions implies sustainability PHG focuses on and runs Designated Medical Institutions, which means the government will reimburse (fully or partially) the amount spent by patients. We believe this type of medical institutions is more preferred than non-designated ones where patients have to pay out of pocket completely. We also see these hospitals have more sustainability in terms of patient flow. First mover advantage: An early entrant equipped with more experience amongst its private hospital peers PHG should be better positioned to identify and capture public hospital reform opportunities than the new market entrants, in our view. As an early entrant to China s public hospital reform, PHG has accumulated extensive experience of working with public hospital owners, regulators and other key stakeholders when participating in different reform methods, including privatization and PPP. PHG is one of the earlier private hospital players. PHG acquired a majority of equity interest in Jian Gong Hospital in 2000 (the first privatization of an SOE-owned hospital in Beijing). In 2010, PHG began to manage Mentougou Hospital, the first government-owned hospital in Beijing to outsource its management through a public-private partnership (PPP). Download our reports from Bloomberg: BOCM enter 5

6 Figure 6: PHG is one of the first movers to the private hospital system Time Participant Major Events Notes 1994 Chindex Established United Family Hospital in Beijing First foreign-invested hospital in China 1999 Asian Industrial Established Wuhan Asian Cardiac Hospital One of the hospitals with the most cardiac surgeries in China 1999 Boai Acquired Shanghai Light Industry Staff Hospital (which was close to Earliest private hospital in Shanghai bankruptcy) and transformed it into private Shanghai Boai Hospital 2000 PHG PHG won the bid to participate in the reform of Beijing Construction Hospital One of the largest for-profit private hospitals in China through investment, reform 2003 Jinling Jinling Pharma acquired major equity stakes of Suqian People s Hospital, Public hospital managing a private hospital then turned it into an investor-owned hospital, then gave trusteeship to Gulou Hospital (Jiangsu's largest public hospital) to manage its daily operation PHG PHG took over the management of Yanhua Hospital, and then Earliest trusteeship of third-level hospital affiliated to enterprise in China transformed it into non-profit healthcare institution trusteed by the largest private group in Beijing 2006 Kanghua Dongguan Kanghua hospital invested by Kanghua Group One of the largest private comprehensive hospitals in China Source: Company (as to the major events of the company only), Frost and Sullivan, BOCOM Int l IOT (Invest-operate-transfer), a unique business model that captures most of the downstream value chain without significant investment PHG has expanded its hospital network mostly by its IOT model. IOT stands for invest-operate-transfer. Under the IOT model, PHG makes a fixed investment for the right to operate and manage a hospital. PHG then books 1) performance-based management fees and 2) revenue from supplying drugs/devices to the hospitals. When compared with acquiring public hospitals, the IOT model allows PHG to capture profit with much less investment outlay. The company also believes the IOT model is preferred by government-owned and/or state-owned (SOE) hospitals because it does not change the public, not-for-profit nature of public hospitals. Moreover, we believe there will be fewer risks involving anti-corruption. This is because the whole value chain is monitored by management from drug procurement, drug supply to hospitals, pricing, and drug prescription. Economies of scale from the supply chain Since PHG manages the procurement needs for its hospitals and clinics, PHG procures and sells drugs pharmaceuticals, medical devices and medical consumables for its in-network hospitals and clinics. As the network expands, higher volume discounts can be obtained from suppliers given the economies of scale. We note PHG s supply chain primarily serves its own network and not other hospitals. Download our reports from Bloomberg: BOCM enter 6

7 Figure 7: PHG could extract much of the downstream value chain bidding price or price ceiling Suppliers of drugs, devices and consumables negotiated price PHG supply chain business bidding price (or price ceiling) PHG's in-network hospitals/clinics *darker blue shows where the supply chain makes profit (bidding price/price ceiling less the negotiated price from procurement) **lighter blue shows where in-network hospital/clinics make profit (and PHG books management fees and performance fees) up to 115% of bidding price (or price ceiling) Patients Being in Beijing is a plus All PHG s in-network hospitals and clinics are strategically located in Beijing, one of the largest healthcare markets in China, according to Frost and Sullivan. PHG has strategically established its hospital network in Beijing. Beijing is considered one of the largest and most reputable healthcare markets in China, according to Frost and Sullivan. Beijing ranked first in terms of the number of Grade III hospitals (84), the number of hospital beds (92,600+) and the number of patient visits (135mn) in 2012, according to Frost and Sullivan. Moreover, many medical experts and medical schools are located in Beijing, the capital of China. These experts and key opinion leaders play an important role in the development of healthcare policies. Therefore, initiatives in Beijing have high precedential value. The government aims to increase the proportion of private hospitals beds from 13% in 2010 to 20% of total hospital beds by Figure 8: The government targets 20% of beds in Beijing to be in private hospitals by Public Private Private as % of total beds 25% % 15% 10% 5% E 2014E 2015E 0% Source: Frost and Sullivan, BOCOM Int l Download our reports from Bloomberg: BOCM enter 7

