China's healthcare sector gets capital injection

Foreign companies and local players are looking to expand in China's underdeveloped healthcare sector. But will they enjoy the returns they expect without an overhaul?

China’s economy is growing at its slowest pace since the global financial crisis and is on track for its worst annual performance since the 1990s. Relatively few sectors look particularly appealing in that environment.

Healthcare is one of the exceptions.

A deluge of capital has poured into the sector this year, courtesy of new listings and investment funds, even as outbound acquisitions have hit a two-decade high.

“The soil for the sector’s development is different [than most other areas of the economy],” Kevin Chen, a partner at Sequoia Capital China who focuses on investment in the healthcare sector, told FinanceAsia. “With the government support, emergence of healthcare talents, and the development of China’s capital markets, the sector has become burgeoning and innovative.”

Sequoia Capital, a Silicon Valley-based venture capital firm, teamed up in November with Irish medical equipment manufacturer Medtronic to set up a China-focused medical technology investment fund worth $60 million.

The sector is hot. Foreign companies are keen to get in, while local companies want to expand and consolidate. But healthcare is also immature, underdeveloped and in need of an overhaul. Without a shot in the arm, investors in China’s healthcare industry may fail to realise the high returns they expect.

Need for reform

China’s healthcare industry has barely got going. Healthcare expenditure accounted for just 5.6% of the country’s GDP in 2013, compared with 17.1%, 11.7%, and 10.3%, respectively, in the United States, France and Japan, according to the World Bank.

The sector is badly organised. Problems range from overpriced but low-quality medical care products and overcrowded city hospitals to long-running tensions between the country’s medical professionals and patients. Chinese media have reported several violent incidents over the past few years, in which doctors and nurses have been seriously injured or killed by patients or their relatives.

The government is stepping up efforts to overhaul the sector nationwide. Firstly, it is throwing money at it: state spending is set to hit $1 trillion in 2020, up from $357 billion in 2011 – making China’s the second-largest market globally after America’s, according to McKinsey.

Private spending is also increasing thanks to China’s aging population, its expanding middle class and rapid urbanisation, improving access to healthcare services.

“China’s expenditure on healthcare used to be at a relative low level. As Chinese people become richer, they naturally care more about health. The pie for the whole industry is getting bigger,” David Li, healthcare analyst at Bocom International, told FinanceAsia.

The Chinese government has vowed to deepen healthcare reform. As part of its proposed 13th five-year plan, announced in early November, Beijing called for the building of a standardised healthcare and hospital management system for both urban and rural areas. It also encouraged private and foreign capital to invest more actively in the sector and promised to treat privately run institutions as equal to their public-owned peers.

In July, the central government also promised to implement a critical illness insurance system that covers almost all citizens by the end of this year.

Consolidation craze

Government spending and private demand is supporting the rapid expansion of healthcare businesses and services, making it a popular destination for portfolio money.

Biostime bought Swisse Wellness

Chinese healthcare groups with deep pockets are pushing for greater consolidation in the domestic market through mergers and acquisitions or “going out” to purchase good-quality assets worldwide.

China has so far this year completed 51 healthcare-related outbound acquisitions worth a total of $2.8 billion, up from just $1.1 billion and 15 transactions in the same period last year. This year has also set record highs in terms of deal volume and deal number since Dealogic’s records began in 1995.

For instance, Guangzhou-headquartered infant formula manufacturer Biostime International acquired Australian vitamin maker Swisse Wellness Group for $904 million in September, making it the largest-ever outbound healthcare-targeted acquisition.

“Unlike other sectors, such as TMT, the growth cycle is usually longer in healthcare,” which lends itself to growth via M&A,  said Sequoia’s Chen.

In the home market, consolidation appears to be taking place at a furious pace. By early December, 256 transactions worth $40 billion have been completed, versus 225 deals worth $9.05 billion that were concluded over the same period of 2014.

According to Zhang Ning, a Beijing-based partner at the US law firm Orrick, Herrington & Sutcliffe, domestic M&A transactions, mainly triggered by industry consolidation, are “more mature and complex” and could reshape the industry landscape.

“Chinese healthcare firms’ overseas acquisitions are still more or less about buying assets, technologies, or resources. But in the home market we’ve seen M&A transactions between leading players as a way to gain bigger market shares. It’s more about consolidation,” Zhang, who focuses on China’s TMT and healthcare industry, told FinanceAsia

One example emerged in late November, when leading preventive healthcare provider iKang Healthcare Group announced it had received a non-binding $1.5 billion acquisition offer from a consortium of investors including its main local rival, Meinian Onehealth Healthcare.

“As the consolidation just starts, we will see more M&A activities in the sector next year,” Zhang said.

Healthcare goes public

Chinese healthcare companies are also flocking to the mainland Chinese and Hong Kong bourses for initial public offerings to help replenish their coffers with fresh equity capital.

Dealogic data shows 26 firms from the sector have listed in Shanghai, Shenzhen, and Hong Kong so far this year, raising a total of $3.8 billion. In spite of the recent four-month ban on IPOs in mainland China, now ended, that is still more than double the amount of capital raised by 11 healthcare firms in the same period last year.

Among the listings this year is Wenzhou Kangning Hospital, China’s largest private psychiatric hospital operator by revenue. It raised $88 million through a Hong Kong IPO in November, and posted one of the territory’s best market debuts of the year, jumping by nearly 30% on its first day of trading.

Coming up through the IPO pipeline are a number of Chinese healthcare companies, notably BeiGene and Beijing Konruns Pharmaceutical. Both are Beijing-based makers of cancer drugs.

China is forecast to spend $150 billion to $180 billion on drugs in 2020, mostly on cancers and rare diseases, representing a 6% to 9% compound annual growth rate, according to IMS Health. The global growth rate is 4% to7%.

Then there is the case of the Chinese healthcare companies listed overseas, which like many of their technology counterparts are keen to return home for higher valuations and trading volumes.

More deals are imminent

According to Dealogic, 26 US-listed Chinese firms have announced plans to de-list their shares this year in deals worth $31 billion. Four of them are healthcare companies, with WuXi PharmaTech being the most notable.

The Shanghai-based research and development service provider, whose clients include many of the world’s largest pharmaceutical and biotech companies, announced in late November that its shareholders had approved its $3.3 billion “go-private” deal.

That represents the second-largest take-private of a US-listed Chinese company after Qihoo’s on-going $9 billion buyout offer, according to Dealogic.

Unsurprisingly, a number of investment banks are beefing up their healthcare-focused teams to seize the business opportunities.

For instance, China Renaissance, a Beijing-based domestic boutique investment bank that has focused on technology firms for years, is set to expand its healthcare practice from 10 people now to 30 in the next two years.

Wall Street heavyweights such as JP Morgan are also recruiting.

“Investment banking activities have picked up in the healthcare sector, although companies are mostly small to medium in size, and we see this trend continuing,” John Hall, the US bank’s co-head of Asia TMT, healthcare and M&A investment banking, told FinanceAsia. “We are adding resources to this area.”

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