Healthcare: The next China VC horizon?

Now there are signs that healthcare investment in China may become just as important. Following the recent China Healthcare Investment Conference in Shanghai, AVCJ surveys the state of PRC healthcare, and the scale of the opportunity for venture investors.

Playing catch-up in China

China’s growing wealth and rising living standards, coupled with an urgent need to improve its social safety net and hitherto underdeveloped private-sector participation, create a very attractive opportunity set for VCs and Western trade players alike. “US healthcare spending is at 16% of GDP, compared with China at 5%,” noted Sam Fazeli, Head of European Equities Research at healthcare specialist investment firm Piper Jaffray. “There’s obviously scope for a significant increase.”

Furthermore, China’s VC industry, much like the healthcare sector, lags behind its Western counterparts. “In the US, healthcare accounts for 30% of all venture,” re-iterates Nisa Leung, Partner and healthcare specialist at Qiming Venture Partners. “In China it’s only about 6%.” VCs with any healthcare specialization therefore have a strong lead to help that number grow.

The PRC opportunity set also makes this the M&A market of choice for global big pharma. “The big pharmaceutical companies are all here [in China], and they’ve all staked a huge part of their future on it,” Glen Giovannetti, Global Biotechnology and Life Sciences Leader at Ernst & Young, told AVCJ. “Their traditional markets – Europe, the US, Japan – are slow-growth to no-growth; they’re facing much more generic competition.”

VCs in China healthcare will therefore have very receptive strategic buyers or partners to complement their strategies. “We feel there’s a tremendous amount of opportunity in pharma for the domestic market, as well as for companies that are looking to manufacture in China for the worldwide market,” confirmed Leung.

“The healthcare industry in China is probably going to grow at 25% a year. The growth opportunity is a no-brainer,” concluded Frank Kung, Managing Partner at Vivo Ventures.

Areas of particular interest

With the market wide open for investment, most VCs are able to avoid the higher-risk areas of drug discovery and cutting-edge R&D for the still very lucrative opportunities in bringing the country up to speed. “We’re still at the low-hanging fruit stage, with limited risk involved but extraordinary growth potential,” averred Hongbo Lu, Principal at Piper Jaffray.

“To date, the opportunities have been, relative to R&D, in lower-risk areas,” affirmed Giovannetti. And Kung noted, “Our initial strategy is focused on growth. We want to invest in the superstructure, infrastructure and industry.”

Leung told AVCJ that her firm is active in “medical devices, pharma and medical services,” the latter including investments in private healthcare chains and specialty hospitals. “I started one of the first private cancer centers in China,” she pointed out.

“We’re very keen on looking at specialty hospitals as well: cancer hospitals, vascular hospitals,” confirmed Norman Chen, Partner at Fidelity Asia Ventures. “We’re very keen on services; we think that’s an area that’s been lacking in innovation and quality of management.”

Kung broadened the definition as wide as to include related financial services plays. “With medical reform, we know tremendous amounts of opportunities have been created,” he said. “In the US there’s a lot of infrastructure for healthcare insurance support. Those infrastructures don’t really exist in China.” Chen agreed that China is going through massive reform of the healthcare system, and that this situation creates opportunities for investors. “China is 1/20th the size of the US in terms of market cap for healthcare overall, and in terms of market cap for healthcare services, it’s 1/100th the size. There’s a massive disparity.”

While acknowledging the importance and attractiveness of the medical services space, as well as other areas such as veterinary medicine and medical devices, Chen also emphasized the value of opportunities seen by some as much riskier – like early-stage pharma and drug discovery companies – for those firms able to tap them.

“Our culture is very entrepreneurial,” he told AVCJ. “Our DNA is more suited to early stage deals, true VC deals, than the later stage.” James Li, Partner at Kleiner Perkins Caufield & Byers, also stressed the significance of, “the emerging R&D areas in China. I see that starting to top up in several years.”

China’s intellectual capital

Prospects for true R&D-driven venture investing in healthcare naturally hinge on the quality of China’s intellectual capital and autonomous medical innovation. Here, the views – and track records – are mixed.

“Innovation-based R&D is just starting to get going,” said Giovannetti. But it hasn’t happened quite yet.  Although some say there are signs that this is changing, Chen conceded, “We’re not seeing so many innovative product companies. Most of our portfolio includes service companies.”

