LifeTech Scientific Corporation (1302.HK, Not Rated): Key Takeaways China Healthcare 20 February 2014

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1 INSTITUTIONAL RESEARCH LifeTech Scientific Corporation (1302.HK, Not Rated): Key Takeaways China Healthcare 20 February 2014 What s New: We recently met with Mr. Michael Zhao, Chief Executive Officer and Executive Director of LifeTech Scientific Corporation, for an update on the company. Company Background: LifeTech manufactures minimally invasive interventional medical devices for cardiovascular and peripheral vascular diseases. The company manufactures occluders; vena cava filters; stent grafts; and delivery and supporting devices. LifeTech was the first Chinese company that successfully developed and commercialized occluders in China, and currently ranks #2 in terms of market share in congenital heart defect (CHD) occluders worldwide (#1 in BRICs). The company also offers five other types of minimally invasive implants and devices, including vena cava filters (VCF), vascular stent grafts, balloon catheters, vascular plugs and coronary stents. LifeTech s products are comparable to leading global products, but at a better price point allowing the company to penetrate emerging markets namely the BRICs where the market is under penetrated relative to developed countries. A low cost manufacturing base coupled with an experienced management team and new product development will drive sustainable long-run growth and shareholder value. Medtronic Strategic Investment: In early 2013, Medtronic a global leader in medical devices purchased a 19.0% equity interest in LifeTech with an option to acquire additional ownership in the company. Along with the purchase, Medtronic received the right of first negotiation to distribute current and future LifeTech products. Medtronic purchased its initial equity investment for HK$3.80 per share or HK$361 million (approximately US$46.5 million) and also purchased a HK$152 million (approximately US$19.6 million) convertible note representing an additional approximately 7.4% equity on a fully-diluted post-conversion basis with an opportunity to acquire additional convertible notes. In keeping with its strategy of expanding into key emerging markets, Medtronic derives ~15% of its revenues from the APAC region, up from 10% in From LifeTech s perspective, the Medtronic investment is critical as it will allow the company to leverage its existing relationship with Medtronic to enter into the key US market as well as gain best practices. Medtronic will likely leverage its partnership with LifeTech to create a value brand/segment and to navigate the cultural gap in China. In January of this year, LifeTech and Medtronic entered into a second supplemental agreement whereby Medtronic would provide consultative services to Lifetech. The services include advising on clinical trials, development of any clinical evidence and the deployment of personnel. We believe that this has led to the recent share price surge. Outlook: Management pointed to a healthy outlook for 2014 aided primarily by new product launches. Company growth will also be driven by product mix, geographical reach and market share gains. The overall environment remains favorable with key product launches in Western Europe and India two key markets for LifeTech. Valuation: LifeTech currently trades at 46.7X 2014E consensus EPS vs. the global peer group average of 19.0X 2014E EPS and at 21.2X 2015E consensus EPS vs. the global peer group average of 16.8X 2015E EPS. Key Risks: (1) clinical risk; (2) competitive pricing pressure; (3) legal and intellectual property disputes; and (4) China specific macro, political and regulatory risks. Figure 1: Summary Financials (Rmb '000) FY09 FY10 FY11 FY12 1Q13 1H13 3Q13 Revenues Gross profit Operating Income Net Income (5) (76) (56) 1 EPS (0.02) (0.15) (0.11) 0.00 Gross Margin 73.0% 79.9% 80.5% 80.1% 82.9% 82.9% 80.1% Operating Income Margin 25.7% 30.0% 12.5% 27.0% 