China healthcare: The specialists
On the back of reforms and a rising consumer class, China's healthcare sector is expected to see huge growth. Sector specialists have emerged to capitalize on the opportunity. How can they differentiate themselves?
China-focused Lilly Asia Ventures (LAV) tapped external capital sources for the first time when it spun out from global pharmaceutical firm Eli Lilly in 2011. However, the GP did not consider itself as a first-time fund.
Between 2008-2010, as a captive corporate VC arm, Lilly Asia made investments worth $50 million. On becoming independent, the existing portfolio was packaged into Fund I, and then Eli Lilly was the sole LP in the $100 million second vehicle. Fund III closed in April at $300 million, with Eli Lilly once again participating at anchor LP alongside a mixture of sovereign wealth funds, fund-of-funds and family offices.
The new fund will invest $5-25 million in 20 growth-stage companies, with 75% of the corpus earmarked for drug development and the rest going into medical devices and diagnostics with a clinical angle. "Everything we touch has a heavy dose of scientific expertise behind it. In order to survive in that kind of deal sourcing environment, we should have a team that's fully specialized," says Judith Li, a partner at LAV. The firm has 10 investment professionals with healthcare industry backgrounds.
Traditionally, China healthcare investments have come from generalist funds, but as the private equity industry matures, at least five sector specialists have raised new pools of capital in the last two years. They include Sino-US plays Vivo Capital and OrbiMed Advisors, China life-science focused BVCF and first-time fund HightLight Capital. Ally Bridge is raising for the second fund, while newly-formed Aequus Asia Capital Partners is also seeking capital.
Industry participants expect this trend to continue as more GPs seek to differentiate in terms of team structure and investment thesis. Are LPs buying into their stories?
Being different
Steven Wang, a partner at CDH Venture, left the firm in last May and set up HighLight alongside Jason Zhao, previously a healthcare specialist at SoftBank China Venture Capital.
The firm closed two vehicles last September - a $200 million US dollar-denominated fund and RMB1 billion renminbi fund. Sequoia Capital is an LP in the offshore vehicle, alongside family offices and fund-of-funds. Chinese entrepreneurs and corporates contributed capital to the local currency vehicle. HighLight has already invested in 14 companies, stretching from mobile health technology to traditional drug manufacturers.
Although there are more healthcare-focused GPs in China, Wang says the number of high-quality teams is limited. While many managers have sector expertise and experience with international pharmaceutical firms, they may not be suited to operating independently, strategic planning, deal execution and team leadership.
"They are professional but not everyone is business savvy," says Wang. "In the healthcare investment world, you need talent and experiences. You come across many failures and stand out because of your personal strength. That's the same in the TMT [technology, media and telecom] sector. There are more GPs in TMT than in healthcare, but good deals still go to relatively few managers."
We can't overestimate our ability to find the cutting-edge technologies to feed the entrepreneurs. That's not our job. Those entrepreneurs work in the industry every day, so they can do it themselves - Steven Wang
Compared to TMT, healthcare businesses take longer to build and Chinese entrepreneurs are therefore picky about which PE firms to work with. Several GPs have developed cross-border investment theses in order to emphasize their value-add capabilities. Ally Bridge, for example, has a strong focus on overseas M&A and has built up 20-strong team, split between China and the US, all of whom have biotech experience.
"Some top companies in China come to me and say, ‘We don't need you to help us in China, but how can you help us find cutting-edge technologies in the US?' That's a good question," says Frank Yu, founder of Ally Bridge. "The US is by far the dominant global player in life sciences. How can one really understand the sector without being familiar with the US market? But most funds in China do not have a remit to invest outside their home market."
Yu adds that founders come to Ally Bridge and they create deals together. Wuxi PharmaTech, a China-based provider of contract R&D services to the global life-science sector, for instance asked the GP to lead a consortium backing a $3.49 billion privatization of the company. Boyu Capital is also involved in the deal, which is likely to be the largest ever healthcare buyout in China.
Ally Bridge sees this as an example of how sector expertise can translate into opportunities of all sizes, from venture capital to buyouts. The firm plans on launching a hedge fund that will invest in every stage of the healthcare lifecycle.
However, HighLight's Wang argues only 10-20% of deals have a cross-border angle. "We can't overestimate our ability to find the cutting-edge technologies to feed the entrepreneurs. That's not our job. Those entrepreneurs work in the industry every day, so they can do it themselves. Our job is to find and support the bravest and most aggressive founder," he says.
Risk factors
On the pharmaceutical side, LAV also adopts an "in China, for China" strategy, investing in domestic drug developers that can bring mid-tier technology from develop markets into China. These investments have great market potentials and less technical risk.
"In the US, on adverage, of every 10 drugs being developed in clinical pipelines, nine will fail. In China the success rate is as high as five out of 10. The fundamental science has already been proven in developed countries, such as the US and Europe, so there is less risk. Within those five out of 10 possibilities, if you can find the right management teams to back, the success rate will rise dramatically," Li says.
Different investment strategy requires different skill-sets, and LPs are willing to provide capital to GPs that can demonstrate domain expertise and a relevant track record. The healthcare opportunity in China is undeniable, but managers have to show they can access it.
"You're seeing a lot of new GPs coming out to the market with a focus on healthcare. Some of them might not be able to survive in the long term if they fail to prove their capabilities with good performance," says Mingchen Xia, a Hong Kong-based principal in Hamilton Lane's fund investment team. "But from a broad perspective, the industry itself is sustainable."
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