Booster effect

Chinese drugs firms prepare for IPOs


CR Pharma: hopeful about a Hong Kong listing

Watsons dates its founding back to 1841 with the opening of the Hong Kong Dispensary. Now a unit of Li Ka-shing’s CK Hutchison Holdings, it celebrated its 175th anniversary at the turn of the year. But the inconvenient truth is that Watsons is even older than that, says Hong Kong market watcher David Webb. Having operated as the Canton Dispensary in Guangzhou since 1828, the chemist moved to Hong Kong as a result of the First Opium War. Thus what Watsons has really been celebrating is Hong Kong becoming a British possession, Webb suggests.

Watsons now operates the largest drug store chain in mainland China nonetheless, with about 2,500 outlets and revenues of almost $3 billion. As Chinese spending on health products and medical treatments grows towards developed country levels, it looks set to prosper further. And the same trend is spurring on pharmaceutical producers and distributors with much briefer histories, many of which have plans to float on the Hong Kong Stock Exchange

That might seem strange after a period in which the share prices of listed groups such as Sinopharm and CSPC Pharmaceutical have underperformed the benchmark indices. All the same, the newcomers have been clamouring for an IPO in the city since the start of the year, with total proceeds expected to amount to as much as $7 billion, which would give China’s aircraft leasing companies a run for their money as the exchange’s top IPO sector in 2016.

The largest debut is purportedly a $3 billion listing by Jiangsu Hansoh Pharmaceutical, which would eclipse Shanghai Pharma’s $2.06 billion IPO in May 2011 as the sector’s largest in Hong Kong. Hansoh Pharma is vertically integrated across R&D, manufacturing and distribution for oncological, antibiotic, psychotropic and anti-diabetic drugs.

The second IPO in the pipeline is CR Pharma, which expects to be spun off as the listed entity for China Resources’ healthcare operations. It is also vertically integrated across the industry and it already has three listed entities in China: CR Sanjiu, which is responsible for the popular cold remedy brand 999; Dong-E-E-Jiao, which manufactures and distributes the health tonic E-Jiao; and CR Double-Crane.

Last year CR Pharma made net profits of HK$5.4 billion ($690 million), which suggests an IPO of $1.5 billion to $2 billion based on a forward earnings multiple in the low teens.

CR Pharma ranks as China’s second largest drug manufacturer and distributor and its ninth largest retailer. Its main comparable is Sinopharm, which has a 16% market share among distributors.

Third in line for a debut in Hong Kong is Simcere Pharmaceutical, which was taken private from the New York Stock Exchange for $495 million in 2013 by its chairman Ren Jinsheng and a group of investors including Hony Capital and Shanghai Fosun Pharma. The Nanjing-based firm manufactures generic drugs.

Similar in size is Xiuzheng Pharma, based in northeastern China, which is said to be hoping to raise $1 billion in an IPO of its own.

Longer term the demand for the leading pharma firms in China looks assured, buoyed by increases to the relatively low proportion of income currently spent on drugs compared to countries in more developed parts of the world, as well as the harsh realities of China’s rapidly aging population.

According to Zhijie Zhao and Yumeng Wang at HSBC, 14.5% of the Chinese population will be older than 65 by 2020 and the proportion will move past 30% by 2050. That means longer queues among the elderly for medical care. Zhao and Wang have just reported an unexpected increase for in-patient numbers, for instance, linking the spike in activity to the baby boom of the early years of the People’s Republic after 1949.

Chronic afflictions such as cancer, diabetes, Alzheimer’s and heart disease are also becoming more likely, they say, because lifestyles are getting less healthy as people get wealthier.

How each of China’s pharma firms is going to benefit from these trends depends on where they feature in the industry value chain. Some are drug producers like Jiangsu Hansoh and Simcere Pharmaceutical, or CSPC, which produces a range of remedies for patients, including treatment for strokes, the leading cause of death in China (1.3 million people have strokes annually, although not all of them die).

Others are more focused on distribution, such as Sinopharm, which connects drug makers with dispensaries in hospitals and health centres. Companies like Watsons concentrate mostly on retail sales.

Despite the positive horizons for the drug makers in the longer term, the short-term outlook is less inviting. More than 20 provinces are currently completing their public bidding for drug supplies, for instance, when they typically force the drug makers to cut prices for sales contracts with hospitals and clinics. China’s aging population is also putting more fundamental pressure on prices in general, says HSBC. Currently, pensioners don’t pay any insurance contribution once they retire. But the sheer number of older people means that the model is unsustainable, especially as more of them begin making medical claims.

So after a decade of massive increases in spending on government healthcare, the State Council is now pursuing ways of reducing costs, including erasing the 15% mark-up charged on sales by public hospitals, forcing administrators to bulk-buy drugs through a smaller number of suppliers, and ordering provincial governments to monitor reimbursement claims more thoroughly.

Another factor in shaking up the industry is the first revision (in seven years) of the National Reimbursement Drug List – the list of medicines covered by public health insurance. That means that newer drugs or more effective versions of older ones will go onto the list, boosting their commercial prospects. Another positive for some of the drug makers is that the government is increasing health insurance payouts for people suffering from severe diseases, which will benefit the firms with products in these particular areas.

In the past, the approvals process for new drugs has also been slow with new treatments taking five or six years to move through the queue. Policymakers have committed to speeding this up and say they will fast-track approvals for selected patents and generics. Standards are also being improved for clinical testing, which will benefit the better-funded firms.

Some of the patent owners will be better positioned to protect their margins during the bidding with health authorities. One example is CSPC, the owner of NBP, a pioneering drug treatment for strokes. As the first homegrown remedy for cerebrovascular disease, the drug is patent-protected.

HSBC says that prices for the drug have been reduced by just 3% in the current tendering rounds, compared to 15-20% for more generic drugs.

Price cuts at some of the drug makers shouldn’t hurt distributors like Sinopharm much either. Indeed, larger producers will want to expand their sales volumes if their margins decline, and they may well turn to the bigger distributors like Sinopharm because of their wider reach.

In fact, the pharma industry is getting less fragmented with the market share of the top 10 Chinese companies increasing from 14% in 2012 to 20% last year. As competition gets more intense, some of the smaller operators could struggle to survive. The larger firms may try to swallow up their smaller rivals, and consolidation could pick up pace across the sector. Hence the rush for initial public offerings this year, perhaps, as companies look for the financial firepower to strengthen their positions.

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