8 Good track record to build upon PHG has helped Jian Gong Hospital and Yan Hua Hospital receive JCI accreditation in Jian Gong was the eighth hospital and Yan Hua was the seventh given JCI in China, according to Frost and Sullivan. As of 1H13, the two hospitals were two out of the only three hospitals in Beijing that have received such accreditation, according to Frost and Sullivan, and the other one is Chindex which had the accreditation in Moreover, PHG in general has improved the hospital in the first full year under PHG s management in terms of performance metrics (i.e. total patient visits and average length of stay (ALOS)). This has enhanced PHG s reputation and helped attract more talents (doctors/medical professionals). This has also served as a reference for hospitals that may consider PHG to be their next hospital operator. Figure 9: Improvement seen after the first year of inception Mentougou Hospital Year 0 Year 1 Year 2 Jing Mei Hospital Year 0 Year 1 Supply chain revenue (RMB mn) Supply chain revenue (RMB mn) Total patient visits ' Total patient visits ' # of inpatient surgeries ('000) # of inpatient surgeries ('000) Avg length of stay (ALOS, days) Avg length of stay (ALOS, days) YOY% Year 0 Year 1 Year 2 YOY% Year 0 Year 1 Supply chain revenue (RMB mn) 308% Supply chain revenue (RMB mn) n.m. Total patient visits '000 10% 29% Total patient visits '000 17% # of inpatient surgeries ('000) 46% 37% # of inpatient surgeries ('000) 29% Avg length of stay (ALOS, days) -14% -10% Avg length of stay (ALOS, days) -10% The government supports the private hospital subsector The government encourages private capital in hospitals. For instance, the government published Certain Policies on Further Encouraging and Guiding Private Capital to Invest in Medical Institutions in 2012, which encourages and provides guidance for private investments to participate in the public hospital reform in Beijing. In China s 12th Five-Year Plan, the government also aims to increase the proportion of beds in private hospitals to 20% of total beds by The PRC government selected 17 cities, including Beijing, to pilot public hospital reform. Business model allows for synergies across its businesses PHG s business model allows the company to capture synergies along its value chain. a. Maximizing the value chain of healthcare services - PHG aggregates the procurement needs for its in-network hospitals. PHG also offers its Phoenix VIP services to patients who are willing to pay a higher price for premium healthcare services. b. Standardizing practices and information technology system - PHG adopts group-wide practices and standardizes the use of advanced information technology to improve operational efficiency. c. Resource sharing Since PHG s operating network is geographically concentrated, it is easier to share resources within the group which could lead to better efficiency and profitability. PHG s healthcare network consists primarily of general hospitals, which offer a full spectrum of healthcare services from primary preventive care to acute care and post-operative rehabilitation. PHG s team includes 80 chief doctors, 229 associate-chief doctors, 488 attending doctors, and 391 resident doctors by the end of 1H13. Download our reports from Bloomberg: BOCM enter 8

9 4) Investment concerns and risks The next price cut could impact PHG s supply chain margins The NDRC and the Beijing government made significant downward bidding/ceiling price adjustments to a large number of pharmaceuticals in However, financials provided did not reveal the impact since the data were only captured in H13 during which not much in terms of drug pricing adjustments was made. After 2009, there were independent drug price adjustments, but did not cause much of an impact demonstrated by the average spending on pharmaceuticals per patient visit of PHG s in-network hospitals and clinics. It is hard to quantify the impact of the next price cut as we believe most drugs used in PHG s network are under government price control, albeit offset by the increasing service fees. Staff cost increasing Staff cost of Jian Gong Hospital grew at a CAGR of 25% from RMB53mn in 2010 to RMB82mn in It has become more costly to recruit and retain medical personnel in recent years. Concentration of customers and suppliers In 2012 and 1H13, PHG s top four customers were PHG s IOT hospitals and clinics: Yan Hua Hospital Group, Jing Mei Hospital Group, Mentougou Hospital and Mentougou Traditional Chinese Medicine Hospital. Figure 10: Top 4 customers represented ~50% of sales but ~75% of trade receivables in 1H H13 Top customer(s) in year As % of total sales 27% 36% 47% 49% As % of trade receivables 67% 80% 81% 74% Source: Company, Frost and Sullivan, BOCOM Int l To further consolidate PHG s procurement needs, and to achieve better efficiency and greater economies of scale, PHG entered into a one-year supply agreement with Hong Hui for the supply of pharmaceuticals to Jian Gong Hospital, Yan Hua Hospital Group and Jing Mei Hospital Group. In 1H13, the five largest suppliers were Hong Hui, Sinopharm Holding Beijing Kangchen Biological Pharmaceutical, Cachet Pharmaceutical, Beijing Southeast Yueda Medical Equipment and Sinopharm Holding Beijing Huahong Pharmaceutical. The below table shows the top supplier and top five suppliers as a percentage of PHG purchases. The increase in percentages was due to agreements with Hong Hui since the beginning of Figure 11: Top 5 suppliers represent ~50% of total purchases in 1H13 % of purchases H13 Top 5 suppliers 44% 39% 56% 51% Largest supplier 12% 11% 46% 39% Source: Company, Frost and Sullivan, BOCOM Int l Download our reports from Bloomberg: BOCM enter 9

10 Risks: Government policies may change Changes in China s regulatory regime for the healthcare service industry, particularly changes in public medical insurance programs or healthcare reform policies. Opportunities may be missed PHG may be unable to identify and capture expansion opportunities for new hospitals, which may place the company at a competitive disadvantage and limit PHG s growth. Some IOT agreement states PHG must compensate the hospital if the hospital records a net loss For certain of PHG s in-network hospitals, PHG s IOT agreements provide that if they incur losses during the tenure of PHG s management, whether or not as a result of PHG s management or due to factors beyond PHG s control, PHG must use PHG s management fees for that year or even PHG s own funds to compensate the hospitals for the loss. PHG may not be as successful outside of Beijing PHG s current in-network hospitals and clinics are all located in Beijing. In the future, PHG may expand to areas outside of Beijing which the company may not be as familiar with. Termination Under IOT agreements, hospital owners may terminate PHG s IOT agreements if PHG fails to reach certain goals or incur major losses. Losses and liabilities Between H13, the total number of medical disputes settled by PHG was 0.01% of total patient visits and 0.2% of total revenue (half of which was covered by insurance). PHG s in-network hospitals and clinics face competition for patients in the markets where PHG operate. The hospital and healthcare service industry is competitive. Generally, PHG s in-network hospitals and clinics face competition from public hospitals, private hospitals and community health clinics located in the same geographic area as PHG s in-network hospitals and clinics. For example, Jian Gong Hospital competes with Xuanwu Hospital of Capital Medical University and Beijing Friendship Hospital located in the same area, both of which are Grade III hospitals. PHG has not obtained title with some of the properties PHG has used to operate Jian Gong Hospital has a total gross floor area of 30,020 square meters, but due to the lack of certain construction-related permits and certificates, 8,586 square meters (or 28.6%) has yet to be permitted. These buildings are primarily for outpatient registration, a library, a morgue, a medical imaging and diagnostic room, and rooms for other ancillary functions. Furthermore, PHG failed to receive construction permits for one property which is under development (130 square meters, or 0.4% of the total gross floor area of Download our reports from Bloomberg: BOCM enter 10

