By NICHOLAS ZAMISKA
August 9, 2006

China's medical-device makers, long outshone in their own market by multinational companies, are starting to look like better investments as they target the smaller hospitals with which the foreign titans don't do much business.

Although the domestic medical-device sector includes few publicly traded companies, it is worth watching as the Chinese government seeks to breathe life into the country's ailing health-care system, beset by mismanagement and unprofitable business models. Beijing's effort includes more funding for inferior rural facilities.

The Ministry of Health announced in July that, as part of China's latest five-year plan, the government would invest 21.7 billion yuan ($2.72 billion) in health care, of which 6.8 billion yuan would be for medical equipment. If the nation's smaller hospitals get a hefty chunk of that money, as expected, their demand for lower-cost medical devices could surge.

The Chinese market for medical equipment and supplies will be about $2.7 billion this year, according to British market research firm Espicom Business Intelligence. It says the market "continues to boom."

Foreign players, such as General Electric's GE Healthcare and Philips Electronics' Philips Medical Systems, still dominate the field with big-ticket wares for the wealthier hospitals. Imports account for 85% to 90% of the market, Espicom says.

Beijing's policy changes, part of a broader effort to reduce a yawning imbalance of wealth between the cities and the countryside, "should provide golden opportunities for domestic medical-device manufacturers," Jinsong Du, a research analyst with Credit Suisse in Hong Kong, said in a report in May. Mr. Du singled out "those with mass-market-oriented low-cost medical-equipment products that can be included as fixed-asset investments."

Andrew Wee, a research analyst at Frost & Sullivan in Singapore, agrees that the middle of the market is the sweet spot for domestic device makers right now. "If you go into the second- and third-tier markets," he says, "there's actually an increasing presence of domestic companies."

The Chinese players could even start to make a dent in the higher end of the market. "Previously China didn't have advanced technology to produce this stuff. They didn't have the know-how," Mr. Du says "But that's definitely changing."

One company looking to ride the wave of Beijing's new investment is China Medical Technologies, in which GE holds a small stake. The Beijing company has two product lines -- an ultrasound machine for targeting cancerous tumors and a disease-diagnosis system. Of China's 18,000 or so hospitals, the Nasdaq Stock Market-listed company is targeting the roughly 17,000 second- and third-tier institutions, says Charles Zhu, the company's vice president for business development and investor relations.

China Medical is very small. For the year ended March 31, it reported sales of 371.8 million yuan. That was 71% higher than the previous year, and for the latest year the company reported a net profit of 199 million yuan.

The share price has been volatile. It touched a 52-week high of $44.93 on Feb. 1, but later fell to less than half that level. On Monday, it closed at $22.26, down 14 cents from Friday. In late-morning trading yesterday, the shares were up 54 cents to $23.22. An analyst says GE this year reduced its holding to below 3% from about 15%, which is one factor pushing down the share price.

Mr. Du of Credit Suisse believes China Medical could benefit from Beijing's anticipated spending spree. He has a 12-month price target of $31.70 on the shares.

Joy Yuan and Qi Zhou, analysts with Goldman Sachs in Beijing, last Wednesday upgraded their rating on the stock to a "buy," with a 12-month target of $28.50.

Another domestic company that some investors are keeping an eye on is Shenzhen Mindray Bio-Medical Electronics, one of China's largest makers of blood-pressure and blood-oxygen-level monitoring equipment. Shenzhen Mindray isn't publicly traded, but according to a Hong Kong newspaper report it intends to seek a Nasdaq listing.

Lisa Li, executive assistant to Shenzhen Mindray's president, wouldn't confirm speculation the company has submitted documents for a proposed listing but said "our lawyer told us we cannot talk with any media" at present.

A Shenzhen Mindray initial public offering could generate a lot of interest. "Their booth at the Chicago Med Equip convention was packed to the gills," says John Wong, senior vice president with Boston Consulting Group. He adds that while the company may still be "somewhat limited technically," he senses that Shenzhen Mindray "got into the industry at the right time."