As VC hesitates, capital markets cool, valuations correct, and scientific quality improves, big pharma has started making is first acquisitions in China biotech. It looks like the floodgates have opened. They have not

The quality of Chinese biotech has steadily improved in the past 15 years, largely thanks to the “sea turtles” phenomenon of returnee scientists and engineers who studied abroad. This was supported by significant government-backed incubation infrastructure.

By 2017, Johnson & Johnson’s USD 350m out-licensing deal with Nanjing-based cancer and cell therapies specialist Legend Biotech was hailed as a breakthrough in ecosystem internationalisation. The last two months have taken that traction to the next level.

In late December, AstraZeneca acquired Shanghai-based and NASDAQ-listed cell therapies player Gracell Biotechnologies in an approximately USD 1bn transaction touted as the first acquisition of a Chinese biotech company by a global strategic.

It provided exits for investors including Vivo Capital, Pivotal bioVenture Partners, and OrbiMed, which contributed to a USD 150m PIPE deal last August. Gracell raised around USD 200m in funding before its 2021 IPO from the likes of Lilly Asia Ventures (LAV) and Temasek Holdings, as well as Vivo and OrbiMed.

The following weeks have been coloured by excited speculation about a chain reaction in similar deals, or at least the idea that they could become routine. Earlier this month, Novartis acquired SanReno Therapeutics, a Shanghai-based kidney disease player that has raised about USD 40m in private funding.

For Novartis, this represented a buyout of the remaining interest in an existing joint venture between US-based Chinook Therapeutics (which it acquired in 2021) and a syndicate led by Pivotal and Frazier Healthcare Partners. Pivotal comfortably achieved a 2x return, according to Meng Gao, CIO of Nan Fung Group, the VC firm’s parent company.

The momentum was extended last week, at least in spirit, with Johnson & Johnson committing USD 2bn to acquire NASDAQ-listed Ambrx Biopharma, a US-based cancer outfit previously controlled by a Chinese consortium led by China Everbright and Hopu Investments. Ambrx still maintains significant Chinese operations, although WuXi PharmaTech is the last remaining investor from the consortium.

“I look at all the patent cliffs multinationals are facing in the next five years and the abundant dry powder on their balance sheets, it’s natural for them to snatch up some of the good assets in China and pursue deeper access into the China market,” Gao said.

“At the same time, for Chinese biotech companies, there’s a mismatch between cash balance and funding needs for clinical and commercialization efforts and a continued desire to be integrated into the global markets. I think this is a trend that is going to continue.”

Big picture

The fundamental drivers behind the M&A green shoots in China provide some evidence for this outlook.

On the buy side, multinationals have proven increasingly hungry for new molecules and consistently cashed up to bring them in-house. By 2030, global biopharma companies will see the patents expire on 190 of their drugs, 69 of which are considered blockbuster revenue drivers. In some cases, sales can fall 25% when copycat versions come into the market. Buying new ones is easier than developing in-house.

Big pharma firepower for global M&A amounted to about USD 1.4trn in 2023, on par with the past two years and noticeably above the sub-USD 1trn range of recent years, according to EY. Improved visibility in the interest rate environment in the US could encourage them to do more deals globally, including in China, where sentiment for biotech has proven resilient versus other sectors.

Global comfort and confidence in Chinese biotech is visible in licensing activity. China was generally seen as having surpassed Europe to become the second-largest exporter of biomedical innovation in terms of drugs going into clinical trials in 2023. PharmaCube estimated it was a record year, with 70 out-licensing deals. Local media has put that figure as high as 89, more than doubling the 2022 total.

This is partially attributable to a rapid decline in in-licensing, which has become a less reliable path to IPO following the introduction of stricter biotech listing requirements in Shanghai. This has left Hong Kong as the only path to IPO for many Chinese companies, but it hasn’t discounted the rise of out-licensing as a signal of international credibility.

“We’re taking so many meetings with big pharma players. They’re actively looking at China biotech to do in-licensing and acquisitions,” Judith Li, a partner at LAV, a spinout from US pharma giant Eli Lilly, said from the sidelines of the J.P. Morgan Healthcare Conference in San Francisco.

“We’re unique because we were born with a big pharma network, but just the sheer number of requests that we’ve got and the very senior level of people – it strongly indicates their interest in China. It really does feel like a renaissance. Even for us in the industry who live and breathe this every day. It’s exciting because it’s happened a little faster than we thought it would.”

Motivating factors multiply quickly on the sell side, most importantly in the notion that valuations are down. Gracell is an effective case in point. Valued at USD 6.2bn at IPO, its market capitalisation topped USD 2bn in 2021 before declining as low as around USD 100m. Li described valuations as “overcorrected.”

Crunch time

Pressures on valuations are arguably exaggerated in China, where biotech as an investment target remains relatively nascent and therefore less predictable. IPOs for pre-revenue companies are only a five-year-old concept in the country. They produced only five exits for private equity and venture capital investors in 2023, compared to 12 in 2022, 14 in 2021 and 10 in 2020.

Meanwhile, investment in China biotech reflects the global VC winter, amounting to USD 3.4bn in 2023, according to AVCJ Research. This is down 33% on 2022 and down 23% on the average for the five prior years.

Zhengchun Yu, a senior partner focused on healthcare M&A at AllBright Law Offices, which advised Gracell in the AstraZeneca deal, observed that many Chinese biotech companies are in a cash crisis, with neither public nor private markets able to provide sufficient funding for the industry. This is unfolding as the national medical care insurance programme aims to shift to more cost-effective therapies.

“China’s private medical insurance is also developing and is yet to be a significant payer for medical therapies. The Chinese market is yet to afford significant commercial values for innovative therapies under this situation. As a result, globalisation becomes the main goal for Chinese biotech companies for a better commercialization,” Yu said.

