Curing China

Within the global pharmaceutical arena, China is no longer being considered a black hole of herbal mystery or even a backwater for copycat cures. It’s a thriving community of innovative scientists, world-class hospitals and exciting companies. Investors would do well to take note.

 

Pharma and China – unusual bedfellows

That’s a particularly pressing point at a time when fractured relations between China and the West are causing murmurs of unease for emerging market investors. Donald Trump’s tariffs have contributed to a 21 per cent decline in the Shanghai Composite Index since the start of the year, while the rising cost of trade between the world’s largest economies have forced many companies to alter their investment strategies.

Pharmaceutical investors have had a similarly tough time in 2018 – between January and September, the S&P 500 Pharmaceutical Index underperformed the wider market by an average of 3 per cent.

The industry is also undergoing a fundamental shift as global corporations increase their focus on innovative gene therapies that have the potential to cure illness. That’s certainly a boon to society, but Goldman Sachs thinks that curing patients outright could hurt long-term profits. Historically, pharma companies have enjoyed repeated, predictable sales from preventative therapies. Treatments that only need to be taken once are therefore a threat for these formerly defensive stocks.

And yet sales growth from the Chinese subsidiaries of global pharma companies has far outpaced recent momentum elsewhere, and 83 per cent of the groups operating in the region are optimistic about the future (higher than any other industry), according to the European Union Chamber of Commerce. Meanwhile, the Chinese government remains obliging to the international trade of medicines. In May – while rising import fees were beginning to tarnish the outlook for most sectors – Beijing eliminated the tariffs on 28 medicines made overseas and reduced the VAT on imported anti-cancer drugs from 17 per cent to 3 per cent. Medicine appears to mellow politics. So, while international pharma and China may seem like unusual bedfellows, they’re proving a good pair at a time when their individual outlooks are gloomy.

 

A market primed for expansion

An explanation for the government’s leniency on drug tariffs lies in its ‘Made in China 2025’ industrial strategy. China is a nation of huge unmet medical needs and, under pressure to change that, officials recently listed the pharmaceutical industry as one of its 10 key sectors for development. That has led to a big uptick in state healthcare investment ($100bn in 2017), a better drug approval process and incentives for life sciences workers employed overseas. According to Frank Jiang, chief executive of Chinese biotech group CStone Pharmaceuticals, “the regulatory changes these reforms have brought are going to catalyse the pharmaceutical industry in China”.

There has also been a sharp increase in the country’s state-funded healthcare insurance. Between 2003 and 2015, coverage increased from 30 per cent to 100 per cent of the population, ahead of the government’s target to provide universal healthcare by 2020. Now officials are attempting to increase the number of treatments covered by state insurance and reduce the disparity between rural and urban areas. In 2017, more than 100 western medicines were added to public insurance policies.

And as healthcare has improved, China’s life expectancy has ticked up, which – combined with the vestiges of the one child policy – has led to a rapidly ageing population. By 2050, more than a quarter of people living in China will be over 65. That’s one of the reasons Christian Hogg, chief executive of London-listed biotech group Hutchison China Meditech (HCM) thinks “it’s inevitable that China will eventually become the biggest pharma market in the world”. Ageing, rising wealth and pollution have led to a sharp increase in western illnesses among China’s enormous population. The country now has 35 per cent of the world’s lung cancer patients and over a quarter of its diabetes sufferers.

 

 

Follow the illness

So, when executives at British pharma giant AstraZeneca (AZN) sat down in the early 2000s to decide which markets to grow into, China was an obvious choice. It was also a very wise one. The group’s reported revenues in the region have grown at a compound annual rate of 10 per cent over the past four years, helping to offset the steady decline in revenues in the wider business in the same period.

 

Astra’s growth in China has outpaced the wider business

	China Rev ($m)	Total Rev ($m)	LFL Grth China (%)	LFL Grth Co (%)	China Contribution (%)
2014	2,242	26,095	22	3	8.59
2015	2,530	24,708	15	1	10.24
2016	2,636	23,002	10	-5	11.46
2017	2,955	22,465	15	-2	13.15
CAGR	10	-5
Total	31	-14

Source: Data compiled from company accounts

 

Astra was an early mover in China. It first established a presence in 1993 and in 2006 announced a $100m (£77.9m) investment, which included the creation of the Innovation Centre in Wuxi. By 2012, while its global peers were turning their backs on the region following a series of corruption scandals with regulatory officials, Astra had invested over $500m. And last year the group joined forces with the Chinese Future Industry Investment Fund – which is managed by private equity company SDIC – to form Dizal Pharmaceuticals. The joint venture will focus on the discovery and development of medicines for unmet medical needs and is being headed up by Xiaolin Zhang, previously head of Astra’s Innovation Centre.