29.6% 24.1% 23.9% Net Income Margin -5.9% 3.8% 8.4% 17.8% % -51.6% 2.7% Sources: Bloomberg, Company reports and Sun Hung Kai Financial Price Chart (HK$) Feb 13 May 13 Aug 13 Nov 13 Feb 14 Share price Vik Chopra vik.chopra@shkf.com Reports available at: Bloomberg Code: <shkr> HSI rebased to sh. price Sources: Bloomberg and Sun Hung Kai Financial Key Data Price HK$ W high/low HK$ 9.05/5.20 Mkt cap HK$m (US$m) 4,360 (562) Shares in issue millions Free float % M avg. t/o HK$m (US$m) 3.4 (0.4) Major shareholder Yuehui Xie 19.75% Sources: Bloomberg and Sun Hung Kai Financial Sun Hung Kai Financial Institutional Research

2 Products Occluders: The company commands a 19% market share in the congenital heart defect occluder market in BRIC countries, European Union countries and the United States, and 55% market share in BRIC countries. LifeTech offers three generations of occluders HeartR, Cera and CeraFlex addressing the three most common defects of atrial septal defects (ASD), patent ductus arteriosus defects (PDA) and ventricular septal defects (VSD). CHD occluders are used to close an abnormal opening in the heart without open surgery. In 2001, the company launched its first generation HeartR nitinol wire frame occluder series, becoming the first Chinese company to sell occluders in China. In 2009, LifeTech commercially launched the second generation Cera occluder series, offering enhanced biocompatibility via ceramic coated nitinol wire frame. Most recently, in 2011, the company launched its third generation CeraFlex occluder series. The first generation HeartR occluders are primarily sold in China, India and Russia, while the second and third generation occluders are sold in Europe and South America. Figure 2: LifeTech Occluder Brands BRAND FEATURES APPROVAL DATE HeartR Composed of PET or eptfe membrane supported by knitted nitinol wire frame with a stainless steel tip to fix the frame and a stainless steel screw to connect to the introducers to the septal defect to stop the shunting of blood SFDA approval for HeartR PDA, ASD and VSD occluders in June 2001, April 2003 and June 2004, respectively Cera All of the features of the HeartR occluder plus ceramic coating to ensure enhanced biocompatibility May 2009 (primarily sold in EU) CeraFlex All of the features of the Cera occluder plus the replacement of stainless steel with nitinol in making tip and loop connection in lieu of screw connection March 2011 (primarily sold in EU) Sources: Company reports and Sun Hung Kai Financial The company is currently in the process of developing a patent foramen ovale (PFO) occluder. A patent foramen ovale (PFO) is a defect in the wall between the two upper (atrial) chambers of the heart, which is an incomplete closure of the atrial septum that results in the creation of a flap or a valve-like opening in the atrial septal wall. A PFO is found in approximately 20% of the population. PFO defects can be closed through open surgery or via the use of a transcatheter. The company is currently conducting a clinical trial for the PFO occluder in the EU and expects to launch this product in 2014, subject to results and regulatory approval. The company is also in the process of developing a Left Atrial Appendage (LAA) occluder and is currently conducting human trials for its LAA occluder. This product is expected to be launched in 2015 or Vena Cava Filters: Vena cava filters (VCF) are designed for the prevention of pulmonary embolism (a blockage of the main artery of the lung by a substance that has traveled from elsewhere in the body). Deep vein thrombosis (DVT) is a blood clot that typically forms in the veins in the lower region of the body such as the thigh, lower leg or pelvis and can lead to a fatal pulmonary embolism. A VCF is placed into the inferior vena cava (large vein that carries de-oxygenated blood from the lower half of the body into the right atrium of the heart) to prevent fatal pulmonary embolism. Most VCFs are permanent, but some filters are