Found an interesting stock last week called Viva Biotech. The company is a CRO (contract research organization) that does pre-clinical research for global pharmaceutical companies and biotechs. They claim that 9 out of top 10 global pharma companeis are their clients, as well as 400 biotech companies in various countries. Around 75% of revenue comes from US, 23% from China and the rest from other countries.
The company has grown rapidly in recent years, revenue was RMB 96.5m in 2016 but grew to RMB 323m ($45m) by the end of 2019. The Chinese CRO market is fairly large and expected to hit $27 billion by 2024, at a CAGR of 27%. Viva Biotech is a very small player compared to larger companies like Wuxi Apptec (which is another good business by the way) and Genscript BIotech.
Viva Biotech has a very unique business model, which is what really caught my eye. The vast majority of revenue (76%) comes from their Cash for Service model, which is just another name for regular fees that their customers pay for their services. They usually hire a whole team of scientists on a particular project and the company bills by the hour, just like in any other service business. The remainder of their revenue comes from EFS (Equity for service) where they take direct equity stakes in their customers. Because many of their customers are cash-strapped biotech upstarts, the company offers them the option to pay with their equity.
This is where the business becomes really scalable. The company evaluates roughly 600 various biotech startups every year, and picks c.5% of them, which become a part of their incubator and can use Viva's services in exchanges for equity in their startup. Over the years, management has built a solid reputation and network among many of the world's leading pharmaceutical organizations, which helps them discover promising technologies or ideas very early. The company employed 731 people at the end of 2019, out of which 614 work in R&D. This gives them a solid base with which to evaluate these startups and determine which are promising and which are not. The company added 15 startups to its portfolio since April 2019, and sold small stakes in two of them at the beginning of 2020. In January, the company sold a 4% stake in Proviva Therapeutics, one of their incubator companies for $4m, and still retaining their 31% stake, valuing the entire company at $100m. They originally bought their stake in June 2019 for $12.6m, so the valuation has roughly tripled since then. There is one red flag, some of the bidders who bought the stake are people related persons of Viva Biotech, which makes the deal look a bit strange.
At the end of 2019, the company had little debt and RMB 904m in cash ($127m) but they recently raised a further $180m in convertible bond offering. Viva intends to use the money for business development and expansion, which is pretty vague. The interest rate is 2.5% fixed, which is very low for such a company. I never invest in indebted companies, but this time I made an exception since they have a lot o cash on the balance sheet and their investments (startups) were valued at RMB 623m at the end of 2019.
If the convertibles are converted, they will result in 15.6% dilution to common stockholders, which is pretty heavy. Some of the money will go their new drug incubation center in Sichuan, which is expected to cost c. RMB 150m. They provided no update regarding COVID-19, which means it's hard to tell the impact on their business. But since they are going ahead with all these investments, I expect they are increasing capacity due to increasing demand for their services.
Since Viva records the revaluation of their financials assets in P&L, the resulting net income is subject to wild swings as the prices of their incubated companies are adjusted each time a report comes out. Excluding these movements, the operating pre-tax income was RMB 63m ($10m) in 2019, up 68% from RMB 37m a year ago. Market cap is HKD 9.8b ($1.26b) which is pretty steep for a company with $10 million in operating income and $9m in operating cash flow. The bulk of the valuation is assigned to their incubator investments, some of which have already shown promise.
The CEO Mao Chen Cheney is a respected scientist, wiwth degrees from Fudan university and Cornell university. He owns roughly 30% of the shares outstanding and is the driving force behind the incubator investments.
Although there are some red flags in Viva, I really like their business model with a biotech venture fund attached, it's very scalable and can lead to some big wins in the future. I'm a huge believer in the Chinese biotech industry, which will perhaps one day rival the one in United States. Viva gives me exposure to some early stage Chinese biotechs, which I could never invest in as a private investor. Given the small size of the company, their debt load and somewhat speculative business model, I have put on only a small position.