China has become Astra’s second-largest geography, contributing 18 per cent of total sales in the first half of 2018 and over half of its emerging markets revenue. The group is therefore gaining ground on Bayer (DE:BAYN), which has been the dominant western player in China since it first launched aspirin in the region in the late 1800s.

And Astra is not the only newbie jostling for a position in this hugely attractive market. Eli Lilly (US:LLY), Merck (US:MRK) and Pfizer (US:PFE) are a handful of companies that have partnered with Chinese peers or funds to stimulate growth in the region. That’s a sensible strategy. By joining up with companies that already have a local presence, these pharma giants gain a greater knowledge of regulatory quirks and have access to China’s famed manufacturing sites and huge workforce.

Research and development collaborations include Eli Lilly’s partnership with Hutchison China Meditech, which has culminated in China’s first ever ‘home grown’ cancer treatment. The two companies have spent the best part of a decade developing Fruquintinib for the treatment of colorectal cancer, which recently achieved positive results in a final phase clinical trial. Chi-Med anticipates regulatory approval in China within the next few months.

 

 

Meanwhile, with China widening its healthcare coverage, it pays for the big companies to stay in favour with the budget controllers and that has resulted in some unusual pairings. Sanofi (FR:SAN), for example, has strengthened its ties with the government by offering diabetes training, while Novo Nordisk (CPH:NOVO) has started to offer local healthcare education.

And some of the UK’s smaller, ‘challenger’ pharma companies are beginning to use China’s enormous potential to offset difficulties in the western regions. Circassia (CIR) is one of these. Since 2016, the group has battled to shake the memories of its failed allergy clinical trial and now China is providing the tonic. The group – which is 20 per cent owned by AstraZeneca – recently created an in-house sales team in China to promote its novel respiratory treatments. Steve Harris, chief executive, thinks the market dynamics are very attractive to small and mid-sized pharma companies.

 

Regulatory rulings

These developments are not coming quickly enough for China’s population, whose healthcare provision has long fallen well below requirements. The problem is not a lack of money or demand, but a challenging regulatory environment which delays the approval of the world’s most innovative new therapies. Historically, Chinese patients have had to wait years after approval in America to gain access to foreign drugs.

The discontentment was highlighted in the recent film Dying to Survive, which follows the troubles of a leukaemia patient who turns to smuggling cheap, unregulated cancer drugs from India for himself and patients who have been pushed into poverty by expensive treatments. The low-budget film struck a chord with the population and became China’s third-highest grossing film ever. It also sparked wide debate about the cost of medical care and was cited by Premier Li Keqiang in an appeal to China's regulators to "speed up price cuts for cancer drugs" and "reduce the burden on families".

Now the Chinese government is taking steps to address the discontentment. Regulators recently abolished the rule that forced companies to repeat all drugs trials in China before they would consider approval, making it far easier for pharma giants to sell their medicines there. Companies including AstraZeneca, Pfizer and Novartis have been quick to capitalise – bringing medicines to China which have been available in the US and Europe for many years – and this has provided much of their growth in the region.  

The regulatory change should also increase the chances of new medicines being rolled out in China at the same time as other major markets, if not before. In March, Astra’s lung cancer drug, Tagrisso, was launched in China just seven months after regulators in western markets gave it the green light – “a very different timeline” compared with the past, according to Sean Bohen, head of global medicines. Sandra Horning, chief medical officer at Roche, has also saluted China’s expedited approval of its lung cancer medicine, Alecensa, just eight months after it was launched in Europe.

 

Approval timelines in China have shortened since new regulation

Pre-regulation change (2014-2016)		Post-regulation change (2017-)
Company	NDA Timeline (months)	Company	NDA Timeline (months)
Boehringer Ingelheim	12	Bayer	3
Pfizer	14.5	AstraZeneca	2
Roche	11.5	Bristol-Myers Squibb	5.5
Novartis	16.5	GlaxoSmithKline	6.5
Celgene	28	Pharmacyclics	9.5
AbbVie	35	Janssen	9.5
Teva	41.5	AbbVie	6
Bayer	18	Gilead	6.5
Novo Nordisk	24	Boehringer Ingelheim	5.5
Allergan	17	Novartis	8.5
	21.8		6.25

Source: IC, RegulatoryFocus.org

 

Significantly, the government has recently launched an accelerated approval pathway which means novel medicines for rare diseases could be made available to desperate patients just a few months after clinical trial results. Astra’s new anaemia medicine, roxadustat, is one of the first medicines to be granted priority review, meaning it will be accelerated through the approvals process if the results of its global clinical study are positive. Historically, big pharma prioritised launch in the US, but with China now so attractive Astra has targeted it as the primary market for the roll-out of roxadustat – the first time any new drug has been launched in China before other major markets. After decades of being starved of innovative treatments for serious conditions, China’s 1.4bn people are becoming global pharma’s prime target.

