China Healthcare:Takeaways for dbAccess China Beijing Hospital Tour

Perspectives of hospital executives

    Our conversations with executives from hospitals suggested that: 1) thegovernment is determined to reduce drug sales as a percentage of hospitalrevenues, and the key to achieve the reform is to provide a correspondingincrease in service fees; 2) removal of 15% mark-up and price erosion in drugtenders are inevitable with mounting pressure on reimbursement funding, thismight lead to volume and pricing pressure on drug companies; 3) hospitals areless likely to be negatively impacted as they have multiple risk mitigationtactics; 4) profit from supply chain is unlikely to be impacted in the near termas well as hospitals have substantial negotiation power. We continue to likePhoenix as it is a hospital play with margin expansion opportunity and growthacceleration in 2016.

    Reducing drug sales as a percentage of hospital revenue is a key trend

    Hospital executives highlighted that the government is determined to lowerdrug sales as a percentage of hospital revenue. According to document 70 byNHFPC, the target ratio is 30% vs. approximately 45% at present. Importantly,hospital executives indicated that the key to achieve this reform is to provide areasonable increase in service fee to compensate the lower drug sales.Executives also expect the removal 15% mark-up, price cut in drug tenders andthe volume shifting to drug stores would be essential to achieve the objectives.However volume growth pressure would linger.

    Insights from hospital executives

    Other key insights provided by executives include: 1) public hospitalsprivatization would lead to significant improvement in operating efficiency withrefocus on medical specialty offering and costs control measures. For example,Jiangong hospital will increase exposure on dental care while Yanhua hospitalhas been expanding interventional cardiology. 2) more market-orientedinitiatives might emerge in the hospital ownership and management. Forexample, Phoenix is considering exploring hospital/physician partnership,which we believe is an exciting trend as separate profit centers may lead tobetter efficiency. 3) it was challenging to sign off management contracts forpublic hospitals in the past two years for all players; 4) the restriction of highend service offering from public hospitals will pave the growth opportunity forprivate sector; 5) the barrier of entry might be the scale, financing capabilityand the physician resources according to these executives.

    Expecting volatility for drug names; prefer Phoenix as a hospital play

    We like Phoenix due to growth acceleration in 2016 as well as its excellent riskprofile amid policy pressure for drug sector. Additionally, we continue toexpect consolidation of P&L from 1-2 hospitals from Baoding in 2H15, as wellas general coal hospital in 4Q15 or early 2016. We believe the initiation ofconsolidation of any new meaningful hospitals is a catalyst that investors havebeen waiting for.