Cordlife Group Limited S$0.690 S$ Intrinsic Value Prev Closing Price. 30 May Fundamental Drivers:

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1 Cordlife Group Limited The Ideal Choice We initiate coverage on Cordlife Group Limited (Cordlife) as the company operates in a niche healthcare subsector that is defensive and has strong cash generating capability. The company also has much upside potential such as penetration rate growth in existing markets, new markets via its right of first refusal with Australia listed Cordlife Ltd (which Cordlife Group currently licenses its branding and knowhow to) and potential new service offerings. Cordlife currently trades at FY13F 11.1X P/E and 1.41X P/B. Recommend Increase Exposure with an intrinsic value of S$ Fundamental Drivers: Many Reasons to Opt for Cordlife: The company is awarded the prestigious American Association of Blood Banks (AABB) certification, adopts the Sepax automated stem cell processing system and has the track record of releasing seven cord blood units globally. We reckon that these merits will entice parents to prefer Cordlife over its peers. Healthy Business Model with Constant Cashflow: Cordlife is the market leader in Singapore and No.2 player in Hong Kong. The Singapore entity can generate more than S$8m profit annually assuming constant penetration rate and new born numbers. Also, the company can potentially collect more than S$5m recurring annual fees from its Singapore customers. More Offerings as Cordlife Moves up the Value Chain: Cordlife Hong Kong had recently offered umbilical cord storage services and we believe that Cordlife Singapore will follow suit in the near future, subject to MoH approval. This new offering may allow Cordlife (especially Cordlife Singapore) to escalate its revenue over the next few years. Dividend Outlook: Cordlife paid out about 50% of its FY11 profit as ordinary dividends (1.8 S cents per share, 0.2 S cents per share special dividend) recently and we reckon that the company will at least maintain this payout ratio given its healthy cash balance and positive cash flow. Increase Exposure Intrinsic Value Prev Closing Price Main Activities S$0.690 S$0.460 Cordlife owns and operates private cord blood banks in Asia. The company focuses on providing cord blood banking and umbilical cord tissue banking services which include the collection, processing, testing, preservation and storage of umbilical cord blood and umbilical cord tissue at birth. Financial Highlights (Y/E Jun) S$ m FY11 FY12F FY13F Revenue Gross Profit Profit After Tax EPS (S cts) Source: SIAS Research Estimates Key ratios (FY13F) PER 11.1 P/BV 1.41 ROE 12.7% Debt/Equity 2% Current ratio 5.22 Source: SIAS Research Estimates Indexed Price Chart Green (FSSTI) White (Cordlife) Source: Bloomberg 52wks High-Low Number of Shares Market Capitalization Analyst: Ng Kian Teck, Lead Analyst kianteck@siasresearch.com Tel: cents/ 43.8 cents m S$107.0 m Page 1 of 14

2 To be the Preferred Custody in Singapore Company History: Cordlife was the result of a demerger from Australia listed Cordlife Ltd. The separation of the more developed business unit enables interested investors to participate in a defensive and stable healthcare business, and therefore improve shareholder value. Business Operation: Cordlife is involved in the collection, processing, testing, cryopreservation and storage of umbilical cord blood and umbilical cord tissue at birth. The latter is only available in Hong Kong currently. The company has processing facilities in Singapore and Hong Kong and provides cord blood banking services to customers in the two regions, as well as Indonesia, Macau and the Philippines. To date, the company stores close to 40,000 cord blood units. The company also has a 10% indirect interest in Guangzhou Tianhe Nuoya Biology Engineering Co., Ltd, the sole cord blood bank operator in Guangdong. International Accreditation, Cutting-edge Technology and Proven Track Record: Cordlife s Singapore cord blood bank is the first in ASEAN to be awarded the prestigious AABB certification in The AABB is a US based standards organization that works closely with the US Food and Drug Administration in the development of blood regulation. The Hong Kong facility received its AABB accreditation in Cordlife also devoted heavy resources into its blood processing technology to maximize the number of stem cells harvested, which will subsequently improve the success rate of the transplant. The Sepax automated stem cell processing technology was chosen as 1) the product can attain up to 99% total nucleated cell recovery rate, 2) it has a smooth cell separation and processes every cord blood unit individually and 3) The Sepax is cleared by the US FDA, European CE mark and Japan Ministry of Health and Labor Welfare. It also complies with AABB and Fact-NetCord (An European based standards organization for cord blood services). In addition, Cordlife has the track record of releasing cord blood units in Singapore (6) and Hong Kong (1), which is a testimony of their processing and storage method. It is the only private cord blood bank in Singapore that has released cord blood units before. The above factors are crucial as the cord blood s usability will influence the results of the treatment and parents will want to do their best to minimize any slip-up. That said, we reckon Cordlife will be able to secure a substantial market share based on their above merits. Page 2 of 14

