Corporate VC in China healthcare: Formula for success

Pharmaceutical giant Eli Lilly was looking for a partner to collaborate with on new cancer treatments for the China market. Innovent Biologics - a portfolio company of its affiliated venture arm, Lilly Asia Ventures (LAV) - that had already been pursing cross-border opportunities with a view to marketing its drugs outside China - seemed to be the perfect fit. The two firms agreed last March to develop products potentially worth more than $456 million. In October the deal was expanded to $1 billion.

"It's a win-win, because from the Lilly perspective, they need a domestic face, they need to have local knowhow, and that's what Innovent brings to the table," says Judith Li, partner at LAV. "But at the same time it has to be international standard. So that's where they're learning from each other."

For Li, Eli Lilly's collaboration with Innovent is a textbook example of the potential for profitable collaboration between a start-up and an established industry figure. It also demonstrates the benefits a corporate player can derive from having an affiliated outpost in a key developing market.

What is often stressed is that it takes industry experience and industry accumulation. For start-ups and entrepreneurs, I won’t invest in someone who is fresh out of school with no relevant background or experience – Karen Liu

However, funds like LAV are rare in China's healthcare investment sector. Despite the boom in investment opportunities for pharmaceutical and biotech companies, GPs say participation by corporate-affiliated venture entities, both captive and independent, continues to be low. Hopeful corporate players may need to wait while the market matures.

The past decade has seen a concentration of PE and VC investment in biotech and pharmaceutical development in China. AVCJ Research's records show steady growth in overall deal value, with a particularly large rise - up to $4.5 billion - last year following a slump to around $500 million in the previous two years. This has come while the number of deals has first risen, from 10 in 2005 to 47 in 2008, and then fallen, from 55 in 2010 to 24 in 2015.

The rising investment corresponds to strong growth in China's healthcare sector in general, fueled by rising incomes and government reforms. In a report last year, Deloitte projected that total healthcare spending would grow at an average rate of 11.8% per year through 2018, to reach $892 billion.

A new breed of specialist healthcare-focused funds has emerged to capitalize on this opportunity, including Ally Bridge Group and HighLight Capital, adding to the efforts of existing Sino-US players Vivo Capital and OrbiMed Advisors. These GPs, whose managers are often from the healthcare industry themselves, seek to invest in promising entrepreneurs in China's healthcare space. The local firms also seek opportunities outside China.

"On the one hand we're helping Chinese companies to globalize their R&D and bring world-class technologies to China," says Frank Yu, founder and CEO of Ally Bridge. "And then at the same time we invest in global companies, especially in the US and European technology companies, to help them accelerate their entry into China."

Notable absence

Due to the key role that corporate venture funds have played in other developing sectors in China, most notably the technology, media and telecom space, one might expect them to be prominent in healthcare as well. However, industry players say that so far there has been little notable activity of this kind, even from multinational pharmaceutical players that have been active in other markets.

The dearth of corporate venture arms is more confusing in light of the energy of those that are active in the sector. WuXi Healthcare Ventures, the captive investment division of contract research outsourcing (CRO) giant WuXi PharmaTech, is one notable exception, as is TigerMed, a Hangzhou-based CRO firm. Both have made several venture investments, often alongside larger dedicated or generalist funds.

Now an independent affiliate of Eli Lilly, LAV also has its roots in the corporate venture world, having begun life in 2008 as a captive fund before spinning out five years ago. Eli Lilly continues to be a significant LP in the firm's funds, and although investment decisions are made independently, the continued connection with the former parent offers considerable attraction to potential investees.

"They like to take investment from a fund like ours - which has almost a dual branding, we're seen as both a pure-play fund and with the backing of a multinational - in order to attach themselves to a strong international brand," says LAV's Li. "In the long run it helps them with everything from recruiting the right talent, all the way to selling their drugs."

The attraction to a start-up of associating with a well-known global brand is undeniable, as are the possible benefits for a global player of backing a new entity with an original idea in a booming economy. Yet successful multinational companies have so far not gotten significantly involved in China's pharmaceutical and biotech research sector, beyond M&A activity.

GPs who watch the sector identify a few reasons for this relative lack of corporate participation in the start-up environment. For one thing, the recent explosion in investment size belies the fact that the space is still immature compared with other markets.

"It is changing a little bit, we see more and more Asian participation," says Dr. Karen Liu, a founding partner of 3E Bioventures. "But what is often stressed is that it takes industry experience and industry accumulation. For start-ups and entrepreneurs, I won't invest in someone who is fresh out of school with no relevant background or experience."

In addition, Chinese companies have yet to build up a strong track record of innovation. Outsourcing models like CRO and contract manufacturing outsourcing (CMO) are still more common in the sector than companies pursuing genuinely innovative research. Though some investors feel that this situation may be changing, currently there are simply too few companies pursuing research that a larger firm would want to invest in, rather than simply acquiring the company and the research for its own use.

The immaturity of the market also means that there has been little chance for homegrown corporate venture investing to take off. Most Chinese entrepreneurs so far lack the experience and capital to be able to pursue an investment strategy of their own.

"In other countries, you may have the people who have been successful in building one business and taking it to IPO, and then come back to do another start-up. But in China you don't have that cycle yet," says Jenny Yao, the head of healthcare at KPMG. "And even the first round of people are still kind of testing the roads to see whether they can be successful."

From the perspective of a multinational corporate investor, China's regulatory environment poses a particularly discouraging effect. If an entrepreneur chooses to pursue a public listing within China, it will have to shed most of its foreign ownership. This is a factor for other foreign investors, but for a corporate arm that wants a significant say in the operation of the company, it can be highly frustrating.

In light of these limitations, China-focused GPs express little surprise that corporate VC does not account for a larger part of the ecosystem. However, the activity that is taking place is generally viewed positively. TigerMed and WuXi are seen as offering local expertise while operating to an international standard, and several GPs have conducted investments alongside them.

Ally Bridge, which participated in the privatization deal for WuXi Pharmatech, later invested with WuXi Healthcare Ventures in San Diego-based molecular diagnostic company AltheaDX. Yu believes that Chinese corporate partners are becoming more attractive as China's market continues to grow.

"WuXi has a lot of China knowhow, and, at the same time, they play by the global rules and operate on world-class standards, so they are trusted by Chinese and international partners alike," says Yu. "This is a phenomenon that's becoming more prevalent, which is that global companies seek help from someone like WuXi to get into China."

Corporate investors can also be useful for conventional GPs, which may see portfolio companies as good candidates for future investment. However, industry participants point out that they will need to take into account the influence of the corporate parent that might be thinking in strategic rather than financial terms on a captive fund's investment decisions.

Changing times

Though China's healthcare sector may not have developed enough to attract attention by corporate venture investors, some GPs feel that this is likely to change over time. The first specialist healthcare funds are less than a decade old, and need time to build up a healthy market with expertise that goes beyond outsourcing. In this light it is understandable that overseas corporate funds have so far been reluctant to dip their toes in the water.

"I think they're still trying to learn about collaboration, and what is the best model for them to expand their reach into China, and then whether or not it takes too long for this particular collaboration to grow into something that's significant," says Nisa Leung, a managing partner at Qiming Venture Partners, which has invested both in and alongside TigerMed.

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• Topics
• Greater China
• Healthcare
• Expansion
• Venture
• Growth capital
• Ally Bridge
• 3E Bioventures
• Qiming Venture Partners
• KPMG