[At a Crossroads: Listed Companies] Orient Bio, 8 Years of Accumulated Losses and Recurring 'Capital Erosion'

The election to choose the next president is just one year away. Speculative funds betting on leading presidential candidates are rapidly increasing in the domestic stock market. Theme stocks related to top-ranking figures in the '2022 presidential candidate approval ratings,' such as Lee Nak-yeon, a member of the Democratic Party of Korea, Lee Jae-myung, Governor of Gyeonggi Province, and Yoon Seok-youl, former Prosecutor General, are surging. As former Prosecutor General Yoon's approval ratings rise sharply, the stock price volatility of listed companies managed by Yoon and his university alumni executives has also increased. Asia Economy aims to examine the business performance and financial stability of political theme stocks.

[Asia Economy Reporter Lim Jeong-su] Orient Bio, whose stock price soared following Lee Jae-myung, Governor of Gyeonggi Province, emerging as a presidential candidate, has been suffering losses for eight consecutive years. Due to the limitations of the domestic experimental animal market, sales growth has been sluggish, and continuous new investments have increased cost burdens. Prolonged net losses have resulted in the company remaining in a state of capital erosion for several years. Since it is known that Governor Lee worked at the Orient Group's watch factory, the group affiliates Orient Bio and Orient Precision Engineering have been bustling in the stock market as so-called Lee Jae-myung-related stocks.

A dominant player with 70% market share but eight years of losses

Orient Bio is a dominant player in the experimental animal field with a market share (MS) of 60-70%. Most competitors are small-scale companies, making it difficult to find rivals domestically. It is regarded as a unique company in the domestic market within this field. Currently, it breeds experimental rodents, primates, and beagle dogs and supplies them to large pharmaceutical companies, biotechnology research institutes, hospitals, and schools.

However, the market size is so small that it is difficult to gain growth momentum solely from the domestic market. According to the bio industry, the total market size for experimental animals in Korea is only about 50 billion KRW. Although Orient Bio's sales have increased recently due to exports of primates, it still only achieves annual sales of around 30 billion KRW.

(Clockwise) Orient Bio Vice President Sang-nyeon Kim, Chairman Jae-jin Jang, Wisconsin Governor Scott Walker, RPRD CEO Ulrich Broeckel, CBO Carter Cliff

In March last year (fiscal year 2019, companies with March fiscal year-end), it recorded annual sales of 30.5 billion KRW on a separate basis. As of December last year, cumulative sales for the third quarter of 2020 were 26 billion KRW, an increase of 3.6 billion KRW compared to the same period last year. The bio equipment sector, including experimental devices, also has a small market size, with annual sales stagnating around 5 to 6 billion KRW.

With sales growth stagnating for a long time, fixed cost burdens have led to operating losses for eight consecutive years. Large-scale facility investments were made for beagle breeding targeting exports, but sluggish market development turned the investment amount into fixed cost burdens. The primate sector's low sales unit price has not significantly helped profitability. Research and development (R&D) and clinical costs for hair growth agent development have also burdened profitability.

As a result, Orient Bio's cost of goods sold ratio rose to about 94%. It once reached 98%, but recently, with increased sales and somewhat reduced cost factors, it has shown a somewhat stable trend. Selling and administrative expenses, accounting for 30% of sales, also weigh on profitability.

Orient Bio recorded an annual operating loss of 11.9 billion KRW in March last year. As of the end of December last year, the cumulative loss for the third quarter was 2.2 billion KRW. The annual performance for March this year is also expected to remain in the red. This means it has recorded losses for seven consecutive years since 2014. A securities analyst said, "There are limitations in the domestic market, and exports are also unfavorable," adding, "It is difficult to expect noticeable performance improvements."

Accumulated losses lead to 'capital erosion'... worsening cash flow due to investments and affiliate support

Orient Bio's financial structure has rapidly deteriorated due to accumulated net losses every year. The accumulated net loss over the past seven years approaches 80 billion KRW. Considering the average annual sales of 20 to 30 billion KRW, this means net losses amount to about half of the average annual sales.

Because of this, the company has been unable to escape capital erosion for a long time. Capital inflows of 10 billion KRW in August 2013, 27.5 billion KRW in June 2015, and 30 billion KRW in February 2019 occurred, and a third-party allotment capital increase raised 11.8 billion KRW in August last year. Convertible bonds (CB) and bonds with warrants (BW) previously issued were also converted into shares, resulting in capital increase effects. However, due to the large loss scale, it remains in a partially eroded state.

Although a capital reduction without compensation was conducted last year to temporarily avoid capital erosion, derivative valuation losses due to stock price increases caused shareholders' equity to fall below capital again. An investment banking industry official predicted, "Unless the company escapes the deficit structure and turns performance to profit, it will be difficult to get out of capital erosion."

Cash flow is also worsening. Due to poor performance, operating cash flow (OCF) is not properly generated, and the company is also burdened by working capital. Most customers are hospitals, pharmaceutical companies, universities, and research institutes, so accounts receivable collection takes a long time. Being in a so-called 'weaker' position, the company has low price negotiation power, which is considered a limiting factor for performance improvement.

Additionally, funds have been invested in affiliate support and facility replacement, resulting in large free cash flow (FCF) deficits. Hundreds of billions of KRW were invested in major post facilities such as the headquarters, Gapyeong Center, Eumseong Center, and Jeongeup Center. Approximately 8 billion KRW was used for new investments and equity acquisitions in affiliates Orient Precision Engineering and Orient Watch. In 2017, 15.9 billion KRW was used to acquire shares in the U.S. OBC, and 4.6 billion KRW was reinvested through equity conversion.

A credit rating agency official diagnosed, "Cash flow is deteriorating as facility investments and financial support for affiliates continue amid poor performance," adding, "If performance does not improve, fundamental financial improvement will also be difficult."