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China’s biopharma industry moves closer to inflection point
Laura Nelson Carney
Capital Group Equity Analyst
KEY TAKEAWAYS
  • China's biopharmaceutical industry is shifting from imitation to innovation, and we are only in the early innings of this transformation.
  • Government reforms are making it easier for foreign drugmakers to tap China’s vast market, improving prospects for both China’s startups and multinationals.
  • Geopolitical tensions are unlikely to derail development of the health care sector in China, where R&D spending is increasing, consumer demand is rising, and the population is aging.
  • For investors, the opportunity set is expanding as talent wars and capital flows are accelerating and driving growth.  

(Note: This is the first article in a series, ”Beyond geopolitics: Long-term investing in China.” The series will examine investment opportunities and challenges in China from a multiyear perspective.)


In the global scramble to develop a COVID-19 vaccine, brand-name biopharmaceutical giants in the United States and Europe appear to have promising candidates. But there are also several lesser known companies playing a role in helping produce a potential vaccine. 


Three of 10-plus vaccines in advanced clinical trials globally are being developed by Chinese firms, which is quite remarkable given where the country had been. Party leaders just a decade ago embarked on structural reforms to modernize the country’s health care system, root out corruption, boost drug quality and create infrastructure to nurture the development of homegrown biopharmaceutical firms. 


After living in Hong Kong and spending the past decade visiting and researching health care companies in China, it’s been fascinating to see development move at such a rapid pace. And we are only in the early innings of this potentially massive transformation. Looking back at the evolution of the U.S. biotech industry, China by comparison is moving at three times the speed. Everything in China is bigger and faster, powered by top-down economic policies. 


Over the next decade, China’s strategic policy initiatives in biomedicine could have broad ramifications for investments in the global pharmaceutical sector and in China itself. Based on our current growth projections, China is steadily closing the gap between it and the U.S. market. This growth comes as China is already the largest global supplier of active pharmaceutical ingredients, a point that has raised concerns during the pandemic given rising geopolitical tensions and policies promoting domestic protectionism.


At the same time, China is beginning to export new and innovative drugs, too. BeiGene last year was the first company to secure U.S. regulatory approvals for a drug largely based on clinical data generated in China. So even in this tense geopolitical climate, I believe prospects remain encouraging for both multinationals and local Chinese firms as China makes a strong push to move up the value chain in health care. U.K.-based AstraZeneca might be one of those beneficiaries: It currently counts 20% of its global revenue from China through partnerships it’s cultivated with four local firms.


China’s pharmaceutical market has rapidly grown to become the world’s second largest

This chart shows the amount of prescription drug sales and 8-year growth rates of pharmaceutical markets in the U.S., China, Japan, Germany and France. By 2019, prescription drug sales in the U.S. had climbed to $510 billion, from $337 billion in 2011, a growth rate of 51%.  By 2019, prescription drug sales in China had climbed to $142 billion, from $69 billion in 2011, a growth rate of 105%. By 2019, prescription drug sales in Japan were $87 billion, down from $127 billion in 2011, a decline of 31%. By 2019, prescription drug sales in Germany were $52 billion, down from $55 billion in 2011, a decline of 5%. By 2019, prescription drug sales in France were $35 billion, from $49 billion in 2011, a decline of 29%.  Sources: IQVIA, GLOBOCAN, World Bank.


What’s fueling innovation


Aging demographics: China looks more like its western counterparts than the young and vibrant populations typically associated with emerging market countries. The median age in China, which was just 19 in 1970, reached 38 this year and will be 47 by 2040, according to United Nations projections. With this greying population has come a rise in medical ailments, including diabetes and cancer, which has forced the government into action.


Health care is a likely beneficiary in an aging China

This chart shows the growth of China’s population age 60 years and older from 1950 with forecasts through 2050. By the end of 2020, China’s population age 60 years and older is projected to be 250 million; by 2050, it is estimated to be 485 million. Source: United Nations, Department of Economic and Social Affairs, Population Division. Data as of August 2019.

Consumer demand: Consumer awareness and demand for better health care has risen dramatically in China, especially with a rising middle class that is willingly to pay for out-of-pocket medical expenses. Vaccine quality is discussed extensively in social media, and vaccines made by multinationals that are available in China are often out of stock because demand exceeds supply.


Government reforms: Plagued with scandals of low quality and ineffective products considered obsolete elsewhere, questionable operators and poor supply chains, both the government and the public have pushed for the sector to be cleaned up. The policy response has been to significantly raise the bar on generic drug quality, encourage local companies to innovate premium drugs and expand access to better medicines.  This has included making changes to stimulate a vibrant ecosystem of early stage innovative biopharma companies. Meteoric rises in valuation and global visibility of some of the leaders like WuXi AppTec has inspired many others.


Government health insurance programs also began reimbursing newer, more expensive and better quality drugs (produced both by multinationals and local companies) for the first time.


We’ve also noticed that China’s regulators have expressed less interest in indirect protectionism of domestic companies; it now sees its role as providing the public with safer and more efficacious medicines regardless of who makes them.


Another emphasis has been making the drug review process more efficient. The number of reviewers for China’s Center for Drug Evaluation grew to several thousand from just 120 reviewers in 2015. By comparison, in the same capacity the U.S. Food and Drug Administration employs approximately 6,000 and Japan’s equivalent agency has around a 1,000. 


