US-China biotech: Troubled transfers

In August, Francis Collins, director of the National Institutes of Health (NIH), the primary body responsible for biomedical and public health research in the US, wrote a letter to his members encouraging them to brief the FBI on any attempts by foreign governments to influence their work. 

“NIH is aware that some foreign entities have mounted systematic programs to influence NIH researchers and peer reviewers,” Collins wrote. He reminded members they must disclose all forms of support and financial interest.

The widely-circulated letter caused quite a stir, especially among Chinese scientists and investors in medical and biotechnological research. “This is clearly targeting China,” wrote Rao Yi, dean of the division of sciences at Peking University, in an open letter published in response to Collins. Drawing comparisons to the behavior of scientists in Hitler’s Germany and Stalin’s USSR, Rao accused Collins of engaging with actions that are “extraordinary deviations from the normal practice of science.”

The spat, which comes on the back of huge commitments from Chinese investors to US biotech companies, has called into question Sino-US relations in the field of science. Industry participants warn that trade tensions between the two countries are likely to result in restrictions that curtail these capital flows. It might also dissuade scientists from moving from the US to China – and for a nascent sector heavily dependent on returnee talent, this is potentially more damaging than investment controls.

“NIH’s warning seems to be targeting China specifically. Now the institution is moving towards tighter scrutiny of those to whom the labs’ technologies will be transferred, there is likely to be a negative impact on Chinese biotech investors seeking targets in the US, as it could be more difficult for them to cooperate with the universities there,” says James Huang, founding partner of Panacea Venture, which specializes in incubating early-stage healthcare companies.

The introduction of the US Foreign Investment & Risk Review Modernization Act (FIRRMA), also in August, appears to confirm that Chinese investors are set for a tougher time. Biotech was cited as an area in which the Committee on Foreign Investment in the United States (CFIUS) can block even small minority foreign investments if it deems the targets to be involved with sensitive technologies.

The added bureaucracy is likely to result in approvals processes dragging on much longer than before. US biotech companies may start asking themselves if Chinese investment is worth the hassle. Huang notes there has already been a drop in the number of Chinese funds competing with Panacea for US projects.

Boom times

China is the world’s second-largest drug market, but the current biotech boom is a new phenomenon. While the US has experienced at least four major boom-bust cycles, China is in the midst of its first upcycle. The country’s aging population has created a huge supply-demand gap for new drugs. And with biotech products accounting for only 12% of the domestic drug market, compared to a global average of 25%, there is still much room for growth. 

Private equity and venture capital investors have leapt on the opportunity. Investment in domestic drug developers reached $1.3 billion last year, but that figure has already been eclipsed in 2018, with $2.1 billion deployed as of July, according to AVCJ research.

This frenzy has naturally spilled over into the US, the world’s leading biotech market. Chinese investors have poured money into the country as they look to grab talent and new molecules that be used to launch drug development start-ups back home. Pitchbook’s data show that China-based VC funds invested $1.4 billion in privately-held US biotech companies in the three months ended in March, accounting for about 40% of the aggregate sum raised. During the same period in 2017, the Chinese total was just $125.5 million. 

“The US remains the major outbound destination for Chinese biotech investors. They are not only attracted to advanced technologies, it’s also because the valuations of some American companies that have drugs in phase one or two clinical trials are cheaper than their peers in China,” says Nisa Leung, a managing partner at Qiming Venture Partners.

Beneficiaries of this wave of “easy money” include Brii Biosciences, a China and US-based start-up founded by US scientist Zhi Hong. The six-month-old company develops drugs in China for chronic diseases using intellectual property sourced from the US. It raised $260 million from a group of investors that included 6 Dimensions Capital, Boyu Capital, Yunfeng Capital, and Blue Pool Capital. Meanwhile, California-based Grail, which focuses on early detection of cancer through blood tests, closed a $300 million in a Series C round. All its investors come from China.

