Stock Analysis — Donghua Software

【Answer 1】 Today, we’ll discuss the stock of Donghua Software. Donghua Software is a company engaged in application software development, computer information system integration, and IT services. Its primary products and services include system integration, technical services, and proprietary or custom-developed software. The company currently holds 60 self-owned intellectual property software products and ranks among the few domestic software enterprises certified at Capability Maturity Model Integration Level 5 (CMMI Level 5). It is also the first enterprise in China to simultaneously hold Class-A System Integration Qualification, Class-A Confidentiality Qualification, and CMMI Level 5 Certification. Company Business Scope: Technology R&D, technical consultation, technical services, technology promotion, and technology transfer; computer information system services; data processing; basic software services, application software services, and public software services; sale of computer software and hardware, peripheral devices, and communication equipment; sale of Class II medical devices; contracting for industrial control and automation system projects, computer communication projects, intelligent building and data center engineering, and computer system engineering; import/export of goods and technologies, and agency import/export. Concepts associated with the company: MSCI China, MSCI Mid-Cap, UWB Concept, Beijing Sector, S&P Concept, Insurance Equity Participation, Banking Equity Participation, FTSE Concept, Industrial Internet, Domestic Software, Internet Finance, Internet Healthcare, Huawei Concept, Military-Civilian Integration, Blockchain, Artificial Intelligence, Margin Trading and Short Selling, Software Services, SZSE 500 Index, Shenzhen-Hong Kong Stock Connect, Biometric Identification, Water Conservancy Construction, Xiong’an New Area, Cloud Computing, Augmented Reality, China Securities Finance Corporation Shareholding, Smart City, Smart Government Services. Fundamentals: In the first three quarters of the year, Donghua Software achieved an operating revenue of RMB 5.58 billion, down 2.9% year-on-year; net profit attributable to shareholders amounted to RMB 620 million, down 18.4% year-on-year. For the most recent quarter alone, the company generated revenue of RMB 1.93 billion, down 10% year-on-year—below market expectations—and overall revenue performance for the first three quarters was relatively weak. In Q3 alone, net profit attributable to shareholders stood at RMB 210 million, down 41.7% year-on-year, reflecting significant volatility in profitability. The company’s gross margin stood at 33.9%, down 1.1 percentage points year-on-year; net margin was 10.8%, down 2.1 percentage points year-on-year. Its sales expense ratio was 4.9%, up 0.6 percentage points year-on-year; its administrative expense ratio was 7.4%; and its R&D expense ratio was 10.1%—higher than industry peers. From 2003 to 2018, the company’s net profit compound annual growth rate was 28%; its average ROE over the past five years has been approximately 10%, indicating solid performance.

Effectiveness of Cost Control Questioned — PBM Industry Faces Major Market Transformation

【Answer 2】 Secondly, the discounts and rebates PBMs receive from pharmaceutical companies lack transparency—and this is their primary source of profit. Given the high concentration of the PBM market, PBMs command large customer bases and thus wield substantial influence over drug pricing. This grants them considerable leverage in negotiations with pharmaceutical companies, many of which willingly trade volume for lower prices. Yet PBMs never disclose the exact magnitude of the discounts and rebates they obtain. Instead, payers reimburse PBMs for drugs at pre-negotiated discounted rates—leaving ample room for price arbitrage. PBMs then determine which drug to prescribe on each prescription based largely on the size of the rebate offered by the manufacturer. Since the discount passed on to payers is typically fixed, PBMs’ drug selection decisions are often not driven purely by cost-effectiveness or clinical appropriateness—this opaque decision-making process is widely criticized. Thirdly, pharmacy networks are built entirely under PBM control. Although the U.S. retail pharmacy market is highly concentrated, numerous small- and medium-sized pharmacies still operate in the specialty and novel drug space. Whether such pharmacies are included in a PBM’s network depends solely on the discount terms negotiated between the PBM and the pharmacy. Pharmacies failing to meet the PBM’s discount requirements risk exclusion from the network. Moreover, an increasing number of PBMs own chain pharmacies of their own and actively seek to exclude non-affiliated pharmacies—thereby capturing greater profits. While pressuring pharmacies on pricing ostensibly serves cost-containment goals, it remains unclear how much of the resulting discount accrues directly to the PBM as profit—undermining payer interests. Finally, PBM rebates have become one driver behind rising drug prices. As PBMs increasingly rely on pharmaceuticals as their main revenue growth engine, their demands for rebates from manufacturers continue to rise. Rebates refer to payments made by pharmaceutical companies to PBMs upon inclusion of their drugs on the PBM’s formulary. PBMs select drugs for prescriptions primarily based on rebate amounts. In recent years, manufacturers have been willing to offer rebates simply to avoid having their drugs excluded in favor of competitors’. To boost sales, manufacturers compete by offering ever-larger rebates—and to offset rebate-related profit erosion, they raise list prices repeatedly. Thus, PBMs have indirectly contributed to drug price inflation—a key reason for payer dissatisfaction. Accordingly, PBMs connect payers, pharmaceutical companies, and pharmacies through control over prescription routing—and maximize their own profits via opaque, non-transparent mechanisms. Although PBMs do help payers reduce costs, payers bear the greatest harm in this arrangement, making them the most vocal critics—and driving market realignment. Additionally, as drug prices attract growing public scrutiny, both the U.S. government and Congress are intensifying efforts to curb rapid drug price inflation. With drug price inflation expected to slow, PBM revenues and profits will inevitably suffer—further pressuring their stock valuations. Major PBMs—including Express Scripts (ESI) and CVS Health (whose PBM business accounts for 39% of total revenue)—have seen sustained share price declines since 2015. ESI’s market capitalization has plummeted by over USD 15 billion.

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