Li, meanwhile, maintained that “the time for innovation and R&D is probably coming a little sooner than people expect.” Citing Fidelity’s own investment experience in animal medicines Chen declared, “If there’s a question of whether there is real innovation in China, we answer, yes. We’re seeing more and more of it emerging.”

Given China’s intellectual firepower, few market participants doubt that strong, autonomous R&D-driven opportunities will arise eventually. China has the talent, affirmed Li. “Half of the scientists in biotech in the US are Chinese, and a lot are coming back [to China],” Leung pointed out. “There’s bound to be innovation.”

Outsourcing and the trans-Pacific play

The China/US healthcare connection is in fact becoming a rival to India’s prominence in global healthcare’s growth and development. In part this is due to the immense potential of drug R&D outsourcing – compelled by rising costs in the US.

A combination of cost savings and VC investment can be very valuable even to Western drug discovery companies. “Drug development companies in the US and Europe often don’t have the resources to develop drugs for their own market, let alone Japan or China,” Fazeli admitted.

It takes about $4 billion to develop a drug in the US right now, or roughly ten times the figure in the heyday of US drug development VC two decades ago. But in China, Li says, “development costs are probably 20-30% lower than the US.” As a result, VCs are turning to contract research organizations (CROs) as one very lucrative investment focus.

“Some of [the CROs] are growing much faster in China because of the different types of therapeutics and patient enrollment,” observed Leung. “For clinical trials, it’s a lot easier to enroll patients in China for Asian-type cancers or diseases.” Fazeli also looked to the possibility of “developing drugs in China, then licensing them out to US and European biotechs, and keeping China for yourself. That’s what some Indian companies have done.”

Another important dimension for trans-Pacific link is the depth of institutional investor support in the US for healthcare plays, both at the early high-risk venture stage and for large mature companies. This makes the US a likely listing destination for Chinese businesses, and gives healthcare VCs with expertise in this area a corresponding advantage.

“The one area with significant capital, cash and deep pockets for this sector is the US,” said Fazeli. “There’s a class of investors there who are used to high-risk, high-reward scenarios,” confirmed Giovannetti. Li pointed to his own firm’s experience successfully listing companies. Even outside the US, China healthcare IPOs have performed well. “We have seen at least three Chinese medical healthcare companies listed in the UK,” Fazeli added. “Some of those companies have put in fantastic share price performances that have been driven by the superior growth they’re showing.”

All healthcare investors agreed on the possibility of ultimately creating $1 billion+ medical and healthcare giants out of the China market, comparable to those already developed in India.

“Clearly we believe there are going to be some home runs,” concluded Chen. “In the drug development phase, those are either grand slams or strikeouts.”

More risk than reward?

As this last comment indicates, even without the usual risk premium involved in China investing, healthcare remains a very risky investment area, fraught with disappointments. “I have many scars that I carry from looking at drug development companies,” cautioned Fazeli. “I cannot give you too many examples of successes.” Giovannetti confirmed that in drug R&D, “frankly, most things fail. When they win, they win big, but most things fail.”

Financial and strategic investors alike may not be fully aware of the whole picture of the opportunity set. “I would like to go away and do a full analysis of what the true opportunity for our companies in China is,” said Fazeli. “So many of the investments… are driven by the hope that the streets of China are paved with gold for them. This is not going to be an easy win here.”

Certain strategies are available to mitigate this risk. Both Fazeli and Giovannetti pointed to the possibility of starting with a lower-risk sectorial business and using this to fund R&D. “You can attract a broader class if you also have a revenue play,” said Giovannetti. But the essential safeguard for all VC investors remained careful selection of management teams, as well as the internal capabilities to help companies scale in the fast-growing China environment.

“The bottom line is the people, the CEO who can run the company,” said Li. “You can do as much due diligence as you want to; the thing you worry about the most is whether your company or your key managers will carry on and move it in the direction they promised.”

Chen cautioned that too much short-term excitement over the sector’s prospects could be self-defeating. “Please be long-term; this is a long-term industry,” he said. “Too much excitement about this industry creates a bit of a frothiness, and leads to short-term investments.”

There is no doubt that immense opportunities lie in the healthcare sector, but it remains to be seen just how investment strategies will unfold.

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• Topics
• Healthcare
• Venture
• Early-stage
• Greater China
• Norman Chen
• Nisa Leung
• FIL Capital Management / Fidelity Asia Ventures
• Qiming Venture Partners
• Kleiner Perkins Caulfield & Byers