China Healthcare: In search of healthy returns?
By Kenny NG
The equity story underpinning this traditionally defensive sector has been largely the same – an ageing population and growth in healthcare expenditure. But is this a playground for everyone?
The statistics for healthcare in China tell an attractive story of growth: its per capita spending of USD 398 significantly lags the global average of USD 6,500, and with rising incomes and urbanization, the market looks poised to cross the USD 1 trillion mark by 2020. “We run around 500 sell-side transactions in China, and a huge portion of those are healthcare-related”, said Toto Ku, Head of China, Merrill Corporation.
Notwithstanding the growth potential from the abundant opportunities in the healthcare space, China has been late to the game, according to Li Huaijie, Partner at Oriza, a CNY 20 billion fund-of-funds manager which has been monitoring the domestic GP market since 2006. He attributes this partly to the inertia of local players to innovate within this space as compared to some of their counterparts in more mature economies, resulting in fewer healthcare investment opportunities in China.
In the last decade, the healthcare space started to see some light on the back of government initiatives to reform medical infrastructure, insurance system and liberalize the market. This led to the emergence of healthcare focused funds and a spectrum of related companies across the value chain. Li sees this trend as a promising sign.
“China has experienced golden age of growth for the healthcare sector in the past 7 to 8 years in terms of fundraising, deal activity and overall improvement in quality of healthcare businesses.”
The onset of technology and digitization of information has also created an entire ecosystem of opportunities for venture funds and aspiring companies looking to get a share of the health-tech space. John Yu, Managing Partner at MyTech, an innovation focused tech company, believes that the realm of healthcare goes beyond drugs and medicine, and feels that technology and artificial intelligence will continue to drive the sector and possibly disrupt other subsegments of the value chain such as equipment, diagnostics and operators.
Nicholas Lee, who leads Morgan Creek Capital’s investments in Asia, commented that a lot of talent has been transitioning back to China. The key to unlocking value is to identify the bottlenecks in the current healthcare ecosystem, and find the best professionals who have the relevant experience and the global network to pool those resources towards the Chinese market.
Marietta Wu, Partner at Quan Capital, an early stage healthcare focused fund, also cited that while government policies in the last 5 years has favored certain subsegments such as drug research and development, the barriers to entry tend to be higher as more specialized skillsets are required.
Going forward, she also feels that digital health is one other area to watch closely as it encompasses all aspects of the value chain, citing how Roche was able to obtain FDA approval on one of its products through the use of real world data during the drug development process.
A long race of financing to the finish.
Li commented that with the gradual maturity and evolution of China’s capital markets, many domestic healthcare investors and operators have found it reasonably easy to raise capital or “exit” their stakes through listing on the local exchange or Star Market. However, on offshore exchanges such as the US or Hong Kong, the same approach can be challenging due to differences in pricing expectations. The rich valuations apparently seen in the onshore market are driven in part by overarching government policies favouring investment in homegrown healthcare operators.
Marietta has a somewhat different view of the pricing and market dynamics of healthcare companies. Using NASDAQ as a reference, she says that the valuation premiums seen of healthcare stocks in the US are partly attributed to greater analyst coverage and the diversity of the market’s investor base. And, listing on the NASDAQ for some companies is sometimes seen as an avenue for getting access to alternate pools of capital, rather than an exit strategy for investors.
“In some sub-sectors such as drug development, the investment horizon can last for many years, and companies may go through multiple rounds of financing from investors at various stages of their development life cycle.”
Marietta likens this to a relay race whereby the ‘baton” is being passed from one investor to another, no one really runs the entire length of the race i.e. sees through the entire lifecycle of the healthcare company from start to end. The ultimate goal is often always to create a product that will eventually be sold and used by one of the pharmaceutical giants. Because of this, she believes that most exit deals in the healthcare space are trade-sale driven rather than via an IPO.
In China’s healthcare: The entry drives the exit.
Steven Wang, CEO and Founding Partner at healthcare focused private equity fund, Highlight Capital, believes that a good exit is defined by the quality of the entry, and the key lies in deal sourcing and target company selection.
In addition to understanding the company’s business model, one must also be knowledgeable in the field, adopt a well-grounded and realistic view during the due diligence process, he said.
“Don’t invest in what you do not understand.”
Some of Steven’s greatest takeaways over the last few years, he says, are the key competencies acquired by his team at Highlight Capital as subject matter experts in various subsectors of the healthcare space. This has enabled the firm to source and negotiate for quality deals at the right valuations.
John Yu also believes that healthcare exits in China can be challenging and stresses that it is more important to focus on the commercial viability of the business rather than depend on government policies to drive the premiums on valuation.
So, a framework for due diligence in the healthcare space?
According to John Yu, due diligence for healthcare companies across geographies should largely be the same. Where they differ comes down to the lifecycle stage of the companies.
“In early stage deals, the founders and team take centerstage, while in more mature companies, more weight is being placed on the financials, competitive landscape and sustainability in growth”
Marietta believes that people are the most important aspect of the company regardless of which point of the company lifecycle they are at. In addition, it is also important to ascertain whether or not the company has a key differentiating factor compared to its competitors.
While the principles of due diligence can be applied to most other businesses, investors looking at the healthcare space will probably need to augment their standard checklists with additional industry specific questions, figure out when and how technology will be disrupting the business, and from time to time, engage the resources of external consultants to get the holistic view before taking that leap of faith.
Investing in healthcare appears to be daunting, especially if you do not understand the technicalities and complexities of the sector. But those with the domain knowledge, access to resources and the grit to see through the commercialization and growth of the business, will eventually emerge as winners in a long-term game.