3 Cord Blood and Its Usage: Cord blood is blood that remains in an infant s umbilical cord and placenta after childbirth. The collection typically occurs within the first few minutes of the infant s delivery, where the umbilical cord will be cut off and the cord blood is being extracted using a syringe. This cord blood will then be placed in a blood bag and sent for testing and processing, where they will extract the hematopoietic stem cells from the rest of the blood specimen. These stem cells will subsequently be stored in an extreme cold environment of below -150 C. These blood regenerative hematopoietic stem cells inside the cord blood can be used to treat hematopoietic and genetic disorders such as leukemia, anemia and immune deficiency. They are also seen as an alternative to bone marrow, though the number of cord blood stem cells may be limited. Figure 1: Cordlife s Operating Processes Source: Company, SIAS Research Page 3 of 14

4 Cord Blood Industry and Outlook: There are currently more than 170 cord blood banking service providers globally. Certain countries with higher population density such as Korea, Japan, Taiwan and Singapore have penetration rates of 15%-28%. US, Europe, China and India have <6% take-up rate owing to lower population density, insufficient awareness and general misperceptions by the public such as the low odds of using banked cord blood in the future and parents can retrieve the banked cord blood if they donate it to the public bank. We reckon that demand for cord blood banking services will improve as the public attains a better understanding of its usage. Another driver for cord blood banking services is the increasing number of clinical research studies on cord blood for new treatments such as diabetics, brain and spinal injuries, liver and kidney diseases and cerebral palsy. Many of these medical conditions are more common and will greatly escalate the possibility of cord blood usage. Figure 2: Some Treatments and Ongoing Clinical Trials for Stem Cells Diseases Treated Using Stem Cell Transplantation Leukemias, Lymphomas, and other Blood Cancers Brain Tumours, Ovarian Cancer, Testicular Cancer and others Bone Marrow Failure Syndromes Metabolic and Other Inherited Disorders Source: Company, SIAS Research Ongoing Clinical Trials Alzheimer's Disease Type 1 Diabetes Parkinson's Disease Cerebral Palsy Spinal Cord Injuries and Other Brain Injury Cordlife Singapore and Hong Kong: Cordlife Singapore has built up its marketing and distribution channels via 1) establishing collaborative relationships with major hospitals in Singapore to spread awareness and 2) advertising on media and magazines to educate the public. Together with their international accreditation, cutting-edge technology and proven track record, these factors explain their dominant position in Singapore. Similar marketing efforts were also launched in Hong Kong. Cordlife also worked with China Cord Blood Corporation (CCBC) to market its services in the three regions to expectant mothers who intend to deliver in Hong Kong. CCBC is one of the top China operators and holds majority shares in Beijing, Guangdong, and Zhejiang Cord Blood Banks Despite continuous media coverage about declining birth rates in Singapore, the absolute number of new born remained stable at about 37,000 to 40,000 over the past seven years on the back of rising foreign immigrants. Absolute marriage number has also stayed stable at about 22,000 to 27,000 annually. Hong Kong is also experiencing falling birth rates, but the number of new born is heightened by the influx of expectant mothers from Mainland China. Excluding the impact of mainland mothers giving birth in Hong Kong, the domestic birth rate stood steady at about 45,000 per year. Page 4 of 14

5 Figure 3: Birth and Population Number from Singapore *:Under the Administration of the Women's Charter and Muslim Law Act Source: Singstat, SIAS Research Figure 4: Birth and Population Number from Hong Kong Source: Censtatd, SIAS Research Figure 5: Penetration Rate and Cumulative Storage Units in Singapore and Hong Kong Source: Deloitte & Touche Financial Advisory Services Limited Page 5 of 14