The funding crunch has come with some signs of countercyclical resilience, however. PE and VC investment in China biotech outpaced the broader healthcare space locally for the first time last year. Non-biotech healthcare investment totalled USD 3.2bn in 2023, down 50% year-on-year and down 68% versus the average for the prior five years.

“We believe that in the context of market uncertainty, increasing difficulty in biomedical R&D, and the capital market still being in the stage of wait-and-see and transformation, this [multinationals developing China pipelines] will be an important trend for global pharmaceutical companies in the M&A industry of China’s biotech in the next few years,” said Lilly Asia Ventures (LAV), head of life sciences for KPMG China.

“At the same time, we may also see more mergers and acquisitions and integration activities between biotech start-ups to achieve complementary resources, and to a certain extent, form industry integration and competition concentration.”

Some of China’s strengths in terms of biotech chemistry categories naturally mesh with global M&A appetite. Local hotspots in immunology and cardiometabolic diseases are likely to get hotter. Gene therapy and neuroscience are prospective. Cancer will be core, especially in antibody-drug conjugates (ADCs) and engineered cell therapies.

Multinationals needn’t see a deep pipeline and platform; one commercially viable and differentiated asset is enough. These assets must be substantively de-risked in terms of science, but early-stage clinical programmes are still of interest. Companies can be loss-making; Gracell and SanReno are both pre-revenue.

AstraZeneca, Novartis, and Bristol-Myers Squibb are commonly named among those most interested in China. Bristol-Myers agreed an ADC licensing deal last month with a US-based subsidiary of China’s Bioken Pharmaceutical worth USD 8.4bn if all milestones are met.

All change?

Chinse biotech-focused VC firm Triwise Capital makes a point of investing in “sea turtle” scientists to increase its appeal to foreign buyers. Still, it is in the process of launching a CNY 300m (USD 42m) fund that will back specific products rather than make company-level investments. Ideally, these products will be mature-stage or otherwise potential domestic M&A targets.

“We think M&A will be the primary exit strategy in the next three to five years,” Triwise founder Dajie Tang said, referring to the domestic M&A opportunity. “Internationally, the firm is engaging international pharmaceutical companies with disease-specific pipelines. Breaking from the single-project pipeline concept, we re-organised their portfolios by disease type, enhancing presentations to potential buyers.”

The prevailing expectation is that the current smattering of global M&A targeting China biotech will trend up slowly, gradually displacing licensing transactions in overall deal flow but remaining a fraction of the market.

As well as being a function of a depressed investment and IPO environment, the M&A activity in China is a confirmation that good science and intellectual property (IP) is now being developed domestically. But it remains to be seen if that level of quality output will proliferate and to what extent local companies will pivot toward more international strategies.

“The door has opened for multinationals, but China’s political and economic risks are still there, and there’s so much good science in the US and Europe, the Chinese assets have to be exceptional,” said Fabio La Mola, a partner at Bain & Company.

Long-term outcomes of global M&A entering the China biotech equation will include an evolution in ecosystem mindset. The presumed playbook of licensing with a view to going public will be rethought. There will be an education process on how to structure deals; confidence will grow as more examples trickle in.

As this unfolds, valuations will firm up. The prospect of more M&A coming to China will inspire entrepreneurs to ask for more. James Huang, founder of biotech specialist Panacea Venture, noted that these companies will need to consolidate to gain efficiency and scale in order to create more attractive companies.

“I know everyone is excited, but given we have more than 7,000 biotech companies in China and we’ve seen just a handful of these M&A deals, it’s just the beginning,” Huang said.

“That said, the fact that China biotech companies are thinking about how to go global is super exciting. They recognise that global pharma can be good partners, rather than the traditional thinking of raising capital through private equity, doing a large round, and trying to package the deal so when the market is hot, they can pitch to the market. They’re looking at other ways to become global.”

Avoiding obstacles

Some founders from acquired companies will start new ones, introducing the concept of the serial entrepreneur to China biotech. They will be more resilient and professional, thinking about international partnerships and manufacturing capabilities. As the best and brightest increasingly see global big pharma as their endgame, they will be less likely to develop domestic giants.

“In the short term, this is like a blood transfusion for China’s loss-making innovative drug and biotech companies, which creates good exit opportunities for investors,” Steven Wang, founder and CEO of Highlight Capital.

“But in the medium and long term, if local exit channels are not smooth and most of the valuable biotech assets are bought out by multinationals, China’s biotech industry will become just an R&D supplier for global companies. If that happens, we may not see large Chinese innovation-focused biopharmaceutical companies showing global influence and pricing power for a long time.”

It’s a reminder that despite biotech’s apparently minimal exposure to geopolitical risks, national agendas remain part of the calculus. Indeed, one investor told AVCJ he sees decoupling hurdles as the only realistic deterrent to increased global M&A targeting China.

The strongest suggestion that this will not happen is in the sheer demand for international capital in light of hesitant VC and IPO markets. Large domestic biopharma companies are not expected to fill this void due to insufficient cash; Nan Fung’s Gao estimates they could have as little as USD 20bn.

Indeed, the government identified biotech as a priority industry in a 24-point guideline last August aimed at improving the business environment for foreign investors. It includes ramping up local R&D projects, as well as the streamlining of clinical trial processes and registrations for drugs already approved overseas.

“Will there be a time when the government decides they’re giving up too much IP? Most likely. The question is how they react,” said one biotech advisor. “I don’t think they will stop M&A. I suspect they will push the local industry to do it instead of the global industry. That won’t happen immediately, but when it does, it will still be a meaningful exit route for VCs.”

[Editor’s note: Amended to clarify big pharma firepower for global M&A amounted to about USD 1.4trn in 2023.]