Decline in performance, soaring goodwill, are the aftereffects of Lepu Medical Technology's (300003.SZ) "growth through acquisition" strategy becoming apparent?

The development risks of the "merger man" Lepu Medical Technology (300003.SZ) seem to be emerging. On August 24, Lepu Medical Technology disclosed its performance report for the first half of 2024. During the period, the company achieved operating income of approximately 3.384 billion yuan, a year-on-year decrease of 21.33%; net profit attributable to shareholders was approximately 697 million yuan, a year-on-year decrease of 27.48%; non-GAAP net profit was 647 million yuan, a year-on-year decrease of 28.48%. Looking at a longer timeline, this may be the largest decline in the company's semi-annual report in the past 3 and a half years - in the mid-term of 2022, 2023, and 2024, Lepu Medical Technology's revenue decreased by 18.20%, 19.35%, and 21.33% year-on-year, respectively, and net profit attributable to shareholders decreased by 26.69%, 24.96%, and 30.53% year-on-year, respectively. As the saying goes, "a falling leaf reveals the autumn," the decline in the performance of any company is not without reason. As a leading medical enterprise with multiple listed subsidiaries, there are certainly hidden secrets within. It is reported that Hong Kong stock SCIENTECH (02291) and Science and Technology Innovation Board ChengDu Sheng Nuo Biotec (688117.SH) are listed companies spun off from Lepu Medical Technology. With the continuous decline in performance, Lepu Medical Technology's stock price obviously cannot hold up: from a peak of 45.8 yuan in July 2020, it has fallen to just over 10 yuan now, a cumulative decline of over 78%. So, what has happened to the "merger man" Lepu Medical Technology? Sharp decline in pharmaceutical revenue, cash flow under pressure Founded in 1999, Lepu Medical Technology went public on the Shenzhen Stock Exchange's Growth Enterprise Market in 2009. The company is a provider of comprehensive solutions covering the entire life cycle of cardiovascular diseases, with business segments including medical devices (including cardiac treatment products, new interventional diagnostic and therapeutic business, in-vitro diagnostic reagents, and medical product distribution), pharmaceutical business, medical services, and health management. Looking at the performance report for the first half of 2024, it is clear that the simultaneous decline in the performance of the three major business segments was a key factor leading to the overall decline in the company's performance. Specifically, during the reporting period, the medical device segment, which had the largest revenue scale, achieved revenue of 1.754 billion yuan, a year-on-year decrease of 13.01%; the pharmaceutical segment achieved revenue of 1.135 billion yuan, a year-on-year decrease of 29.05%, the largest decline among the three segments; and the medical services and health management segment achieved revenue of 496 million yuan, a year-on-year decrease of 27.80%. Regarding the performance mentioned above, Lepu Medical Technology stated at the earnings conference that the performance did not meet expectations, mainly due to the advancement of the 'Four Same' policy for drugs, which hindered retail shipments and reduced pharmacy sales marketing, and it may take 1-2 quarters to comb through channel prices and digest channel inventory. Looking more closely, the medical device segment, as the segment with the largest revenue scale in the company's business, includes three sub-segments: cardiovascular intervention, in-vitro diagnostics, and surgical anesthesia. The decline in performance in the first half of this year was mainly due to the drag from the in-vitro diagnostic business. In the first half of 2024, Lepu Medical Technology's in-vitro diagnostic business achieved operating income of 198 million yuan, a year-on-year decrease of 57.15%, mainly due to the high base number of epidemic-related products in the same period last year and price declines due to increased competition for some products. In addition, the surgical anesthesia business decreased by 3.87% year-on-year, while cardiovascular intervention increased by 16.92% year-on-year. The pharmaceutical segment, with the largest decline in percentage, is mainly due to two reasons: one is the continued promotion of the drug centralized procurement policy, which has led to a significant decrease in drug prices. Although sales have increased, overall revenue has been affected. The other reason is that the increase in research and development investment has not translated into actual economic benefits in the short term. The research and development cycle for new drugs is long, and there is high uncertainty. In its financial report, Lepu Medical Technology pointed out that it currently believes that the adjustment of the drug business due to the clearance of retail channel inventory may need to continue for 1-2 quarters. It is expected that the raw material drug business will remain stable year-on-year, and the business revenue of the preparation sector may decrease to about 15-16 billion yuan. After the channel clearance is completed, excluding innovative drugs, the recovery