 

Home advantage

But Western pharma companies should be aware of a rise in competition from domestic players. As well as opening up the market to foreign investment, Beijing’s new regulatory code has clamped down on manufacturing standards and replication requirements for biologically equivalent or generic drugs. Chinese domestic companies have therefore had to shape up and this has helped weed out some of the poorer, less innovative companies in the region.

The clampdown is expected to free up the market so that innovators can flourish and it’s already having an impact on the state of the Chinese domestic pharma market. In a report for McKinsey, Ling Lu, a partner at Lilly Asia Ventures, said many of the country’s companies “are now expanding from a manufacturing focus to investing more in innovative portfolios”. “Innovation is increasingly coming from biotech start-ups established by the alumni of multinational companies”.

 

 

Innovation in China should not be overlooked – a sentiment clearly shared by Craig Chase, who was given the all-clear from his multiple myeloma after six weeks of treatment in a Chinese hospital. Traditional US therapies had failed to have an impact on Mr Chase’s blood cancer count for three years, so after reading about an innovative new treatment presented at the prestigious American Society of Clinical Oncology, he decided to travel to China and became the first US citizen to receive cancer treatment there.

The treatment in question uses experimental chimeric antigen receptor (CAR) T-cell technology, which involves extracting a patient’s immune cells, re-engineering them in a lab and inserting them back into the body so that they fight off cancerous cells.

When Mr Chase first told his US doctors he was thinking of accessing this treatment in China, they were worried about how Chinese doctors would deal with some of the more aggressive side effects. Most CAR-T therapies are still unregulated and patients in clinical trials have died after the treatment triggered an excessive production of immune cells known as a “cytokine storm”. But Mr Chase wasn’t too worried. Earlier this year, he told the Financial Times: “I knew they were setting up to peddle this drug in the US, so they’re not going to take an American into their trial programme and send him home in a body-bag.” He was right. After six weeks of treatment, Mr Chase returned to the US with no trace of multiple myeloma.

His treatment, made by Nanjing-based group GenScript, is not the only CAR-T therapy undergoing late-stage clinical trials in China. In fact, there are already more clinical trials in the country than in the US and analysts at Bernstein think CAR-T “is among the few corners of biotech in which China may have a chance to compete globally”.

 

 

The country is also gaining ground on the US when it comes to the gene editing technique known as CRISPR. This highly innovative treatment allows researchers to replace bits of genetic code much faster than in other types of genetic modification. Scientists based in China were the first to test CRISPR gene editing in humans when, in 2016, they inserted edited cells into a patient with aggressive lung cancer during a clinical trial. Although CRISPR is still a long way from commercial approval, China’s manufacturing capabilities and looser moral stance on gene editing (many Western academics are worried CRISPR might lead to ‘designer babies’) could provide the ideal platform for CRISPR development.

 

Emerging opportunities or risky outlook?

But despite the scientific and clinical progress, recent events have reminded investors of the risky nature of investing in Chinese pharmaceutical stocks. After climbing 26 per cent between January and May (while the wider market trickled down 5.7 per cent), the CSI 300 Healthcare Index has crashed back to its lowest levels for more than a year after some of its companies became embroiled in a vaccines scandal.

Changsheng Bio-technology Company is just one of the groups that has been slapped with a massive fine after exaggerating clinical data and producing low-quality vaccines for children. CAR-T hero GenScript has lost half of its value as the sector’s shine has worn away and analysts have suggested that its share price had been boosted by the hype surrounding the sector, rather than real opportunities for the company.

But we would argue that the same is true of all biotech companies, not just those operating in China. Biotech investment is a risky business, relying on the black or white outcome of clinical trial results which can rarely be predicted. It should always form part of a wider portfolio of lower-risk assets.

The global pharmaceutical and biotech industry is experiencing an unprecedented period of disruption and we think China (in a rare turn of events) offers a more certain outlook. Healthcare provision is improving, wealth is accumulating and regulation is advancing. Investors who can align themselves with those positive trends could be well placed to benefit in the long term, as long as they’re willing to deal with some short-term volatility.