<p>February 6, 2009<br/>China Pharmaceuticals<br/>Time to Look at the<br/>Neglected China Drug Sector<br/>Investible industry leaders emerging… We are<br/>initiating coverage of the China pharmaceuticals<br/>industry with an In-Line view, as we now see ample<br/>investment opportunities in the China drug sector. A<br/>major hindrance to investing in the sector had been the<br/>lack of quality companies with large enough market cap,<br/>due to the fragmented nature of the industry. This is<br/>changing fast with the emergence of such marquee<br/>companies as Hengrui, a top oncology player, and<br/>Simcere, a top integrated drug marketing powerhouse.<br/>There are ~15 A-share drug companies with market cap<br/>above US$1bn, and a number of quality overseas-listed<br/>drug companies such as the United Laboratories (TUL).<br/>…as industry growth surges. Pharmaceuticals, the<br/>largest subsector within China Healthcare, should<br/>continue to be bolstered by a large aging population,<br/>rising disposable income, and increasing government<br/>spending.<br/>Why In-Line view: While the overall industry growth<br/>has been impressive, the long-anticipated industry<br/>consolidation has yet to materialize. Most industry<br/>players are still low-tech manufacturers making very thin<br/>profit margins due to large sales &amp; marketing outlays<br/>and aggressive price competition.<br/>We thus think the time is right to pick winners: We<br/>expect the upcoming healthcare reform to increase<br/>demand for drugs and bring many new opportunities to<br/>reputable generic drug makers. We believe companies<br/>with the following attributes will benefit from the new<br/>dynamics: 1) proprietary products and/or first-to-market<br/>generic drugs to ensure market exclusivity, 2) strong<br/>rural sales networks and a focus on specific disease<br/>areas (e.g., oncology), and 3) a low cost structure and<br/>established brand name. Our top pick is TUL (3933.HK,<br/>OW), followed by Jiangsu Hengrui (600276.SS, EW)<br/>and Simcere Pharmaceuticals (SCR.N, EW).<br/>Risks: Government slows down spending on healthcare<br/>and/or imposes direct price control on drugs.</p><p>Table of Contents<br/>Investment Case............................................................................................................................................................. 3<br/>Investment Positives...................................................................................................................................................... 6<br/>Investment Concerns..................................................................................................................................................... 9<br/>Valuation ....................................................................................................................................................................... 11<br/>Performance Table....................................................................................................................................................... 13<br/>China Pharmaceuticals – Relative Stock Price Performance vs. Index .................................................................. 14<br/>Pharmaceutical Basics ................................................................................................................................................ 16<br/>Market Overview........................................................................................................................................................... 17<br/>Expanding Insurance Coverage Is Key to Industry Growth ..................................................................................... 19<br/>Drug Price Controls ..................................................................................................................................................... 22<br/>Drug Registration Process.......................................................................................................................................... 24<br/>Legal Protection for Drugs.......................................................................................................................................... 26<br/>Distribution of Pharmaceuticals ................................................................................................................................. 27<br/>New Healthcare Reform Plan ...................................................................................................................................... 29<br/>Top 20 China Pharmaceutical Companies ................................................................................................................. 32<br/>Glossary ........................................................................................................................................................................ 33<br/>Appendix: China Healthcare Value Chain Overview ................................................................................................. 39<br/>Distributor Overview.................................................................................................................................................... 40<br/>Services Overview........................................................................................................................................................ 41<br/>Retail Overview............................................................................................................................................................. 43<br/>Consumer Overview..................................................................................................................................................... 44<br/>Regulation..................................................................................................................................................................... 45</p><p><br/></p>