of pure sales of related products is expected to drive a slight rebound in business revenue for the preparation sector. Furthermore, the decline in revenue from the medical services segment is mainly due to the slight decline in demand for home-related medical device products for monitoring vital signs domestically and internationally after the epidemic. The company's requirements for this business have shifted from continuous revenue growth to a strategic shift towards achieving stable profitability, revealing the fact that the growth of this business is weak. The negative effects of the aforementioned double decline in performance are also reflected in Lepu Medical Technology's cash flow. According to relevant financial data, in the first half of 2024, the company received cash from selling goods and providing services of 3.129 billion yuan, a year-on-year decrease of 28.14%. The net cash flow generated by operating activities was 159 million yuan, the net cash flow generated by investment activities was -822 million yuan, and the net increase in cash flow during the period was -640 million yuan, further reflecting the current pressure on cash flow in the company.For practical economic reasons and others, Lepu Medical Technology's performance decline "butterfly effect" has already started to emerge.High goodwill risks are emerging, facing significant impairment risks It is worth noting that, compared to the decline in performance, Lepu Medical Technology is facing an even more worrying greater risk that is also emerging. That is the "aftermath" of mergers and acquisitions. Observing that after Lepu Medical Technology went public, there was a shift from a focus on research and development innovation to more emphasis on capital operations, attempting to follow the "buy-to-grow" route. For example, in 2010, the company successively acquired Weijinfan Medical, Beijing Sida, and held shares in Qinming Medical Devices, entering the market for heart valves and diagnostic equipment. In 2011, the company also acquired a controlling stake in Dutch company COMED B.V. According to incomplete statistics, from 2010 to 2019, Lepu Medical Technology made more than 30 acquisitions, obtained stakes in approximately 30 companies, with a total transaction value exceeding 6 billion yuan. The short-term growth effects brought about by these large-scale acquisitions are evidently significant - Lepu Medical Technology has not only become a leading cardiovascular health industry platform in China, but its performance has also rapidly grown. Revenue increased from 1.669 billion yuan in 2014 to 6.36 billion yuan in 2018, and net profit increased from 423 million yuan in 2014 to 1.22 billion yuan in 2018. However, with every blessing comes a curse, and the "buy-to-grow" operation has also brought about some aftermath. On the one hand, the debt levels are persistently high. From 2020 to the first half of 2024, the company's total debt levels were 7.619 billion yuan, 8.425 billion yuan, 8.114 billion yuan, 7.525 billion yuan, and 7.856 billion yuan respectively. With such high debt levels, coupled with declining revenue and reduced cash flow, the company is likely to face considerable short-term liquidity pressures. On the other hand, the high goodwill also poses risks of impairment. It is reported that under the growth-through-acquisition model in recent years, Lepu Medical Technology's goodwill has been continuously increasing, reaching 3.948 billion yuan by the first half of 2024. With such high goodwill levels, accompanied by declining performance of some subsidiaries, the risk of impairment is not insignificant. For example, Lepu Pharmaceutical, Zhejiang Lepu Pharmaceutical, and Bingkun Medical were major subsidiaries of the company in 2023, with an impact on the company's net profit exceeding 10%. Based on the financial reports, Lepu Medical Technology has been making impairment provisions for the goodwill of these subsidiaries in recent years, but some subsidiaries have shown a clear downward trend in performance. According to relevant financial data, in the first half of 2024, Lepu Pharmaceutical's revenue decreased by 40.28% year-on-year, Bingkun Medical's operating income decreased by 1.99% year-on-year, and Zhejiang Lepu Pharmaceutical's operating income increased by only 1.42% year-on-year. Correspondingly, the year-end goodwill balances of these three major companies were 311 million yuan, 375 million yuan, and 533 million yuan, respectively, and have not been depreciated since 2019. Therefore, with the impact of declining or stagnant growth in the performance of these three major companies, the risk of impairment facing Lepu Medical Technology is evident. In summary, where there is smoke, there is fire. As a leading medical and health industry group in China, Lepu Medical Technology has already laid the groundwork for its subsequent decline in performance through the short-term and rapid route of "buy-to-grow". After all, for a medical enterprise, strengthening research and development innovation, optimizing product structure, expanding market channels, and striving to enhance the company's core competitiveness are the key factors for achieving sustainable development.