11 Jian Gong Hospital). Risks include: 1) a fine of up to 10% of the construction cost, and/or 2) to demolish the building within a reasonable period which could cost RMB 25mn in the first year (3mn demolition within 3 months, 22mn for relocation to another place including a 12-month rental fee). Furthermore, PHG leased and occupied four properties in Beijing with a total gross floor area of 669 square meters for office and business use. These four property lease agreements have not been registered with the relevant PRC government authorities, which could cost PHG a fine ranging between RMB1,000-10,000 for each unregistered lease agreement. Bad debt Under the current government medical insurance programs, patients are required to pay hospitals only a portion of their medical expenses upfront and hospitals will seek payment of the balance from the government. Since PHG generates significant revenues from patients covered by these medical insurance programs, any delay/dispute in reimbursement payment by the government could lead to an increase in accounts receivables or result in write-offs. However, this has not happened to PHG before. New risks related to new services PHG intended to provide in the future PHG plans to provide additional services to its in-network hospitals and clinics, namely 1) specialized medical functions (e.g. diagnostic center, medical testing centers and laboratories), and 2) laundry, sanitation services and convenience stores. PHG has no experience of running these businesses before and intends to provide these services to other hospitals after centralizing these services within the group. Download our reports from Bloomberg: BOCM enter 11

12 5) Valuation Our DCF driven TP of HK$13.90 is a probability weighted average of our three key scenarios we identified namely: 1) Bear case: status quo (no IOT), 2) Base case: one IOT addition in late 2014, 3) Bull case: one IOT addition in late 2014 and another in late We also used our PEG method to cross check our TP. Figure 12: Valuation Summary - Our TP of HK$13.90 is a weighted average of below three key scenarios Scenario Bear case Base case Bull case Our TP One 600-bed Grade III hospital IOT in 2014 Status quo (no additional IOTs) Accretive starting 2015 One 600-bed Grade III hospital IOT each in 2014 and 2015 Accretive starting 2015 IOT 15% more expensive in 2015 than in 2014 '13E-'15E Sales CAGR 20% 33% 33% '13E-'15E EPS CAGR 24% 37% 37% '16E Sales vs. base case -19% 0% 19% '16E EPS vs. base case -22% 0% 22% COE 8.81% 8.81% 8.81% WACC 8.75% 8.75% 8.75% Terminal growth 4.0% 4.0% 4.0% DCF fair value (HKD) $8.90 $13.79 $14.58 Probability 5% 50% 45% $13.90 Source: BOCOM Int l estimates 1) DCF Our DCF assumptions include a COE of 8.81% (risk free rate 3.31%, beta 1, and equity risk premium 5.5%), a WACC of 8.75% and terminal growth rate of 4%. Our base case DCF analysis shows a fair value of HK$ per share. Figure 13: DCF assumptions DCF COE WACC 7.8% 7.8% 7.8% 8.8% 8.8% 8.8% 9.8% 9.8% 9.8% Risk Free rate 3.31% Perpetuity 3% 4% 5% 3% 4% 5% 3% 4% 5% Beta E-2025E $3,043,150 $3,043,150 $3,043,150 $2,898,250 $2,898,250 $2,898,250 $2,762,655 $2,762,655 $2,762,655 Equity Risk premium 3.50% 2026E-2030E $2,638,304 $2,638,304 $2,638,304 $2,394,932 $2,394,932 $2,394,932 $2,176,371 $2,176,371 $2,176,371 Additional risks 2% Terminal $4,645,372 $5,940,982 $8,178,565 $3,076,743 $3,760,521 $4,808,899 $2,105,594 $2,495,728 $3,050,099 COE 8.81% NAV $10,326,825 $11,622,436 $13,860,018 $8,369,925 $9,053,704 $10,102,082 $7,044,620 $7,434,754 $7,989,125 Share count 833, , , , , , , , ,763 WACC NAV/share $12.39 $13.94 $16.62 $10.04 $10.86 $12.12 $8.45 $8.92 $9.58 WACC = Re x E/V + Rd x (1-corporate tax rate) x D/V 1.27 $15.73 $17.70 $21.11 $12.75 $13.79 $15.39 $10.73 $11.32 $12.17 Re 8.81% E 1,952,516 D 230,600 V 2,183,116 Rd 11% Tc 25% WACC 8.75% Source: BOCOM Int l estimates Download our reports from Bloomberg: BOCM enter 12

13 Figure 14: DCF sensitivity analysis Terminal rate WACC 3% 4% 5% 7.8% % % Source: BOCOM Int l estimates 2) PEG We note the industry 13E- 15E PEG ratio is 1.45x for hospitals and 1.25x for distributors. Using PHG s 2014E gross profit split for hospitals (general hospital + mgmt fee = 44%) and distribution (supply chain = 56%), the 2014E PEG ratio is 1.34x for comparison. Figure 15: PEG ratio PEG 2014E PHG Gross profit breakdown Industry '13-'15E PEG Weighted PEG Hospital 44% 1.45x 0.64x Distribution 56% 1.25x 0.70x Weighted average 1.34x 2014E Industry '13-'15E PEG Hospital 1.45x Distribution 1.25x Average 1.35x *Weighted according to the gross margin split by PHG s different businesses Source: BOCOM Int l estimates The below depicts our target 2014E PEG ratio is 1.27x, close to the weighted industry average 1.34x. Figure 16: PEG ratio Target price $ E EPS (RMB) E EPS (HKD) E P/E 46.6x '13-'15E EPS CAGR 37% 2014E PEG 1.27x Source: BOCOM Int l estimates Download our reports from Bloomberg: BOCM enter 13

