WXXWY - WuXi Biologics: Spin-Off And New Projects In The Limelight (Rating Upgrade)

2023-07-19 06:49:45 ET

Summary

• I have a favorable opinion of WuXi Biologics' planned spin-off, which could re-rate its valuations in a positive manner and help to accelerate the future growth of the spun-off business.
• WXXWY's disclosures at its recent Investor Day regarding new project count have negative read-throughs for its near-term top-line growth prospects.
• I upgrade my investment rating for WuXi Biologics to a Hold following a review of its spin-off plans, but WXXWY isn't a Buy as its business outlook is still unfavorable.

Elevator Pitch

I rate WuXi Biologics (Cayman) Inc. ( WXXWY ) [2269:HK] shares as a Hold. I previously touched on WuXi Biologics' financial guidance and downside risks in my previous May 8, 2023 write-up for the stock.

I raise my rating for WuXi Biologics from a Sell to a Hold after considering the positives relating to the company's proposed spin-off. But WuXi Biologics doesn't deserve a Buy rating, as the company's number of new projects for 1H 2023 fell short of expectations.

WuXi Biologics' shares are listed on the OTC market and in Hong Kong. The company's OTC shares with the WXXWY ticker currently boasts a three-month mean daily trading value of $700,000 (source: S&P Capital IQ ). In comparison, WuXi Biologics' shares traded on the Hong Kong Stock Exchange have a relatively higher three-month average daily trading value of $100 million. The Hong Kong-listed shares of WuXi Biologics with the 2269:HK ticker can traded using US brokers providing trading access for international markets such as Interactive Brokers.

Planned Spin-Off

In the earlier part of this month on July 9, WuXi Biologics announced that it is planning to "spin-off and separately list the shares of WuXi XDC Cayman Inc., a subsidiary of the Company, on the Main Board of the (Hong Kong) Stock Exchange."

In the announcement, WuXi XDC is described as a business which offers "integrated and end-to-end CRDMO services with respect to ADC and other bioconjugates for global customers" which contributed 6.5% of WuXi Biologics' FY 2022 top line. CRDMO and ADC refer to Contract Research, Development and Manufacturing Organization and Antibody-Drug Conjugate, respectively.

Based on my analysis, there are two key positives associated with WuXi Biologics' proposed spin-off of WuXi XDC.

A key positive relating to the spin-off is the potential for WuXi XDC to grow at a faster pace as a separately-listed company.

According to its listing prospectus citing data from Frost & Sullivan , WuXi XDC is the outright leader in the China's ADC outsourcing market with a 69.5% market share, and it is also the second biggest ADC outsourcing company in the world with a 9.8% market share. Frost & Sullivan also predicts that the worldwide ADC outsourcing industry will expand at a 2022-2030 CAGR of +30%.

Specifically, WuXi XDC has a very healthy backlog of $373 million or RMB2.7 billion as of end-May this year which is equivalent to more than two and a half years of its revenue, considering its FY 2022 top line of RMB990 million.

As a publicly listed business following the proposed spin-off, WuXi XDC should be in a better position to raise capital to finance its future growth plans. The expected success of WuXi XDC will continue to benefit WuXi Biologics, as WXXWY expects to be able to continue consolidating WuXi XDC's financials post-IPO. WXXWY targets to retain more than a 50% equity interest in WuXi XDC after its spin-off, so that WuXi XDC can remain as WuXi Biologics' subsidiary.

The other key positive emerging from WuXi Biologics' spin-off of WuXi XDC is the potential valuation re-rating effect.

The market values WuXi Biologics at a consensus forward next twelve months' Enterprise Value-to-Revenue multiple of 7.9 times (source: S&P Capital IQ ) now, taking into account WXXWY's consensus forward FY 2023-2027 revenue CAGR (in local or RMB currency terms) of +25%.

As mentioned above, the estimated 2022-2030 CAGR for the worldwide ADC outsourcing market is +30%, which can be regarded as a proxy for WuXi XDC's future top line growth. At WuXi Biologics' investor call (audio and transcript not publicly available) on July 10, 2023, WXXWY shared that WuXi XDC is the "fastest growing business segment" for the company, due to the relatively higher outsourcing rate for ADC at 70% as compared to around 30% for other biologics on average.

Therefore, it is fair to assume that WuXi XDC can likely trade at a consensus forward Enterprise Value-to-Revenue multiple that is higher than that of its parent (WuXi Biologics) as a result of the former's superior growth outlook. If the market does indeed assign a richer valuation multiple to WuXi XDC vis-a-vis its parent, this should help to drive a positive re-rating of WuXi Biologics' valuations.

In a nutshell, the planned spin-off might boost the growth prospects of WuXi CDC and expand WuXi Biologics' valuation multiples.

Investor Day Disclosures

WuXi Biologics hosted its Investor Day for 2023 in late-June, and there were certain unfavorable read-throughs from the company's disclosures.

The number of new projects for WuXi Biologics decreased significantly from 59 in the first half of 2022 to 25 for 1H 2023. Of the 25 new projects in the first half of this year, 17 were new preclinical projects which is a lower number as compared to WXXWY's 54 new preclinical projects for 1H 2022.

With my May 8, 2023 update, I had cautioned that "the tough financing environment for WXXWY's customers" might "translate into below expectations sales" for WuXi Biologics. WXXWY's disclosure of a lower than expected number of new projects at its Investor Day suggest that the company's future sales might be below what the market is projecting.

Concluding Thoughts

After analyzing WuXi Biologics' proposed spin-off transaction, I have chosen to rate WXXWY as a Hold now as opposed to a Sell previously. While I am positive about WuXi Biologics' planned spin-off, I still have concerns about the company's top line growth prospects in the short term, taking into account the decline in the number of new projects for WXXWY in 1H 2023. As such, I think that a Hold is a fair rating for WuXi Biologics.

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