This has helped the government make changes to “triage” drug applications to separate and accelerate those that are innovative and addressing substantial unmet medical needs from those that are redundant and undifferentiated (e.g., the 20th or 50th generic entrant).   


China opens wallet for pharmaceutical research 

Chart shows pharmaceutical research and development spending in the United States and China from 2014 to 2023. Figures for 2019 through 2023 are estimates. Spending in the United States increases slowly, from around $60 billion in 2014 to almost $90 billion in 2023. Spending in China increases much more rapidly, from around $9 billion in 2014 to around $49 billion in 2023. Source: Statista.

Spending growth: China is one of the few large economies in the world that is markedly increasing health care expenditures. While it is still low on a relative basis, I expect spending to increase. For instance, in 2018 (latest figures available) health spending accounted for only 6.6% of the country’s gross domestic product; it is expected to be above 7% this year. In comparison, the U.S. spends 18% of its GDP on health care and Germany, 11%.


Health care spending has soared in China

Chart shows health care spending in China from 2000 to 2018. Health care expenditures in China have steadily climbed from $65 billion in 2000 to $835 billion as of 2018. This figure includes government spending, collective spending, and private out-of-pocket spending on health care. Sources: National Bureau of Statistics of China, RIMES, Statista.  Data is latest available as of October 31, 2019. Data converted from yuan to USD, using the exchange rate on June 30, 2020.

 


Geopolitics and global supply chains 


There are advantages for multinationals to partner with local companies in China. These include:  

  1. Drug development: Multinationals have opportunities to tap into a larger pool of eligible patients; this is especially true for cancer research, where China has two times as many patients eligible for clinical trials than the rest of the world combined. A local firm can help bridge relationships with regulators and hospitals. 

  2. Costs: Clinical trials account for approximately 90% of the cost of developing a drug for global use. Labor costs for clinical trials are cheaper in China compared with the U.S., Germany and Switzerland. Our research has found these costs can be lower by as much as 25% and turnaround times are often faster, sometimes by six months or more. A CEO of one Chinese biotech firm our team spoke with said he can hire 50 PhD researchers and build a new production facility from scratch within 12 months of winning a new contract mandate. 

  3. Commercial upside: China could be a greater source of potential revenue and profit for multinationals over the next 10 years if current growth trajectories hold up. 

Given these considerations, I expect collaborative efforts even as politicians in the U.S. and Europe weigh the merits of reconstructing parts of their global supply chains. The upside: If it’s possible to speed up global clinical trials by doing parts of them cheaper in China without compromising quality, it could speed time to market by a year or two and reduce total development costs. For instance, California-based Amgen and BeiGene, which operates dual headquarters in Beijing and Massachusetts, have teamed up to develop 20 cancer drugs in Amgen’s pipeline. 


BeiGene is a further illustration of a new breed of biotech firm emerging in China: It has a deep bench of senior talent with decades of experience working for multinationals and focuses on both China and the U.S. 


Winning talent wars and shifting capital markets


Talent is key to pushing toward the next level of innovation, and the tide of human capital is shifting — an historic brain drain of scientists leaving China for the U.S. and Europe is becoming a brain gain. Many in the field have returned to China; others never left, given the growing number of promising opportunities. We are finding that deep-pocketed startups are poaching top talent from multinationals and compensation packages have risen dramatically for some key roles.


Venture capital funding has surged for health care startups in China, with roughly $60 billion invested since 2015, according to data from ChinaBio Consulting. Amid this optimism, there’s been a wave of investment bankers and sell-side analysts from Wall Street banks joining startups as CFOs, as well as top scientists from multinational biopharma companies making similar moves to well-funded startups.


In capital markets, China’s push to transform its health care industry is changing the complexion of the benchmark MSCI China Investable Market Index. Back in 2010, health care was the smallest sector by weight in the index — and as of June 30 it ranked as the fourth largest at 5.7% as company market values have climbed dramatically. The government also launched the Shanghai Exchange Science and Technology Innovation Board (STAR Board), where a number of early-stage biotech companies have debuted since listings began a year ago.


A surge in market value for China’s health care sector

Chart shows growth of market capitalization for the health care sector in the MSCI China Investable Market Index from June 30, 2010 to June 30, 2020. In 2010, the market cap was $9 billion; in 2015, it was $32 billion; it had climbed to $139 billion as of June 30, 2020. Sources: RIMES, MSCI.

 


Investment implications


In my view, what is underappreciated today is that China is starting to contribute from an innovation perspective globally. There are some early-stage companies working on potential drugs that could become first-rate medicines on a global basis. I am seeing this in the cell therapy space, where China has just as many trials in progress as the U.S., and in some areas of cancer research, where China’s pipeline is almost as rich as the U.S. 


None of this will come without challenges and risks. Some drugs may never get out of trials and not all business models will succeed as competition escalates. While China’s reform achievements to date have exceeded the expectations of many, more work needs to be done to improve business practices and industry standards and there will be plenty of growing pains along the way. That said, China’s biopharma industry is moving closer to an inflection point, and the number of investment opportunities is likely to grow in the years ahead.



Laura Nelson Carney is an equity investment analyst with six years of industry experience as of December 31, 2019. She holds a PhD in neurosciences from Imperial College London and a bachelor's degree in human biology from Stanford University.


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