14 Figure 17: Comp table Company Ticker Currency Px Mkt cap EV/EBITDA P/E EPS CAGR PEG P/B ROE (USD) '13E '14E '15E '13E '14E '15E ('13E-'15E) '13E '14E '15E '13E '14E '15E '13E '14E '15E Hospital HCA Holdings, Inc. HCA USD , x 7.1x 6.4x 15.4x 13.5x 11.6x 13% 1.2x 1.1x 0.9x DaVita HealthCare Partners Inc. DVA USD , x 8.5x 7.8x 17.0x 17.5x 15.9x 9% 1.9x 1.9x 1.8x 3.0x 2.6x 2.2x 17.6% 14.9% 14.1% IHH Healthcare Bhd MY MYR , x 17.5x 15.1x 48.8x 37.2x 30.8x 26% 1.9x 1.4x 1.2x 1.7x 1.7x 1.6x 3.6% 4.4% 5.2% Ramsay Health Care Limited RHC-AU AUD , x 14.0x 12.4x 33.1x 28.1x 24.4x 14% 2.3x 1.9x 1.7x 6.2x 5.6x 5.0x 18.6% 20.0% 20.6% Universal Health Services, Inc. UHS Class B USD , x 8.4x 7.4x 18.6x 16.1x 14.7x 11% 1.7x 1.4x 1.3x 2.6x 2.3x 2.0x 14.0% 14.1% 13.6% Envision Healthcare Holdings, EVHC Inc. USD , x 13.5x 11.1x 75.6x 41.1x 30.7x 46% 1.6x 0.9x 0.7x 3.6x 3.6x 3.2x 4.7% 8.8% 10.4% Sonic Healthcare Limited SHL-AU AUD , x 11.5x 10.3x 20.2x 17.4x 15.7x 11% 1.8x 1.5x 1.4x 2.3x 2.2x 2.1x 11.5% 12.8% 13.5% Bangkok Dusit Medical Services BGH-TH Public Co. Ltd. THB , x 17.3x 15.1x 29.1x 25.9x 22.4x 14% 2.1x 1.9x 1.6x 4.5x 4.0x 3.7x 15.6% 15.7% 16.5% MEDNAX, Inc. MD USD , x 9.8x 9.3x 19.9x 17.5x 16.4x 11% 1.9x 1.6x 1.5x 2.7x 2.5x 2.3x 13.7% 14.2% 14.1% Tenet Healthcare CorporationTHC USD , x 6.6x 6.4x 26.2x 17.5x 12.7x 35% 0.7x 0.5x 0.4x 5.3x 4.5x 3.3x 20.1% 25.5% 26.4% Community Health Systems, Inc. CYH-US USD , x 7.3x 7.0x 15.9x 11.4x 9.7x 30% 0.5x 0.4x 0.3x 1.3x 1.2x 1.1x 8.1% 10.3% 11.0% Health Management Associates, HMA Inc. Class AUSD , x 8.1x 7.2x 26.2x 21.4x 19.5x 22% 1.2x 1.0x 0.9x 3.3x 2.9x 2.6x 12.6% 13.7% 13.2% LifePoint Hospitals, Inc. LPNT USD , x 7.2x 6.6x 19.8x 17.6x 15.7x 12% 1.7x 1.5x 1.3x 1.2x 1.1x 1.1x 5.9% 6.4% 6.9% Aier Eye Hospital Group Co., CN Ltd. Class A CNY , x 47.1x 34.8x 34% 1.8x 1.4x 1.0x 8.8x 7.5x 6.3x 14.1% 15.9% 18.2% Apollo Hospitals Enterprise Limited IN INR , x 16.3x 13.3x 36.3x 30.2x 24.2x 23% 1.6x 1.3x 1.1x 4.3x 3.9x 3.5x 11.8% 12.8% 14.4% Bumrungrad Hospital Public Co., BH-TH Ltd. THB , x 14.1x 12.3x 26.5x 23.4x 20.6x 13% 2.0x 1.7x 1.5x 6.7x 5.8x 5.1x 25.3% 24.9% 24.8% Al Noor Hospitals Group PLCANH-GB GBP , x 14.0x 10.9x 25.0x 17.2x 13.6x 36% 0.7x 0.5x 0.4x 9.5x 6.4x 4.6x 38.2% 37.5% 34.1% Raffles Medical Group Ltd R01-SG SGD , x 16.4x 14.2x 24.7x 23.4x 20.4x 10% 2.5x 2.4x 2.1x 3.9x 3.5x 3.1x 15.8% 14.9% 15.4% KPJ Healthcare Bhd MY MYR , x 15.2x 13.4x 32.6x 27.6x 25.7x 12% 2.6x 2.2x 2.1x 3.1x 2.9x 2.7x 9.5% 10.4% 10.6% IPC The Hospitalist Company, IPCM-US Inc. USD x 12.1x 10.6x 25.6x 22.3x 20.2x 12% 2.1x 1.8x 1.7x 3.2x 2.8x 2.5x 12.4% 12.7% 12.4% PT Siloam International Hospitals SILO-ID Tbk Reg-SIDR x 24.3x 15.7x 316.2x 132.9x 73.3x 108% 2.9x 1.2x 0.7x 6.9x 6.6x 6.2x 2.2% 5.0% 8.4% Topchoice Medical Investment CN Corp. Class ACNY x 24.3x 17.3x 49.6x 39.1x 29.3x 30% 1.6x 1.3x 1.0x 10.0x 8.0x 6.3x 20.2% 20.4% 21.6% Fortis Healthcare (India) Ltd IN INR x 17.9x 13.2x 77.2x 35.0x 30% 2.6x 1.2x 1.1x 1.1x 1.0x -1.1% 1.4% 2.9% Bangkok Chain Hospital Public BCH-TH Co., Ltd. THB x 10.3x 9.7x 23.1x 19.6x 16.8x 17% 1.3x 1.1x 1.0x 3.4x 3.2x 3.0x 14.7% 16.4% 17.7% Chularat Hospital PCL CHG-TH THB x 14.5x 12.9x 25.0x 23.6x 19.7x 13% 2.0x 1.9x 1.5x 4.2x 3.8x 3.6x 16.6% 16.1% 18.5% Concord Medical Services Holding CCM Ltd. ADRUSD x 6.0x 5.6x 15.4x 13.0x 12.3x 12% 1.3x 1.1x 1.0x 0.8x 0.8x 0.7x 5.2% 5.9% 5.8% 15.5x 12.9x 10.9x 41.1x 29.9x 22.5x 23% 1.7x 1.4x 1.2x 4.1x 3.6x 3.2x 13.2% 14.2% 14.8% Hospital distribution McKesson Corporation MCK-US USD , x 9.4x 8.5x 19.6x 16.6x 14.7x 17% 1.2x 1.0x 0.9x 4.7x 4.5x 4.5x 24.2% 27.1% 30.9% Cardinal Health, Inc. CAH-US USD , x 10.0x 8.9x 19.1x 18.4x 16.5x 9% 2.0x 1.9x 1.7x 3.9x 3.6x 3.2x 20.4% 19.4% 19.5% AmerisourceBergen Corporation ABC-US USD , x 10.3x 9.1x 22.5x 19.1x 16.4x 16% 1.4x 1.2x 1.0x 6.9x 6.5x 5.6x 30.7% 34.0% 34.2% Shanghai Pharmaceuticals Holding CN Co. Ltd. Class CNY A , x 7.3x 6.6x 16.1x 14.4x 12.9x 14% 1.1x 1.0x 0.9x 1.4x 1.3x 1.2x 8.5% 8.9% 9.2% Sinopharm Group Co., Ltd. Class 1099-HK H HKD , x 16.3x 13.8x 15% 1.3x 1.1x 1.0x 2.0x 1.8x 1.6x 10.5% 11.3% 11.7% 10.3x 9.3x 8.3x 19.3x 17.0x 14.9x 14% 1.4x 1.2x 1.1x 3.8x 3.5x 3.2x 18.9x 20.1x 21.1x Off-shore listed China healthcare Sihuan Pharmaceutical Holdings 460-HK Group Ltd. HKD , x 15.5x 12.8x 27.0x 21.4x 17.3x 25% 1.1x 0.9x 0.7x 3.9x 3.1x 2.8x 14.3% 14.7% 16.1% Sino Biopharmaceutical Limited1177-HK HKD , x 11.8x 10.2x 30.4x 24.9x 20.5x 21% 1.5x 1.2x 1.0x 5.8x 4.9x 3.8x 19.2% 19.5% 18.8% CSPC Pharmaceutical Group 1093-HK Ltd. HKD , x 15.0x 11.4x 36.5x 27.6x 21.5x 24% 1.5x 1.2x 0.9x 3.7x 3.3x 2.9x 10.0% 12.0% 13.7% Sinopharm Group Co., Ltd. Class 1099-HK H HKD , x 6.2x 5.4x 19.3x 16.3x 13.8x 15% 1.3x 1.1x 1.0x 2.0x 1.8x 1.6x 10.5% 11.3% 11.7% China Medical System Holdings 867-HK Ltd. HKD , x 16.8x 13.1x 25.4x 20.8x 16.5x 23% 1.1x 0.9x 0.7x 5.2x 4.4x 3.5x 20.3% 21.4% 21.5% Shandong Weigao Group Medical 1066-HK Polymer Co. HKDLtd. Class H 2, x 21.1x 17.2x 33.2x 27.5x 22.5x 21% 1.6x 1.3x 1.1x 3.7x 3.4x 3.0x 11.2% 12.3% 13.5% Shanghai Pharmaceuticals Holding 2607-HK Co. Ltd. Class HKD H , x 7.7x 7.0x 17.8x 15.8x 14.2x 14% 1.3x 1.1x 1.0x 1.5x 1.4x 1.3x 8.5% 8.9% 9.2% China Shineway Pharmaceutical 2877-HK Group Limited HKD , x 4.9x 4.1x 10.5x 9.7x 9.0x 6% 1.9x 1.7x 1.6x 1.7x 1.5x 1.4x 16.1% 15.7% 15.3% China Traditional Chinese Medicine 570-HKCo. Limited HKD , x 14.8x 11.7x 29.1x 20.8x 18.1x 19% 1.6x 1.1x 1.0x 5.1x 5.6x 4.4x 17.4% 26.8% 24.3% MicroPort Scientific Corp. 853-HK HKD x 10.6x 8.4x 24.4x 20.2x 16.6x 21% 1.2x 1.0x 0.8x 2.4x 2.2x 1.9x 10.0% 10.8% 11.5% Tong Ren Tang Technologies 1666-HK Co., Ltd. Class HKD H , x 25.1x 19.4x 29% 1.1x 0.9x 0.7x 3.2x 3.1x 2.7x 9.9% 12.3% 14.1% Guangzhou Baiyunshan Pharmaceutical 874-HK Holdings HKD Company 25.60Limited Class 726H 24.8x 18.3x 14.8x 25.0x 18.7x 14.6x 31% 0.8x 0.6x 0.5x 3.9x 3.2x 2.7x 15.6% 17.3% 18.3% Lijun International Pharmaceutical 2005-HK (Holding) Co., HKDLtd , x 9.9x 8.1x 16.7x 14.1x 11.3x 22% 0.8x 0.6x 0.5x 2.5x 2.0x 1.7x 14.9% 14.0% 15.5% Shanghai Fosun Pharmaceutical 2196-HK (Group) Co., HKD Ltd. Class H 1, x 24.8x 20.5x 22.1x 19.4x 17.2x 12% 1.9x 1.6x 1.5x 2.8x 2.5x 2.2x 12.6% 12.8% 12.9% United Laboratories International 3933-HK Holdings Ltd. HKD x 7.9x 7.3x 120.4x 25.4x 16.9x 111% 1.1x 0.2x 0.2x 1.0x 0.9x 0.9x 0.8% 3.7% 5.3% Lee's Pharmaceutical Holdings 950-HK Limited HKD x 13.5x 10.6x 27.1x 21.6x 17.9x 16% 1.7x 1.4x 1.1x 5.6x 4.6x 3.8x 20.5% 21.3% 21.1% Mindray Medical International MR-US Ltd. Sponsored USD ADR Class A 3, x 13.0x 11.4x 20.5x 18.8x 16.8x 19% 1.1x 1.0x 0.9x 3.2x 2.8x 2.5x 15.5% 14.9% 15.0% Wuxi PharmaTech (Cayman) WX-US Inc. Sponsored USD ADR , x 13.2x 11.2x 20.8x 19.0x 16.8x 13% 1.6x 1.4x 1.3x 4.2x 3.5x 2.9x 20.3% 18.2% 17.0% 16.8x 13.2x 10.9x 29.9x 20.4x 16.7x 24% 1.3x 1.1x 0.9x 3.4x 3.0x 2.6x 13.8% 14.9% 15.3% Source: Bloomberg, Factset, BOCOM Intl As of 1/17/2013 Download our reports from Bloomberg: BOCM enter 14