There are several ways in which US biotech assets are transferred to China. The most popular option is for companies or investors to license molecules from established US pharmaceutical companies, which are developed into drugs in China. The Chinese parties make an upfront payment that covers licensing through commercialization and they carry the financial and regulatory burdens of development in certain regions. 

One company that has employed this strategy to great effect is Zai Lab. It became the first Chinese start-up to in-license from a US pharma player in 2014 and has since similar agreements with Sanofi, Bristol-Myers Squibb, UCB, Hanmi Pharm, Tesaro, GlaxoSmithKline, and Paratek Pharmaceuticals. By the time of its $150 million US IPO last year, the Zai Lab pipeline comprised six drug candidates, three with Greater China rights and three with global rights. 

Many other Chinese companies have followed suit but executing this model requires strong ties to US pharmaceutical companies and a track record of engaging in this business in China. “Some Chinese companies that haven’t done such deals before or don’t have good networks, so they have found it difficult to do in-licensing in the US,” says Leung, a Zai Lab board member. “Sometimes they end up acquiring assets that no one wants or paying too high a price.”

Another approach, and one most commonly pursued by large corporations, is simply acquiring established businesses that already have drugs and licenses. Outbound Chinese M&A activity involving US biotech reached $2.8 billion in 2017, according to McKinsey & Company, led by Sanpower’s acquisition of Dendreon Pharmaceuticals for $820 million. However, acquisitions of this nature are likely to face increased scrutiny from the likes of CFIUS.

Finally, some Chinese companies look to operate below the regulatory radar by building their own R&D teams and investment arms in the US. Jiangsu Hengrui Medicine and Simcere Pharmaceutical have both done this with a view to developing drugs that can enter clinical trials simultaneously in the US, China and Europe, says Frank Yu, founders, CEO and CIO of Ally Bridge Group.

Brain drain

While it’s difficult to quantify the impact of changing sentiment in the US on Chinese investors, the availability of talent is a major concern. VC investors stress the importance of having not only the right molecule but also the best team to develop it. Chinese scientists whose resumes include the names of leading US pharmaceutical companies and universities have long been the lifeblood of Chinese biotech. 

Of the approximately 352,000 Chinese students currently in the US, most specialize in chemistry or engineering, according to a UBS report. In the last six years, an estimated 250,000 out of the two million students who have returned to China from the US are working in the life sciences industry.

However, this talent pool is about to shrink. Following government confirmation that it had introduced tighter screening of Chinese students, it was reported that postgraduates studying in the US in fields such as robotics, aviation and hi-tech manufacturing have been limited to one-year visas. Chinese citizens applying for a US visa require additional permissions if they work in research or management at any institution that might arouse US suspicion. 

The recent HIH statement doesn’t bode well for Chinese scientists in the US either. There are concerns these individuals might be asked to choose one country as their patron. “Chinese scientists in the US have to choose a side, they can’t hope to get funding from both the Chinese and US governments in the future,” says one manager from a healthcare-focused fund in China.

Huang of Panacea adds that as most American universities have specific departments that oversee technology transfer to outside parties, agreements involving Chinese entities are likely to be examined closely. Chinese citizens working for leading US pharmaceutical companies could also find there are more hurdles when they are involved in technology transfers to China-based companies. “Regulators will question very carefully the methods and entities to which technologies will be transferred, the process will not be as simple as before,” Huang says.

Meanwhile, any investment in US biotech where there is Chinese involvement – even if it is a single board member – could be subject to a higher approval threshold. Groups will close ties to the state will inevitably come in for the fiercest scrutiny, but it doesn’t end there. 

“Funds with a Chinese government background could be seen by the US as most sensitive and the situation is better for funds with no state links,” says Ally Bridge’s Yu. “In general, though, both will be categorized as sensitive investors.”   

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• Topics
• Greater China
• Healthcare
• North America
• Early-stage
• Expansion
• China
• USA
• Pharmaceuticals
• Qiming Venture Partners
• Ally Bridge
• Panacea