Editor's note: At the recent ChinaBio® Day, held on Tuesday, September 15 in San Francisco in conjunction with BioPharma America™, four panel presentations centered their discussions on specific features of the China biopharma sector. In the “Financial Crisis” panel, representatives of the financial sector shared their insights on the 2009 version of China’s life science. The discussion ranged over several topics, including government incentives, innovation, corporate structure and over-incentivizing. The following is a summary of the discussion.


Panel Moderator:
Stephen B. Thau, JD, Partner and Co-Chair of Life Sciences Group, Morrison and Foerster

Panel Members:
Frank Kung, PhD, MBA, Managing Partner, Vivo Ventures
Yuwen Liu, MBA General Manager, BioBay
Hongbo B. Lu PhD., MBA, VP and Senior Research Analyst, Piper Jaffrey & Co William Molloie, Partner, PricewaterhouseCoopers

Thau (MOFO): How have China’s government policies helped life science companies in China?

Liu (BioBay): BioBay is a state-owned company, so it’s not really government. From what I see at BioBay, the government has large amounts of disposable income, which is being spent on healthcare and drug development. There are multiple programs with funds, including the A63 program and the New Drug program. Also, provincial governments are involved as well as municipal governments. All together, there is lots of money going into drug development.

Thau (MOFO): Frank, as an investor, how does the money going into drug development affect you?

Kung (Vivo): In the US, the investment market has been depressed. Because there are no derivatives in China, the effect is much less severe, felt mainly as a lowering in exports. There is lots of liquidity in the system in China, so companies have almost unlimited ability to borrow. As a result, stock price/earnings ratios in China are 35-40 for public companies, and 15 times for private companies. This makes it tough for private investors to compete because the government is willing to give grants and banks are ready to loan. Companies don’t need private sources of capital. On the other hand, the IPO and investment markets are opening up, providing exits. All in all, it’s a mixed message for investors.

Because of the US downturn, we see experienced entrepreneurs going back to China, where the economic future is brighter. The number of returnees is increasing. They might set up their own business or otherwise go to work for an established company.

Liu (BioBay): There were five new companies in the last month at BioBay. That tells me general business activity is very strong.

Molloie (PWC): It’s not a matter of whether the entrepreneur or from China or the US, the question is: how can you leverage assets using China?

Lu (Piper Jaffrey): The magnitude of government spending needs perspective. Right now, the growth rate in government spending is 25%, up from the usual 15%. Hospital infrastructure and equipment will be a major category of growth, especially in rural areas. The same is true for drugs on the Essential Drug list, which will be distributed by stores. More money will be spent on preventative medicine. Pharmacies will be split off from hospitals. Insurance coverage will also be big factor, as will medical devices, which are currently under-used.

The manufacturer receives 20% of the cost of goods; distributors account for an additional 35%; the rest is “just lost.” The essential drug list will encourage consolidation among companies, and that may have been one of the government’s purposes in establishing the list. If your company is well established, you will flourish under the reform plan.

Thau (MOFO): Is there a shift in emphasis in the kinds of companies that are being funded? Is it moving toward the more innovative companies?

Kung (Vivo): The shift is happening very rapidly. Because of healthcare reform, there will be two big markets: basic drugs and specialty pharma. Private parties and insurance companies will pay more for services, and they will be patrons of specialty pharma. Investors are aware of this and are interested in specialty market.

In China, “Me Better” is a very attractive business plan because the regulatory system is different than in the west. Known drugs are processed quickly, making the “Me Better” drug business a very attractive plan. In the west, approval takes too long for this category of drugs to pay off. On the other hand, in China, innovative drugs are processed slowly by the SFDA, making them more expensive.

Molloie (PWC): There is movement away from fulfillment (which includes manufacturing) and toward innovation. The rate of change is very fast, creating opportunities.

Liu (BioBay): Grants will go to companies with cost-effective, innovative drugs. Local government officials have 4 to 5-year terms, so companies with a short-term road to revenues (and thus to taxes) have an advantage for grants. Over half of the companies in BioBay are device companies or other programs that are approvable soon.

Molloie (PWC): When officials want to accomplish something, they will move very quickly if your company can assist them in reaching their goals. I’ve never experienced anything of similar intensity in the US.

Lu (Piper Jaffrey): Public companies are not interested in innovation because it is too risky and long-term.

Kung (Vivo): We did a survey of the technology parks in China, and we found that most companies are not innovative. We also found that the amount of money raised for them is very low. China must develop alternative sources for funding. In China, most of the innovative companies have a profitable company as a backer, a company that is willing to invest over the long term.

Thau (MOFO): In what sectors is government funding helping to create private funding?

Liu (BioBay): I know of a company that received $13 million in government grants because it could raise money from venture capital funds. Of course, you have to be a China company to get government funds, and you must have a China-born CEO. You can have a Cayman-located company, but the taxes and assets (including the IP) must be in China.

Thau (MOFO): In terms of life science companies now being established in China, are they being staffed mainly with Chinese employees?

Liu (BioBay): When I worked for a western company, I spent a lot of time trying to teach my employees how to write a business email in English. The skills of many employees do not include how to work; they know how to write papers for school. I learned by working for a subsidiary of American company, not by going to the US. We Chinese are trainable.

Kung (Vivo): The management and even the board members are important for the success of company. A real Chinese company can take only RMB as an investment. In July, for the first time, RMB-denominated funds outspent dollar-denominated funds, which are losing their appeal. The majority of investment opportunities are companies that can take only RMB. What kind of money you can accept will have an effect on the kind of board you attract. Domain knowledge and how you do business in China is also very important for success.

Thau (M&F): What are the limits of growth?

Kung (Vivo): The limiting factor for growth is not a lack of vision because almost everyone we talk to has a similar vision: the China pharma market is growing to attain the number three position in the world. CEOs must differentiate their company’s products by service, quality or cost.

Liu (BioBay): Things are moving too fast; change is occurring too fast. Money will be wasted.

Molloie (PWC): A situation like this requires flexibility, which may be more than most companies can do.

Audience Question: There have been three IPOs in last few months: do you expect the IPOs to continue?

Kung (Vivo). Yes, I do.

Audience Question: In the US model, startups give founders significant stakes of their shares. Does that hold true in China as well?

Kung (Vivo): We see all kinds of companies and structures. One thing that is changing is that stock options are gaining popularity in China. Current China law does not recognize the stock option mechanism.

Audience Question: Every jurisdiction is trying to out-incentivize the other. How does that stop?

Liu (BioBay): The cost of bringing a single company into a particular park is going up. There are not very many industries left for government to fund; life science was one of the last. Once the parks find out that the return isn’t there, they will stop offering huge incentives to companies, and incentives will become more rational. Before selecting a particular park, companies should make sure the park offers more than just incentives; it must also have the proper infrastructure.

Audience Question: Are companies going to China just for the incentives, that is, because conditions are so difficult in US?

Kung (Vivo): I don’t think so, because it is very difficult to move money out of China. There must be an additional reason for a company to go there.

Molloie (PWC): A company needs to have a subsidiary in China, just to have a chance to raise money elsewhere.

Disclosure: none.