15 6) Financial analysis and forecasts Our forecast We derive our sales projection by forecasting the patient traffic and spending trend/pattern for each of the hospitals. We list two examples below: General hospital forecast & Supply chain business forecast For Jian Gong hospital, we multiply the patient traffic and average spending to derive sales for the general hospital services segment. (2013E, 747,000 outpatients spending RMB 412 each and 11,000 inpatients spending RMB 14,228 each = RMB 468mn). For the supply chain business, we calculate the total pharmaceutical sales (patient number x pharma spending) and apply a split which the supply chain business books. (e.g. 2013E: 747,000 out-patients spending RMB 238 and 11,000 in-patients spending RMB 5,176 on pharmaceuticals = RMB 236mn; then we take 50% for the supply chain business). We use a similar methodology in forecasting revenues related to general hospital services and supply chain businesses. Figure 18: Jian Gong example Jian Gong Hospital E 2014E 2015E Outpatient v isits ('000) ,094 Average spending per out patient visit (RMB) Healthcare services Pharmaceuticals Inpatient v isits ('000) Av erage spending per inpatient v isit (RMB) 12, , , ,228 15,210 15,971 Healthcare services 8, , , ,051 9,775 10,264 Pharmaceuticals 4, , , ,176 5,435 5,707 Total rev enue (RMB mn) General hospital services Hospital mgmt services Supply chain business Jian Gong Hospital (YOY%) E 2014E 2015E Outpatient v isits ('000) 20% 29% 25% 22% 20% Average spending per out patient visit (RMB) -4% 0% -1% 0% 0% Healthcare services 8% 15% -2% 0% 0% Pharmaceuticals -10% -8% 0% 0% 0% Inpatient v isits ('000) 14% 20% -2% -2% -2% Av erage spending per inpatient v isit (RMB) -4% 6% 8% 7% 5% Healthcare services -5% 3% 9% 8% 5% Pharmaceuticals -4% 12% 7% 5% 5% ALOS (day s) -9% -8% -8% -5% -3% Number of beds in operation as the end of the period 0% 4% 5% 3% 2% Total rev enue (RMB mn) 21% 23% 13% 16% 15% General hospital services 12% 24% 16% 16% 15% Hospital mgmt services Supply chain business 59% 18% 2% 17% 16% % pharma sales goes to supply chain 41% 61% 59% 50% 50% 50% estimates Download our reports from Bloomberg: BOCM enter 15

