Deal focus: EQT fulfills Laobaixing's prescription

EQT’s decade-long journey with Chinese pharmacy chain Laobaixing (LBX) came to an end in November when FountainVest Partners and Primavera Capital Group paid $557million for a 24.78% stake in the business. Having initially committed $92 million for 48% of the company in 2008, EQT walked away with more than $800 million. Deduct tax payments and the multiple is about 7.7x.

During the holding period, EQT recalibrated LBX’s business model and led a 40-fold expansion in its store footprint, reaching 4,800 outlets. Scale facilitated an IPO in Shanghai in April 2015, which saw the private equity firm’s interest diluted to 34.77%. Once the 36-month lock-up period for controlling shareholders expired, it started considering exit options.

“We started selling in July 2018 when the share price began to move up. We completed four sell-downs and three block trades, all while the market was rising,” says Martin Mok, a partner and head of the Asia mid-market team at EQT. “We've been following the rules set by Chinese regulators – we can sell no more than 3% per quarter and we’ve only used that quota when the market environment has been strong.”

In addition to racking up RMB5.34 billion ($770 million) through public market sales, the GP received around $36 million in dividend payments. Although the holding period is well beyond EST’s average of five years – due to regulatory requirements and the general state of the markets – Mok believes retaining exposure for longer was worth it, based on LBX’s financial performance. However, it was not always this way.

No more superstore

Founded in 2001 and based in Hunan province, LBX was the first retail pharmacy chain in China to follow a low-price superstore strategy. When EQT got involved, the company had 58 large format outlets that were making money, 30 smaller stores that were making a loss, and 30 mid-size outlets caught somewhere in between. “The slogan was ‘The biggest store area, the largest range of products, and the cheapest price,’ but the concept of biggest couldn’t work forever,” said Mok.

LBX primarily served elderly patients who made intermittent visits by bus and bought at large volume. EQT recognized that convenience was the key in appealing to a younger demographic. The upshot of this was a series of workshops intended to perfect the small store model and make it profitable. LBX was encouraged to be more convenience store than superstore, carefully assessing the staffing requirements, interior design, and payment channels for each location.

In each of the first two years, Mok spent nearly 50 days at LBX. An early breakthrough came through the introduction of bulk purchasing – consolidating national volume by focusing on private label brands and sourcing directly from manufacturers – which helped double net margins. “Bulk purchasing is really pushing through certain champion SKUs [stock-keeping units] and standardizing them," says Mok. “The gross margin was initially about 22%, the EBITDA margin was about 6%, and the net profit margin was 3%. The first thing we did was increase the EBITDA margin to 10% and the net profit margin to 5-6%.”

Another value-add initiative was the pursuit of national expansion through M&A. Several months before LBX was established, the regulatory environment in China was liberalized, enabling companies to operate nationwide under a single business license. It was clear that money and scale would become significant competitive advantages. At the same time, the break-even period for a single newly opened store had risen from one year to three years. Acquisition was obviously the way to go.

“Significant synergies can be realized in bulk purchasing, human resources management, engagement with regulators, and digitization,” Mok explains. “If you are large scale, your investment in a new branch will be proportionally smaller than for a smaller company.”

EQT started seeing improvements in LBX’s performance even before the deal closed, with EBITDA increased 40%, on a 12-month basis, after signing and before payment. The lag between these two events was caused by the Ministry of Commerce requesting an antitrust review of the transaction, which took eight months. The valuation multiple for the business increased during this period, while EQT could delay calling capital from LPs, which boosted the IRR.

“During those eight to nine months, we actually did a lot. We ran workshops with all the top managers to get an early start. Typically, that’s how we like to do it. Buyers generally like to wait as long as possible because it means we can get to know the management,” Mok says.

Reform agenda

For FountainVest and Primavera, LBX’s growth potential is largely tied to domestic healthcare reforms, some of which are aimed at easing the burden on hospitals as drug distributors. It is estimated that about half the historical revenue of China’s hospitals has come from prescription medicines. With hospitals now prohibited from marking up the prices of the treatments they sell, prescription services are expected to shift to pharmacies. At present, pharmacies account for only 20% of total drug sales.

This trend is also linked to online-to-offline (O2O) delivery. Younger generations of Chinese are increasingly willing to buy medicines through digital channels and regulators have made it clear these must come from pharmacies, not Alibaba Group’s Tmall or JD.com. Dozens of start-ups have emerged that facilitate communication between doctors and patients and the issuing of prescriptions – they include Ping An Good Doctor and WeDoctor – but the physical pharmacy is an integral piece of this value chain.

Frank Tang, chairman and CEO of FountainVest, describes LBX as having one of the widest distribution networks of any local pharmacy business, as well as being among the most competitive. “We firmly believe that driven by technology promotion and industry integration, China’s retail pharmacy industry is facing huge and sustainable development opportunities, which is in line with the trend of China’s medical system reform and efficiency improvement,” he says.

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• Topics
• Greater China
• Healthcare
• Exits
• PIPEs
• China
• EQT Partners
• Primavera
• Fountainvest Partners
• Pharmaceuticals