August 31, 2016 1:00 pm JST
Commentary

Damjan DeNoble - Why Chinese drugmakers are looking overseas

The latest run of overseas acquisitions by Chinese companies has brought a new focus on life sciences. In May, China's Creat Group reached a deal to acquire Bio Products Laboratory in the U.K. for about $1.1 billion while the same month, conglomerate Fosun International's pharmaceutical arm announced a buyout worth around $1.3 billion of India's Gland Pharma.

It's easy to assume that the Chinese bids are based on a position of strength, with the offers characterized as strategically prudent responses to China's slowing economy and fragmented domestic drug industry.

The truth, however, is that Chinese health care companies are operating from a place of weakness. Far from making strategic acquisitions to establish themselves as global pharmaceutical players, Chinese companies are making deals abroad in a short-term bid to stay relevant as the domestic drug development ecosystem has become increasingly unresponsive to the needs of local companies that wish to develop innovative health care products.

Superficially, the offshore moves can look impressively synchronized. For example, Fosun and Luye Group, which bid for French pharmaceutical company Ethypharm in March, are among the biggest and most advanced members of Sino-PhIRDA, an association of Chinese companies devoted to developing innovative biopharmaceutical products.

What can get lost is why Chinese health care companies are pursuing growth in global markets rather than in China itself, a market seen by most multinational drug companies as the holy grail of future growth and low-cost innovation. In theory, Chinese health care companies' close ties with government should give them an edge in competing with multinational companies in the domestic market; meanwhile, the ability of Chinese drugmakers to deploy large sums of capital abroad should be a key long-term global advantage. So why are they not pursuing a two-track approach to market dominance?

One explanation, according to Nick Stephens, senior associate at Boston Healthcare Associates, is that China's health care companies are in some ways "more akin to global equity investors rather than multinational pharmaceutical companies." Like many Chinese conglomerates, Fosun, Luye and Creat invest across multiple industries that are often unrelated to each other except for the fact that they are all deemed potentially profitable.

"For an innovative biopharmaceutical manufacturer, right now China is hardly the most attractive first market to launch" a new product, he says, because the badly understaffed China Food and Drug Administration is relatively slow moving and its requirements so uncoordinated with those of other major foreign regulators. Stephens adds that while the "CFDA is making strides to improve regulatory approval timelines and integrate with internationally harmonized clinical trials frameworks, in practice that's far from complete, and the direction they will take with regard to eliminating duplicative clinical research requirements is yet to be fleshed out with sufficient certainty."

There is also the problem of investment returns. Chinese health care companies believe that realizing a profit on any innovative drug launched domestically is difficult because reimbursement for innovative medicines is floundering in another bureaucratic morass.

On this score, Stephens points out that the National Reimbursement Drug List, which regulates what medicines hospitals can reimburse manufacturers for, is so out of date that local provinces and cities are piloting their own critical disease initiatives to finance patient access to medicines that they desperately need.

Stephens said this "uncertainty surrounding whether and when China will figure out its health care financing sufficiently to allow for an update of its public formulary is a big question mark for manufacturers and their investors when evaluating an investment in launching a product in China."

Some observers might have the misperception that Chinese health care companies normally have the support and the environment they need to innovate. But as highlighted in a recent report by the U.S. National Bureau of Asian Research, Chinese government planners and companies are running up against growing demand for low-cost state health care. This is exposing natural limitations to the country's governance structure and making it impossible to turn the innovative aspirations of drug manufacturers into reality.

Whether Chinese health care companies are unable to manufacture drugs profitably for the Chinese market or whether they are simply making prudent, strategic decisions not to matters little to the resulting evaluation of the motives behind their global M&A activities. Denied a growing domestic market base as a starting point - something that has been critical for the rise of Chinese global giants in industries such as internet services and energy - Chinese health care companies are being forced to look outwards, whether or not they believe such a move is strategic.

Their attempts to acquire health care assets overseas is logical in a world where foreign innovators are working together like never before to extend product pipelines while no Chinese biopharmaceutical company has succeeded in acquiring regulatory approval in either the U.S. or the EU for a new drug in any major disease area.

With a government mandate to innovate despite political and economic barriers and with prospects for homegrown innovation dim, Chinese health care companies are being forced to bid for global health assets both to acquire intellectual property rights and the development capacity that would allow them to bring new products through the regulatory approval process to patients in developed markets.

When there are no other options on the table, a "strategy" is necessarily one born out of weakness and necessity. This increases the risk that poor decisions will be made. It also leaves open the possibility that what seems like the start of a great wave of investment activity may actually be leading to the next bad acquisition that will set back the goals that Chinese health care companies hope to achieve.

Damjan DeNoble is a health care business consultant with a focus on China and Southeast Asia.

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