16 Figure 19: Removing inter-segment revenue for its supply chain business RMB ' H12 2H H13 2H13E 2013E 2014E 2015E Revenue Total 394, , , , , , ,065 1,038,757 1,285,849 1,847,845 General hospital services 288, , , , , , , , , ,873 Hospital mgmt serv ices 16,348 19,412 12,647 27,630 40,277 9,861 34,161 44,022 70, ,270 Supply chain business (b) 151, , , , , , , , ,592 1,260,016 Less: inter-segment rev enue (b) (61,796) (98,335) (54,850) (61,524) (116,374) (53,165) (64,995) (118,195) (138,257) (160,314) Supply chain business 89, , , , , , , , ,336 1,099,702 Inter-segment rev enue as % of supply chain business -41% -37% -31% -24% -27% -21% -16% -18% -17% -13% Source: Company, BOCOM Intl estimates Note we need to eliminate inter-segment revenues (that is supply chain sales that are booked twice for Jian Gong) for the consolidated revenue line. Thu is only for Jian Gong. Management fees forecasts For management fee, we calculate the total general hospital sales (2013E, 860,000 out-patients spending RMB 416 each and 19,000 in-patients spending RMB 17,570 each = RMB 687mn). Then we take a percentage of where PHG books its management fee. In this example, we have assumed around 3%. This leads to PHG booking RMB 17.2mn in 2013E. We use a similar methodology in forecasting sales for management fees. Download our reports from Bloomberg: BOCM enter 16