now available that are retrievable (i.e. they can be pulled back into a catheter and removed from the body). The majority of the company s vena cava filters are sold in China and the company commercially launched the product in The company received CE approval in February LifeTech is also working on a new generation of vena cava filters that can be kept in the vena cava for more than three months instead of the current 15 days. This new generation of vena cava filters is presently in animal trials. Stent Grafts: A stent graft is an artificial tube inserted into the body typically to reinforce a weak spot in an artery called an aneurysm (usually a blood-filled balloon-like bulge in the wall of a blood vessel). A stent graft is composed of polytetrafluoroethylene (eptfe) material supported by a rigid metal structure. This rigid structure is called a stent. LifeTech s stent grafts are used to mainly address thoracic aortic aneurysms (aortic aneurysm present primarily in the thorax) and abdominal aortic aneurysms (ballooning of the abdominal aorta). An aortic aneurysm Sun Hung Kai Financial Institutional Research 2

3 is an enlargement of a weakened area of the aorta (largest artery in the body originating from the heart and carrying blood out of the heart and distributing it to other parts of the body). 90% of abdominal aortic aneurysms occur below the kidneys and occur most commonly in men who are smokers between 65 and 75 years old. Similarly, thoracic aortic aneurysms occur in individuals between 60 and 70 years old and hypertension and smoking are the most common causes. Abdominal aortic aneurysms are more common than thoracic aortic aneurysms. The company manufactures two types of stents one in a straight tubular shape and the other in a Y tubular shape. The straight stent is used in thoracic procedures and the Y tubular shaped stent is used in the abdominal region. SFDA approval was granted in June 2004 and this product is primarily sold in China. The company also sells vascular plugs, coronary stents, bovine heart valves and associated delivery and supporting devices. Sales & Distribution LifeTech sells its products through a direct sales force as well as through sales agents. 90%-95% of its sales are generated through its global network of distributors selling LifeTech s products into China, India and Europe. China remains the company s largest market, accounting for ~70% of total revenues. The company s products are mostly sold in the more developed Eastern region in China, where more sophisticated hospitals are located. Almost all of the company s products are sold at Tier III Class A hospitals, which tend to perform the majority of all cardiovascular operations in China. Industry Overview The cardiology and peripheral interventional market consists of Congenital Heart Defect (CHD) Occluders, Vena Cava Filters (VCF), Endovascular Grafts for Abdominal Aortic Aneurysms (AAA), Patent Foramen Ovale (PFO) Occluders and Left Atrial Appendage (LAA) Closure Devices. According to the World Health Organization (WHO) cardiovascular disease is the number one cause of death worldwide, accounting for approximately 29% of deaths in Specifically, ischemic heart disease (reduced blood supply of the heart muscle due to coronary artery disease) accounts for 12% of all deaths and cerebrovascular disease (conditions affecting blood circulation to the brain) and stroke accounts for 10% of all deaths worldwide per year. The primary growth driver in emerging markets will be changing lifestyles and an aging population that is living longer. This is particularly prevalent in India and China. The threat of cardiovascular disease could put immense strain on the developing healthcare systems of these two counties. As healthcare systems in both countries develop and evolve, India and China cannot ignore the adverse effects of cardiovascular disease. It is estimated that global market for interventional devices used in CHD, VCF, AAA, PFO and LAA will be worth