ANALYSIS: Qilian International Seeks U.S. Public Capital in $24 Million IPO

Qilian International is seeking to raise expansion capital as its operating metrics have improved amid slowing revenue growth.

Donovan Jones
    Nov 24, 2019 5:05 AM  PT
ANALYSIS: Qilian International Seeks U.S. Public Capital in $24 Million IPO
author: Donovan Jones   

Short Take

Qilian International Holding Group Ltd. (QLI) has filed to raise gross proceeds of $24 million from a U.S. IPO, according to an F-1 registration statement.

The firm provides produces and markets traditional Chinese medicine-based (TCM-based) health products.

QLI's operating results have improved, but revenue growth appears to be decelerating, which makes its IPO roadshow a more challenging sell to investors.

Company & Customers

Jiuquan City, China-based Qilian was founded in 1969 to develop and market traditional Chinese medicines and derivatives, as well as other health-related products.

Management is headed by CEO Zhanchang Xin, who has been with the firm since its inception and is also the chairman of the firm's VIE, Gansu Qilianshan Pharmaceutical.

Qilian's product portfolio consists of Gan Di Xin, Qilian Shan Licorice Extract, and Qilian Shan.

Qilian's licorice products include Gan Di Xin, Qilian Shan, Licorice Extract, and Qilian Shan Licorice Liquid Extract as well as oxytetracycline products, Oxytetracycline Tablets and Qilian Shan Oxytetracycline Active Pharmaceutical Ingredients (APIs) used in animals and people.

The firm also sells Ahan, a TCM-based antimicrobial product that combines 12 herbs used for treatment of refractory chronic skin diseases.

For patients that are in need of anticoagulant therapy, the firm is producing Heparin Sodium Preparations for patients with cardiovascular diseases, cerebrovascular diseases, and those on hemodialysis.

Qilian's fertilizer brands include the Xiongguan Organic Fertilizer and Xiongguan Organic-Inorganic Compound Fertilizers.

Management says its estimated annual production capacity is 4,000 tons of oxytetracycline APIs, 3 billion oxytetracycline tablets, 1,000 tons of licorice extracts and liquid extracts, 5,000 kilograms of Heparin Sodium Preparations, 4 million sausage casings and 100,000 tons of fertilizers.

The firm sells its products primarily through distributors, dealers and corporate customers and has a few large customers which account for 22% of its sales.

Selling, G&A expenses as a percentage of revenue have been fluctuated but are trending lower.

The sales & marketing efficiency rate, defined as how many dollars of additional new revenue generated by each dollar of sales & marketing spend, was 1.2x in the most recent six-month period.

Market & Competition

According to a recent market research report by South China Morning Post, the traditional Chinese medicine market is projected to expand from China as the country seeks World Health Organization's recognition of its medicine.

Data from a 2016 report shows that acupuncture is being practiced in 186 countries around the world.

Per a report from IBISWorld, 2019 revenue for the industry is expected to reach $45 billion, representing an annual growth rate of 10.6% from 2014 to 2019.

More than 2,600 businesses are active manufacturers and the industry employs over 191,000 persons.

Major competitors that provide traditional Chinese medicines include:

  • Kangmei Pharmaceutical

  • Beijing Tong Ren Tang

  • Tasly Pharmaceutical Group

  • Zhengzhou Ruilong Pharmaceutical

  • Jiangsu Kanion Pharmaceutical Co.

(Source: Sentieo)

In addition, the firm has numerous competitors in its other product lines of fertilizers, sausage casings and heparin sodium preparations.

Financial Performance & IPO Details

QLI's recent financial results can be summarized as follows:

  • Growing topline revenue but at a sharply decelerating rate

  • Increasing gross profit and gross margin

  • Growing operating profit and increased operating margin

  • A swing to negative cash flow from operations

As of March 31, 2019, the company had $3.1 million in cash and $13.7 million in total liabilities. (Unaudited, interim)

Free cash flow during the twelve months ended March 31, 2019, was $1.6 million.

QLI has filed to raise $24 million in gross proceeds from an IPO of 4 million shares of its common stock at a midpoint price of $6 per share, not including customary underwriter options.

For a China-based company, it is unusual to sell ordinary shares to U.S. investors. The typical approach is to see American depositary shares (ADSs), which remove a potential administrative burden for U.S. investors.

Assuming a successful IPO, the company's enterprise value at IPO would approximate $204.6 million.

Per the firm's latest filing, the firm plans to use the net proceeds from the IPO as follows:

We intend to use the net proceeds from this offering for production capacities expansion, marketing purposes, and acquisition of upstream and downstream companies manufacturing traditional Chinese medicine pieces.

Management's presentation of the company roadshow is not available.

The sole listed underwriter of the IPO is Univest Securities.

Commentary

QLI is attempting to raise U.S. expansion capital at a challenging time in the U.S. IPO market and for Chinese firms in particular.

The firm's financials indicate its topline revenue growth is slowing although net results have been improving.

Sales and marketing expenses as a percentage of revenue have been uneven but trending lower, which demonstrates increasing efficiencies as the firm grows.

The market opportunity for traditional Chinese medicines is large and growing as producers seek to provide improved products and consumers are increasingly open to less toxic treatment options.

However, the firm faces significant competition from large operators in the industry with established distribution channels.

Like many Chinese firms seeking to tap U.S. markets, the firm operates within a VIE structure or Variable Interest Entity. U.S. investors would only have an interest in an offshore firm with contractual rights to the firm's operational results but would not own the underlying assets.

This is a legal gray area that brings the risk of management changing the terms of the contractual agreement or the Chinese government altering the legality of such arrangements. Prospective investors in the IPO would need to factor in this important structural uncertainty.

IPOs are essentially growth stories. When a firm such as QLI shows its growth rapidly decelerating, the story becomes more challenging to sell, even if the firm is producing profits.

(The opinions expressed by contributing analysts do not reflect the position of CapitalWatch or its journalists. The analyst has no positions in any stocks mentioned, no plans to initiate any positions within the next 72 hours, and no business relationship with any company whose stock is mentioned in this article. Information provided is for educational purposes only, may be incomplete or out of date, and does not constitute financial, legal, or investment advice.)

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