17 Figure 20: Jing Mei example Jing Mei Hospital Group E 2014E 2015E Outpatient v isits ('000) Av erage spending per out patient v isit (RMB) Healthcare serv ices Pharmaceuticals Inpatient v isits ('000) Av erage spending per inpatient v isit (RMB) 18, , , ,570 17,422 17,275 Healthcare serv ices 10, , , ,127 10,979 10,832 Pharmaceuticals 8, , , ,443 6,443 6,443 Total rev enue (RMB mn) General hospital serv ices Hospital mgmt serv ices Supply chain business Jing Mei Hospital Group (YOY%) E 2014E 2015E Outpatient v isits ('000) 30% 17% 9% 5% 5% Av erage spending per out patient v isit (RMB) 0% 6% 25% 12% 9% Healthcare serv ices 2% 13% 9% 5% 5% Pharmaceuticals 0% 7% 18% 15% 10% Inpatient v isits ('000) 21% 10% 15% 15% 10% Av erage spending per inpatient v isit (RMB) -8% 2% -1% -1% -1% Healthcare serv ices -3% 8% -1% -1% -1% Pharmaceuticals -16% -7% -2% 0% 0% Total rev enue (RMB mn) 44% -69% 21% 15% General hospital serv ices 24% 16% 12% Hospital mgmt serv ices 6% 6% 6% Supply chain business % 74% 19% 14% % pharma sales goes to supply chain 0% 0% 35% 50% 50% 50% Management fee as % of general hospital rev enues 0% 0% 2% 3% 3% 4% Source: Company, BOCOM Intl estimates Download our reports from Bloomberg: BOCM enter 17

18 Our three scenarios: 1) Base case: We expect the company to spend approximately RMB 300mn in new IOT additions in We expect such scale to be similar to that in Yan Hua hospital, in which PHG invested ~RMB 250mn. We project RMB 300mn to be spent in 2014 and the new IOT will start to contribute in 2015E before being fully optimized in 2016E. Figure 21: Base case - we project one new IOT hospital Hospital group revenue (including intersegment revenue from supply chain) <<for reference only>> RMB mn E 2014E 2015E 2016E 2017E 2018E Total sales , , , , , , Jian Gong Hospital ,021.0 General hospital serv ices Hospital mgmt serv ices Supply chain business Yan Hou Hospital Group General hospital serv ices Hospital mgmt serv ices Supply chain business Mentougou Hospital General hospital serv ices Hospital mgmt serv ices Supply chain business Jing Mei Hospital Group General hospital serv ices Hospital mgmt serv ices Supply chain business Mentougou TCM Hospital General hospital serv ices Hospital mgmt serv ices Supply chain business New IOT Hospital (2014) General hospital serv ices Hospital mgmt serv ices Supply chain business YOY% E 2014E 2015E 2016E 2017E 2018E Total sales 33% 44% 32% 23% 41% 13% 10% 8% Jian Gong Hospital 21% 23% 13% 16% 15% 12% 9% 7% General hospital serv ices 12% 24% 16% 16% 15% 12% 9% 7% Hospital mgmt serv ices Supply chain business 59% 18% 2% 17% 16% 13% 9% 7% Yan Hou Hospital Group 67% 10% 5% 42% 19% 14% 10% 8% General hospital serv ices Hospital mgmt serv ices 10% 26% -31% 93% 17% 13% 9% 8% Supply chain business 78% 8% 10% 38% 19% 14% 10% 9% Mentougou Hospital 304% 197% 33% 28% 19% 14% 12% General hospital serv ices Hospital mgmt serv ices 286% 68% 52% 43% 32% 13% 11% Supply chain business 308% 219% 32% 26% 18% 14% 13% Jing Mei Hospital Group % 71% 21% 15% 13% 9% 9% General hospital serv ices Hospital mgmt serv ices 41% 39% 30% 26% 8% 8% Supply chain business % 74% 19% 14% 12% 9% 9% Mentougou TCM Hospital 2055% 14% 9% 9% 9% 8% General hospital serv ices Hospital mgmt serv ices 39% 29% 25% 23% 7% Supply chain business 1956% 13% 8% 8% 8% 8% New IOT Hospital (2014) 14% 10% 8% General hospital serv ices Hospital mgmt serv ices 13% 9% 8% Supply chain business 14% 10% 9% Download our reports from Bloomberg: BOCM enter 18