approximately US$2.7bil by 2015 globally, representing a CAGR of 12%. The largest growth will come from China and the BRICs ex. China, clocking in at 19.6% and 22.6% CAGR. Sales of interventional devices in China and the BRICs ex. China totaled US$303mil in 2010 and are expected to grow to US$789mil by 2015, representing a CAGR of 21%. The EU and U.S. markets are already mature and growth will be slower there than in China and the BRICs ex. China. Congenital heart defects refer to heart defects present at birth. Approximately 50%-60% of all congenital heart defects are diagnosed within the first month of birth and another 10% of congenital heart defect diseases are diagnosed later in life. The most common congenital heart defect is ventricular septal defect (VSD). VSD is a Sun Hung Kai Financial Institutional Research 3

4 hole in the wall dividing the left and right ventricles (lower chambers) of the heart and usually develops before birth and most often found in infants and newborns. The congenital heart defect market is expected to be worth US$345mil by 2015, up from US$212mil in 2010, representing a CAGR of 10.3%. Growth is expected to be driven by China and BRICs ex. China. Selected Management Profile The company has an experienced management team. The Chairman has been with the company for 10 years and the CEO has more than 10 years of experience in the cardiovascular medical device industry, having worked for nine years with Johnson & Johnson s Cordis subsidiary in the United States, Europe and Australia and as a general manager of Cordis China. The company s Development & Strategic Planning Director has more than 10 years experience in the Chinese medical device industry. Xie Yuehui, Chairman of the Board and Executive Director: Xie is the Chairman of the Board and Executive Director. He is primarily responsible for the company s overall strategic planning and the management of the company s business. Xie has 20 years of experience in business management in China, over 10 of which was spent in the medical device industry. He obtained a bachelor s degree in materials from Kunming Institute of Technology in 1991 and a master s degree in business administration from Tsinghua University in Zhao Yiwei Michael, Chief Executive Officer and Executive Director: Zhao is the Chief Executive Officer and Executive Director. He is principally in charge of the daily operations of the company. Zhao has over 21 years of experience in general corporate management at multinational medical and life science companies in major global markets, including the United States, Europe, Australia and China. From 1998 to 2006, Zhao held several senior management positions at Johnson & Johnson Medical s Cordis Corporation, one of the world s leading developers and manufacturers of minimally invasive treatments and products for vascular diseases. He obtained a bachelor of science degree from Huntington College in 1990 and a master s degree in business administration from Richard Ivey School of Business of the University of Western Ontario in Liu Jianxiong, Chief Financial Officer: Liu is the Chief Financial Officer of the company and has been a member of the Association of Chartered Certified Accountants since 1997 and a registered tax agent since Liu has 18 years experience in the accounting field. He started his career as an auditor at Kwan Wong Tan & Fong (currently Deloitte-Kwan Wong Tan & Fong) in 1993 and continued to work with a number of multinational companies. Sun Hung Kai Financial Institutional Research 4

5 Figure 3: Revenue By Segment Surgical Vascular Repair Business Figure 4: Revenue By Geography South America Europe Others Peripheral Vascular Diseases Business Congenital and Structural Heart Diseases Business Asia, excluding PRC and India India PRC Sources: Company reports and Sun Hung Kai Financial Sources: Company reports and Sun Hung Kai Financial Figure 5: China s Occluder Device Market Market Share by Competitor Figure 6: BRICs Occluder Device Market Market Share by Competitor Others AGA/St. Jude Others Starway Lepu Medical Lepu Medical LifeTech AGA/St. Jude LifeTech Sources: BioMedGPS and Sun Hung Kai Financial Sources: BioMedGPS and Sun Hung Kai Financial Sun Hung Kai Financial Institutional Research 5

