April 17, 2018 — Three years ago, we unveiled the China Drug Innovation Index (CDII), prepared in collaboration with BayHelix in the context of the annual BioCentury China Healthcare conference.
The index highlighted progress and challenges facing the development of a healthy ecosystem to support China biopharma innovation. I covered some of the key findings in an article here on LinkedIn, “This is what experts tell us about China Innovation.”
As the environment continues to rapidly evolve, we will update the Index for the upcoming edition of the BioCentury Healthcare conference, to be held on November 13-14 in Shanghai.
Inspired by the insights and discussions triggered by the CDII, we decided this year to dig deeper into the dynamics of investment in the healthcare sector, by creating the China Healthcare Investment Index (CHII). We surveyed investors from leading PE and VC funds who have a unique viewpoint on what is really happening on the ground.
To explore this new angle, and in partnership with the 9th edition of the China Healthcare Innovation Conference (CHIC), we developed an index structured around the following dimensions: Attractiveness of China’s healthcare market, healthcare expenditure, regulatory environment for investment, deal financing, quality of assets, and capabilities.
The index was structured through discussions with several key members of CHIC, including for example, James Li, CEO of JW Therapeutics and one of the original founding members of CHIC. The index was also informed by a survey of over 20 leading investors in China’s healthcare sector. The list reads like a Who’s Who of the industry with an average experience of 10 years in China healthcare investment.
My colleagues at McKinsey, Florian Then and Fangning Zhang, both Partners with our Healthcare Practice in China, led the analyses behind the Index.
So what do the results show us?
1. There is ample access to money with fund-raising on a steep growth trajectory.
We estimate that the total amount of cash available through PE/VC funds reached $40 Billion in 2017, up from $4 billion in 2014, a 10x increase in just three years. The number of funds has increased significantly, from 48 in 2014 to 74 in 2017, but more strikingly, the average size of the funds has ballooned from $83 million to ~$540 million. Examples of large funds launched in 2017 include Eight Roads (Fidelity), Orbimed Asia, Quan Capital (Zai Lab), and Lilly Asia Venture’s fourth healthcare fund.
2. Money is being deployed rapidly but significant “dry powder” is available.
VC investment in China healthcare reached $12 billion in 2017, up from $1.7 billion in 2014. The number of deals supported reached 478 in 2017, up from 64 in 2014. This implies an average investment of roughly $25 million per deal. It also implies that many funds still hold ample dry powder to invest. Supply of money is great, but at some level implies that the competition for attractive deals is getting very intense. We would expect this to become even more acute, as more players, some with limited healthcare experience, jump into the game.
3. China remains a highly attractive market for healthcare investment driven by strong demand fundamentals.
By 2030, China’s urban population will reach 1 billion, of which more than 500 million will reach the middle class. China will have 100 million people aged 65 or older, bigger than Germany’s total population. China will face staggering disease burden, for example, at the current pace, China will have 300 million cardiovascular patients, 150 million diabetic patients, and the annual number of new cases of cancer will reach 5 million. Many Chinese patients are under-served today due to low disease awareness, low diagnosis, imbalanced healthcare infrastructure, and affordability barriers. As more Chinese enter the middle class, they will demand more credible health information, higher quality care, and a better patient experience.
4. The regulatory environment for investment in China remains relatively stable; domestic deals are easier to close than cross-border ones.
Not surprisingly, conducting local deals is easier than inbound deals, with outbound deals seen as most complex to pull off. This is partly driven by regulation. For example, in November 2016, the State Administration of Foreign Exchange (SAFE) lowered the threshold for outbound transaction approval from $50 million to $5 million, making it more challenging for Chinese companies to invest capital overseas. Chinese funds are setting up shop in the US; for example, Qiming Ventures Partners opened a US outpost in 2017.
5. Sources of value creation vary across healthcare sectors.
For the pharma and biotech sector, scientific and technological innovation, and fast followers with local relevant innovation, contribute to 90 percent of value creation. In the MedTech sector, however, fast followers with local relevant innovation and cost competitiveness contribute to 80 percent of value creation. In sharp contrast, 60 percent of value creation for healthcare technology (e.g., big data, analytics, AI) comes from disrupting the healthcare value chain.
6. Assets available are of mediocre quality, with some notable exceptions.
Too often, the programs being developed in China are copycats of well-established programs from developed markets. Breakthrough innovation is rare to non-existent. The implications of this is that investors are most likely to bet on a particular team rather than on a specific asset. This “me too” phase will be a transitional one, with leading Chinese biotechs aiming to move up the value chain towards truly innovative programs.
7. China has high quality entrepreneurs, yet the caliber of business and management leaders needs to be improved.
The energy and ambition of Chinese entrepreneurs cannot be understated. They hold high aspirations of transforming access to innovative healthcare for their fellow Chinese. However, real gaps exist in management capabilities and experience building a successful venture. Specifically, the ability to make strategic decisions and to building a high performance organization were highlighted by investors as key gaps to address. Funds in China may need to take a more hands-on approach to managing the development of the ventures.
Overall, the China Healthcare Investment Index paints a relatively bullish picture of the prospects for the industry, with some key challenges to address. Regulators are already taking action to address some of them, the opening of IPO markets in the Hong Kong Stock Exchange being a prime example.
But ultimately, the pace of development will be shaped by improvement in access for innovative drugs, the upskilling of Chinese entrepreneurs, and the continued flow of experienced R&D experts from more developed markets towards China.