6 Stable Business and Upside Potential: Cord blood banking services are usually priced around the same range (+/-15%) for each nation, with the market leader usually charging a slight premium, probably due to its stronger local presence and better track record. That said, Cordlife is the market leader in Singapore and the No.2 player in Hong Kong. Figure 6: Cord Blood Banking Price Comparison Company/ Region Collection Fee Annual Storage Fee Cordlife Singapore S$1950 S$250 for 21 years S$4200 for first 10 years S$250 for next 11 years S$ for next 21 years Stemcord S$1585 S$275 US Cord Blood Banks About US$ About US$ European Cord Blood Banks About About 100 Malaysia Cord Blood Banks RM About RM250 China Cord Blood Banks About RMB 5,800 About RMB Cryolife Hong Kong HK$37,400 0 for 18 years HealthBaby Hong Kong HK$38,000 0 for 18 years Cordlife Hong Kong HK$36,000 0 for 18 years *:Cord Blood Storage Only, Exclude Umbilical Cord Storage Source: Various Sources Figure 7: Cordlife s Market Share in Singapore(LHS) and Hong Kong (RHS) Source: Deloitte & Touche Financial Advisory Services Limited Cordlife has a healthy business model and is capable of generating constant cashflow. As Cordlife recognizes revenue based on the percentage of cost incurred, the company can earn approximately 80% of the revenue once the stem cell is being stored. Assuming that the company retains its current market share and that the number of newborns and market penetration rate remain constant, the Singapore entity can generate more than S$8m profit annually. In addition, approximately 66% of Cordlife Singapore s existing customers chose the S$1,950 collection fee package while another 17% adopted the S$4,200 collection fee package. Assuming that Cordlife Singapore has 30,000 cord Page 6 of 14

7 blood units, the company can receive another S$5.0m and S$1.25m annual cash flow from customers in the first category and second category respectively (contribution from the S$4,200 collection package will only start after year 10). The remaining 17% customers are those who paid the entire package upfront. The Hong Kong entity currently contributes marginal profit to Cordlife as the company has yet to achieve economies of scale due to lower market share and penetration rate (Singapore has 51,000 cumulative cord blood storage units by all the private banks vs Hong Kong s 30,500). That said, we reckon that contribution from Hong Kong will gradually pick up on the back of higher population (compared to Singapore) and growing penetration rate. Figure 8: Segment Breakdown Revenue ( S$ '000) North Asia (Mainly Hong Kong) 5,741 7,873 6,459 South Asia (Mainly Singapore) 16,843 20,290 19,214 PBT (S$ '000) North Asia (Mainly Hong Kong)* ,586 South Asia (Mainly Singapore) 6,893 9,039 8,250 *: Include contribution from associate, Guangzhou Tianhe Nuoya Source: SIAS Research Presently, most of the cord blood services mainly revolve around the extraction of hematopoietic stem cells. However, umbilical cord also has mesenchymal stem cells and epithelial stem cells. The former has the ability to protect tissue, regenerate and repair tissue damage while the latter has the potential for corneal replacement, intestine repair and lung epithelia. Cordlife Hong Kong had recently attempted to broaden its services by offering the storage of umbilical cord with a basic package of HK$35,000 (for the storage of mesenchymal stem cells) and a superior package of HK$64,000 (for the storage of mesenchymal stem cells and epithelial stem cells). Both plans cover a storage period of 18 years. We view Cordlife Hong Kong s enlarged services portfolio as a move up the value chain and that Cordlife Singapore is likely to offer similar services in the near future, subject to MoH approval. If this occurs, there is a possibility that Cordlife Singapore s contribution may escalate rapidly and lead to upside risk from our base forecast. Both entities may also offer more related services such as the storage of umbilical cord lining and there is also the possibility of generating more recurring revenue when customers continue storing their cord blood after their existing contracts expire. Page 7 of 14

8 Figure 9: Stem Cells can be transformed into Different Cell Types Source: Delta Research Innovations >50% Sponsorship from Government: Singapore has a baby bonus scheme which was launched to incentivize parents to have more children (only Singaporean children are eligible). There are two components: 1) a cash gift of S$4,000 (for the first and second child) and S$6,000 (for the third and fourth child) will be given in four equal installments into the children s Child Development Account (CDA), 2) a dollar for dollar government matching contribution up to a certain limit will be made available to the CDA before the child turns 6 years of age. The CDA can be used to pay for fees incurred in healthcare institutions licensed under the Private Hospitals and Medical Clinics Act (including Cordlife). As such, parents will be incentivized to opt for Cordlife services as they can be subsidized by up to more than 50%. Figure 10: Grant from the Government Child Order Cash Gift from the Govt Matching from Govt Total First and Second S$4,000 S$6,000 Up to S$10,000 Third and Fourth S$6,000 S$12,000 Up to S$18,000 Fifth and Beyond NA S$18,000 Up to S$18,000 Source: babybonus.gov.sg Worthy Asset Purchase Which Generates Cash: Cordlife Singapore s existing facility at Singapore Science Park 2 has a capacity of 60,000 cord blood units and the cord blood bank will probably reach full capacity over the next five years. The company has envisaged this issue and has acquired two levels of A Posh Bizhub (approximately 23,000 sq feet, 60 years lease, located at Yishun) in This new facility is capable of storing up to 650,000 cord blood units and is under construction now. The company expects to receive the temporary occupation permit by end As the asset is purchased when the economy had yet to recover from the 2008 financial crisis, Cordlife Singapore paid S$8.06m for this asset and assuming S$3m for renovation, it works out to an economical cost of 67 S cents per sq feet per month. Furthermore, Cordlife may lease out one of the levels as they do not need such a large space. They currently occupy only 6,500 sq feet. This asset may instead generate a net cash surplus (including debt expenses) of S$10,000 monthly. Page 8 of 14