6 Figure 7: Comparable Valuation Analysis Mkt Cap Avg Daily Trading P/E PEG P/B EV/EBITDA Dividend Performance Stock Currency Price (USD Mil) (USD Mil) Sales CAGR EPS CAGR Yield YTD 1m 3m 6m China Medical Device Companies Lifetech Scientific Corp HKD x 46.5x 21.1x NA NA NA 11.6x 9.4x 6.5x NA NA NA 55% 72% 0.0% 49% 44% 35% 50% Shandong Weigao Group Medical HKD , x 25.9x 21.2x 1.7x 1.4x 1.1x 3.5x 3.2x 2.9x 24.7x 19.8x 16.0x 21% 17% 1.0% -7% -6% -2% 23% Lepu Medical Technology Beijin CNY , x 27.9x 24.4x NA NA NA 4.8x 4.3x 3.9x NA NA NA 17% 12% 0.9% 2% 6% 25% 52% Mindray Medical International USD , x 16.2x 14.0x 1.3x 1.2x 1.0x 2.8x 2.5x 2.2x 14.5x 12.5x 11.0x 15% 13% 1.3% -4% -9% -10% -17% Average 3, x 29.1x 20.2x 1.5x 1.3x 1.1x 5.7x 4.8x 3.8x 19.6x 16.2x 13.5x 27% 28% 0.8% 10% 9% 12% 27% US Medical Device Companies Johnson & Johnson USD , x 15.9x 14.8x 2.4x 2.3x 2.1x 3.7x 3.2x 2.8x 10.4x 10.0x 9.0x 5% 17% 3.0% 1% -3% -2% 3% Abbott Laboratories USD , x 17.8x 15.8x 1.7x 1.6x 1.4x 2.6x 2.5x 2.3x 10.9x 11.8x 10.4x 3% 82% 2.3% 2% -1% 3% 11% Edwards Lifesciences Corp USD , x 22.6x 19.4x 1.4x 1.4x 1.2x 4.7x 4.7x 3.9x 14.5x 14.9x 12.8x 6% 11% 0.0% 3% -1% 6% -3% Medtronic Inc USD , x 14.0x 13.1x 1.7x 1.6x 1.5x 2.9x 2.6x 2.4x 10.0x 8.5x 7.7x 4% 9% 2.2% -2% -6% -4% 4% St Jude Medical Inc USD , x 16.9x 15.6x 1.7x 1.6x 1.5x 4.5x 3.7x 3.3x 12.9x 12.0x 11.0x 3% 21% 1.6% 9% 2% 18% 31% Boston Scientific Corp USD , x 26.7x 22.2x 2.7x 2.5x 2.1x 2.7x 2.5x 2.3x 16.3x 11.7x 10.4x 2% -160% 0.0% 11% -1% 16% 21% Average 70, x 19.0x 16.8x 1.9x 1.8x 1.6x 3.5x 3.2x 2.9x 12.5x 11.5x 10.2x 4% -4% 1.5% 4% -2% 6% 11% Sources: Bloomberg and Sun Hung Kai Financial Sun Hung Kai Financial Institutional Research 6

7 Appendix: Consolidated Financial Statements Income Statement (Rmb '000) FY09 FY10 FY11 FY12 1Q13 1H13 3Q13 Revenues COGS Gross profit Operating Expenses Operating Income Interest Expense (0) (2) (4) (3) Other Non-Op Income/Loss (21) (23) 5 (7) (86) (71) (5) Profit Before Tax (0) (73) (49) 4 Tax Net Income (5) (76) (56) 1 EPS (0.02) (0.15) (0.11) 0.00 Gross Margin 73.0% 79.9% 80.5% 80.1% 82.9% 82.9% 80.1% Operating Income Margin 25.7% 30.0% 12.5% 27.0% 29.6% 24.1% 23.9% Net Income Margin -5.9% 3.8% 8.4% 17.8% % -51.6% 2.7% Balance Sheet (Rmb '000) FY10 FY10 FY11 FY12 1Q13 1H13 3Q13 Cash & Equivalents NA 274 NA Accounts Receivables NA 45 NA Inventories NA 27 NA Current Assets NA 404 NA PP&E NA 65 NA Total Non Current Assets NA 135 NA Bank Borrowings - ST NA 35 NA Accounts Payables NA 4 NA Current Liabilities NA 91 NA Bank Borrowings - LT NA 63 NA Total Non Current Liabilities NA 203 NA Shareholders' Equity NA 245 NA Cash Flow Statement (Rmb '000) FY10 FY10 FY11 FY12 1Q13 1H13 3Q13 Operating cash flow NA 11 NA Investing cash flow (5) 7 (40) (32) NA (90) NA Financing cash flow (10) (27) NA 154 NA Sources: The Company and Sun Hung Kai Financial Sun Hung Kai Financial Institutional Research

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Institutional Equities Contacts Address: 42/F, The Lee Gardens, 33 Hysan Avenue, Causeway Bay, Hong Kong Phone: Research (852) Sales (852) Web: Fax: (852) Research Stephen Yang, CFA stephen.yang@shkf.com (852) Nicholas Studholme-Wilson nicholas.studholme@shkf.com (852) Vik Chopra vik.chopra@shkf.com (852) Eva Yip, CFA eva.yip@shkf.com (852) Stuwart Chen stuwart.chen@shkf.com (852) Jeremy Ng jeremy.ng@shkf.com (852) Edward Chung edward.chung@shkf.com (852) Doris Ma doris.ma@shkf.com (852) Sales Richard Seaward richard.seaward@shkf.com (852) Andrew Scott andrew.scott@shkf.com (852) Charles Streeter charles.streeter@shkf.com (852) Katina Wong katina.wong@shkf.com (852) Cherain Wong cherain.wong@shkf.com (852) Sun Hung Kai Financial Institutional Research 8