19 Figure 22: Base case financial summary Income Statement RMB ' E 2014E 2015E 2016E 2017E 2018E Total Revenue 394, , ,032 1,038,757 1,285,849 1,847,845 2,097,546 2,300,639 2,495,571 Gross profit 92, , , , , , , , ,698 SG&A expenses (26,497) (32,752) (49,912) (112,635) (87,438) (125,653) (142,633) (156,443) (169,699) EBITDA 85, , , , , , , , ,305 Operating income (EBIT) 66,424 89, , , , , , , ,999 Finance costs (2,634) (18,169) (23,785) (25,652) ,122 Profit Before Taxes 65,032 78, , , , , , , ,836 Tax Rate 25% 26% 25% 25% 25% 25% 25% 25% 25% Net Income 42,812 48, , , , , , , ,282 Diluted EPS Diluted Weighted Av erage Shares 602, , , , , , , , ,763 Margins E 2014E 2015E 2016E 2017E 2018E Gross margin 23.6% 24.1% 24.4% 21.4% 23.4% 22.6% 25.2% 25.1% 25.2% SG&A 6.7% 6.4% 6.6% 10.8% 6.8% 6.8% 6.8% 6.8% 6.8% EBITDA 21.6% 23.0% 27.3% 20.8% 25.2% 24.3% 25.7% 24.6% 24.2% Operating (EBIT) margin 16.9% 17.7% 17.8% 10.6% 16.6% 15.8% 18.4% 18.3% 18.4% Profit before tax margin 16.5% 15.5% 19.4% 14.3% 21.6% 19.8% 21.4% 20.3% 19.8% Net margin 10.9% 9.4% 13.3% 10.0% 15.2% 14.0% 15.3% 14.6% 14.3% YOY% E 2014E 2015E 2016E 2017E 2018E Total Revenue 29% 49% 37% 24% 44% 14% 10% 8% Gross profit 32% 51% 21% 35% 39% 27% 9% 9% EBITDA 37% 77% 4% 50% 39% 20% 5% 7% Operating income (EBIT) 35% 50% -18% 94% 37% 32% 9% 9% Profit Before Taxes 21% 87% 1% 88% 32% 23% 4% 6% Net Income 12% 110% 2% 89% 33% 24% 5% 6% Diluted EPS 12% 110% -1% 41% 33% 24% 5% 6% Diluted Weighted Av erage Shares 0% 0% 3% 34% 0% 0% 0% 0% Balance Sheet RMB ' E 2014E 2015E 2016E 2017E 2018E Inventories - Total 22,267 23,200 35,073 63,301 55, ,962 72, ,611 89,557 Trade receiv ables 20,100 23,845 83, , , , , , ,839 Cash and ST Inv estments 321, , ,574 1,270, , ,005 1,416,040 1,464,137 1,939,186 Total Current Assets 409, , ,211 1,807,958 1,435,878 1,829,163 1,979,068 2,417,279 2,589,117 Property. Plant & Equipment - Net 91,527 94, , , , , , , ,161 Total Non-current Asset 254, , , , , , , , ,288 Total Assets 664,310 1,134,678 1,020,860 2,459,915 2,388,561 2,761,918 2,897,724 3,320,822 3,475,406 ST Borrowings 0 200,000 5,803 6, Total Current Liabilities 144, , , , , , , , ,588 LT Borrowings 200, , , Total Non-current Liabilities 212,589 10, , ,788 13,462 13,462 13,462 13,462 13,462 Total Liabilities 357, , , , , , , , ,050 Equity attributable to equity holders of the company 283, , ,256 1,852,609 1,989,731 2,171,446 2,396,162 2,631,364 2,880,761 Capital 130, , ,580 1,404,483 1,404,483 1,404,483 1,404,483 1,404,483 1,404,483 Retained Earnings 48,464 95, , , , , ,015 1,196,217 1,445,614 Non-controlling interest 23, ,160 92,502 99, , , , , ,595 Total Equity 306, , ,758 1,952,516 2,102,141 2,298,482 2,538,912 2,788,114 3,052,356 Total Liabilities & Shareholders' Equity 664,310 1,134,678 1,020,860 2,459,915 2,388,561 2,761,918 2,897,724 3,320,822 3,475,406 Cash Flow Statement RMB ' E 2014E 2015E 2016E 2017E 2018E Net Income/Starting Line 65,032 78, , , , , , , ,836 Depreciation & Amortization 17,573 20,184 36,164 42,219 46,453 84,602 91, , ,590 Operating profit before change in working capital 84, , , , , , , , ,305 Funds from/for Other Operating Activ ities (3,506) (27,839) (6,251) (286,678) 83,737 (242,157) 188,094 (221,434) 188,547 Income tax es paid (11,040) (20,917) (27,595) (30,039) (63,119) (76,975) (105,834) (111,452) (118,703) Cash from Operating Activities 70,057 62, ,419 (100,743) 344, , , , ,148 Purchases of PP&E (17,157) (34,347) (28,115) (38,527) (347,179) (64,675) (77,609) (85,124) (92,336) Cash from Investing Activities (328,099) (36,120) (102,200) 576 (347,179) (64,675) (77,609) (85,124) (92,336) Interest Paid (Cash Flow ) (2,409) (18,858) (23,882) (25,652) ,122 Cash from Financing Activities 298, ,081 (282,083) 1,235,777 (288,629) (77,243) (95,527) (99,854) (105,763) Net Change in Cash 39, ,313 (217,864) 1,135,610 (291,619) (11,458) 449,036 48, ,049 Net Cash - Ending Balance 74, , ,124 1,248, , ,658 1,394,693 1,442,790 1,917,839 Download our reports from Bloomberg: BOCM enter 19

20 2) Bear case: In this scenario, we project no IOT addition. Figure 23: Bear case : we project no IOT additions Hospital group revenue (including intersegment revenue from supply chain) <<for reference only>> RMB mn E 2014E 2015E 2016E 2017E 2018E Total sales , , , , , , Jian Gong Hospital ,021.0 General hospital services Hospital mgmt serv ices Supply chain business Yan Hou Hospital Group General hospital services Hospital mgmt serv ices Supply chain business Mentougou Hospital General hospital services Hospital mgmt serv ices Supply chain business Jing Mei Hospital Group General hospital services Hospital mgmt serv ices Supply chain business Mentougou TCM Hospital General hospital services Hospital mgmt serv ices Supply chain business YOY% E 2014E 2015E 2016E 2017E 2018E Total sales 33% 44% 32% 23% 17% 13% 10% 8% Jian Gong Hospital 21% 23% 13% 16% 15% 12% 9% 7% General hospital services 12% 24% 16% 16% 15% 12% 9% 7% Hospital mgmt serv ices Supply chain business 59% 18% 2% 17% 16% 13% 9% 7% Yan Hou Hospital Group 67% 10% 5% 42% 19% 14% 10% 8% General hospital services Hospital mgmt serv ices 10% 26% -31% 93% 17% 13% 9% 8% Supply chain business 78% 8% 10% 38% 19% 14% 10% 9% Mentougou Hospital 304% 197% 33% 28% 19% 14% 12% General hospital services Hospital mgmt serv ices 286% 68% 52% 43% 32% 13% 11% Supply chain business 308% 219% 32% 26% 18% 14% 13% Jing Mei Hospital Group % 71% 21% 15% 13% 9% 9% General hospital services Hospital mgmt serv ices 41% 39% 30% 26% 8% 8% Supply chain business % 74% 19% 14% 12% 9% 9% Mentougou TCM Hospital 2055% 14% 9% 9% 9% 8% General hospital services Hospital mgmt serv ices 39% 29% 25% 23% 7% Supply chain business 1956% 13% 8% 8% 8% 8% New IOT Hospital General hospital services Hospital mgmt serv ices Supply chain business Download our reports from Bloomberg: BOCM enter 20