9 Promising Contribution from Associate: In October 2009, Cordlife Ltd invested 10% equity stake in Guangzhou Tianhe Nuoya, the sole licensed cord blood banking operator in the province of Guangdong. Guangdong is China s most populous province with a population of >100m and annual newborns of >1.1m. However, private cord blood banking penetration rate is approximately 2% owing to affordability and lack of awareness. Despite that, the entity still generated S$1.7m of associate profit for Cordlife in there is room for upside contribution. Investment in associate amounts to S$16.8m in Cordlife s recent 3Q FY12 results. Figure 11: Birth and Population Number from Guangdong Source: Various Sources Right of First Refusal: Cordlife also entered into right of first refusal agreements to acquire Cordlife Ltd s cord blood banking business in Indonesia, the Philippines and India. The company also entered into a subscription agreement with CSCT (a subsidiary of Cordlife Ltd that owns 85% of Cordlife India) in March 2012 where Cordlife will invest S$1.5m for two years. The investment has a redemption value of S$2.2m (20% return per annum) and Cordlife has the option of converting the investment amount into 30% of CSCT (or 25.5% of Cordlife India). This agreement also indirectly values Cordlife India at approximately S$8.6m. We like Cordlife s move as they have the option of expanding into different markets with minimal risks. Recent Performance and Dividend Outlook: Cordlife s 9MFY12 performance was healthy, with 14.2% revenue growth and 10.8% gross profit increment over corresponding period. 9M FY12 PAT fell by 25.4% mainly due to one-off IPO expenses (S$1.9m), without which, PAT would have grown by 5.4% YoY. The company also announced of 2.0 S cents interim dividend (of which 0.2 S cents is special dividend), in compliance with their dividend policy of at least 25% of FY11 profit in FY12. As Cordlife has a strong cash flow business model and that the funding needed for acquisitions and renovation at A Posh Bizhub (a total of about S$19.6m) was raised during the IPO, we reckon that the company has the ability to issue more dividends to shareholders. As at end March 2012, Cordlife had S$33.6m cash on hand and generates about S$2m of operating cash flow every quarter. Page 9 of 14

10 Figure 12: Cordlife Financial Results *: Annualized from 9M results **: Excluding IPO Expenses Source: Company, SIAS Research Peers: Cordlife has several listed global peers but most of them are small as cord blood banking is still a relatively new subsector. Due to subsidies in Singapore (which subsequently lead to high penetration rate) and effective cost control by Cordlife Singapore, Cordlife is able to generate higher return than its peers. That said, this counter is priced about 16% lower than its global peers and 55% lower than its Singapore healthcare peers in terms of P/E. Figure 13: Peer Comparison P/E P/B ROE (%) Debt/Equity (%) Mkt Cap (S$m) Cryosite Ltd Cryo-save Group NV China Cord Blood Corp Vita 34 Ag Stemlife Bhd Global Peers Avg Healthway Medical Raffles Medical Health Management Pacific Healthcare NA 2.77 NA Biosensor Singapore Healthcare Peers Avg Cordlife Group Ltd* *: SIAS Research FY13 Estimates Source: Bloomberg, SIAS Research Estimates Page 10 of 14

11 Concerns Though Cordlife s outlook seems promising, there are several risks that we would like to highlight to investors. 1) Demand for Cordlife s services may somewhat be affected by global economic performance as evidenced by the 8.9% decline in revenue between FY10 and FY11. The company can partially mitigate any cash flow impact via passive income from customers annual payments. 2) Hong Kong has recently placed a hospital ban on nonresidents from next year onwards due to public discontent over insufficient medical staff to accommodate the locals (partially led by higher number of expectant mainland mothers). This may to a certain degree affect Cordlife Hong Kong s short term performance but the entity had always been putting their attention on the locals. Cordlife Hong Kong has the potential to be as profitable as Cordlife Singapore as the demographics of both cities are around the same. 3) Cord blood banking services is still a rather niche subsector and vulnerable to external factors such as 1) the level of public awareness and perception, 2) medical development on other substitutes and 3) competition from new entrants (if any). Page 11 of 14

