合生元(01112) 　　Near-term sales likely to be dragged down by channeldestocking due to new CBEC regulations 　　Margins for the Swisse business should trend down in themedium term given a bigger portion of direct sales in China 　　We resume coverage with a Reduce rating (previously Hold)and a target price of HKD16.30 (previously HKD22.00) 　　What’s new? We are resuming coverage of Biostime with a Reduce rating (previouslyHold) and a target price of HKD16.30 (previously HKD22.00) following the completionof the Swisse acquisition first announced in September 2015. Although the acquisitionenables Biostime to diversify into the fast-growing adult nutrition business, we arecautious on the near- to medium-term outlook for the company given the currentregulatory uncertainty. In particular, some of its existing products may not be eligible tobe sold through the cross-border e-commerce (CBEC) channel after the grace periodin December 2017, and destocking by its distributors will likely remain a drag onnear-term sales. We believe Biostime would need to step up efforts to establish itsdirect sales for the Swisse business in China, which could be margin dilutive, as directsales would have a lower gross margin. Our new 2016-18e earnings estimates are10-22% below consensus, as we believe the Street is too optimistic on margins. 　　The CBEC regulations. The new CBEC regulations, first announced in early April 2016,state that only goods on positive lists are eligible to be sold via the CBEC channel. Thepositive lists include more than 1,200 types of products; however, some of Biostime’skey products, such as high-strength cranberry capsules, are not included on a positivelist. The new CBEC regulations have been put on hold until December 2017. While it isdifficult to quantify the impact from the new regulations, we estimate that at least 30%of Swisse’s sales could be affected by the new regulations, but some of the company’skey products can be reformulated as liquids, which could still be sold via the CBECchannels under the general food category. 　　Valuation and risks. We continue to use PE to value the stock, as we believe thismethodology captures the company’s near-term earnings momentum. Our new targetprice of HKD16.30 is based on 17x PE (previously 15x); we now benchmark our targetPE multiple to peers’ valuation given the significant change in Biostime’s businessmodel and capital structure following the acquisition. Key upside risks to our ratingand estimates include a more favourable-than-expected regulatory environment andstronger-than-expected top-line growth leading to efficiency gains.