12 Valuation: Cordlife has many upside opportunities via existing markets (higher penetration rates), different geographies (new markets) and new service offerings (storage of umbilical cord and cord lining). Its relatively stable business model, healthy cash generating capability and possible higher than expected dividend distribution (2 S cents per share in FY13) make it look attractive. We conservatively estimate the company s revenue to grow by 10% in FY13F and FY14F and 7% in FY15. FY13-15F gross margin and net margin is projected to be around 70-71% and % respectively. ROE for the period will be roughly %. Cordlife has a high current and non-current receivables turnover of >400 day (about S$31.6m as of 3Q FY12) mainly due to cord blood banking service revenue that have yet to be billed to customers specifically those that have subsequent annual payments to Cordlife. Similarly, the company has deferred revenue (current and non-current) of S$11.4m. This is probably a result of certain customers who paid for the entire cord blood banking service package upfront but certain portion of the revenue have yet to be recognized. Our model does not include potential revenue from other new regions (including those markets which Cordlife has the option to purchase from Cordlife Ltd) and new service offerings. However, we conservatively included the capital charge for the IPO proceeds (which explains the jump in invested capital in FY13). Adopting an Economic Profit Valuation method and applying a final WACC of 7.42% with 3.0% terminal growth rate, we arrive at an intrinsic value of S$0.690 for Cordlife, representing an upside of 50%. Figure 14: Economic Profit Valuation S$' mn FY11 FY12F FY13F FY14F FY15F Revenue EBIT Tax on EBIT NOPLAT (Company) Invested Capital % of debt 3% 3% 2% 2% % of equity 97% 97% 98% 98% WACC 7.40% 7.41% 7.41% 7.42% Capital Charge Economic Profit Terminal 104 Discount Rate Present Value Book Value 67 Risk Free 2.5% Explicit Value 14 Beta 1.0 Terminal Value 79 Market RP 5.0% Value of Firm 161 Cost of Equity 7.5% Number of Shares Cost of Debt 4.0% Value per share (S$) LT Growth 3.0% Source: SIAS Research Estimates Page 12 of 14

13 Figure 15: Financial Forecast and Estimate S$ m FY2010 FY2011 FY2012F FY2013F FY2014F FY2015F Revenue Gross Profit Net Income After Tax EPS (S cents) Dividend Yield (%) NA NA 4.3% 4.3% 6.5% 7.2% Total Current Assets Total Non-Current Assets Total Current Liabilities Total Non-Current Liabilities Total Equity Net Income Before Tax Cash from Operating Activities Cash from Investing Activities Cash from Financing Activities Net Change in Cash ROE 25.1% 20.9% 9.7% 12.7% 12.7% 12.9% ROA 14.3% 15.3% 7.8% 10.1% 9.9% 9.8% Debt/Equity 0% 1% 2% 2% 2% 2% Current Ratio P/E P/B Source: SIAS Research Estimates Page 13 of 14

14 Rating Definition: Increase Exposure The current price of the stock is significantly lower than the underlying fundamental value. Readers can consider increasing their exposure in their portfolio to a higher level. Invest The current price of the stock is sufficiently lower than the underlying fundamental value of the firm. Readers can consider adding this stock to their portfolio. Fairly Valued The current price of the stock is reflective of the underlying fundamental value of the firm. Readers may not need to take actions at current price. Take Profit The current price of the stock is sufficiently higher than the underlying fundamental value of the firm. Readers can consider rebalancing their portfolio to take advantage of the profits. Reduce Exposure - The current price of the stock is significantly higher than the underlying fundamental value of the firm. Readers can consider reducing their holdings in their portfolio. IMPORTANT DISCLOSURE: As of the date of this report, the analyst and his immediate family may own or have positions in any securities mentioned herein or any securities related thereto and may from time to time add or dispose of or may be materially interested in any such securities. Portfolio structure should be the responsibility of the investor and they should take into consideration their financial position and risk profile when structuring their portfolio. Investors should seek the assistance of a qualified and licensed financial advisor to help them structure their portfolio. This research report is based on information, which we believe to be reliable. Any opinions expressed reflect our judgment at report date and are subject to change without notice. This research material is for information only. It does not have regards to the specific investment objectives, financial situation and the particular needs of any specific person who may receive or access this research material. It is not to be construed as an offer, or solicitation of an offer to sell or buy securities referred herein. The use of this material does not absolve you of your responsibility for your own investment decisions. We accept no liability for any direct or indirect loss arising from the use of this research material. We, our associates, directors and/or employees may have an interest in the securities and/or companies mentioned herein. This research material may not be reproduced, distributed or published for any purpose by anyone without our specific prior consent. Page 14 of 14