Why China’s Looming Demographic Crisis Will Fuel Boom in Cross-Border Healthcare M&A
By Drew Bernstein, Co-Managing Partner, Marcum Bernstein & Pinchuk, LLP
Over the past five plus years the M&A markets in the U.S. have been at a feverish pace through the continuum while the activity may have slowed in 2017 it’s by no means over. Additional, the buyers are no longer just limited to U.S. operators.
In 2016 China emerged as the world’s most active player in cross-border M&A, with $225.4 billion of outbound deals, more than doubling the prior record of $102 billion in 2015 according to Dealogic. The types of assets Chinese buyers are seeking has shifted from primarily energy and resource plays a few years back to now focus on globally recognized brands and advanced technologies. But given the very powerful demographic dynamics in China, we should expect that healthcare is likely to become one of the most active sectors for both M&A and innovative partnerships in the years to come.
Exploding Demand for Healthcare
The United States is not alone with a shift in demographic, China’s right by our side. The combination of profound changes in demographics, wealth, and disease prevalence is predicted to cause Chinese healthcare spending to explode over the next few years from $500 billion in 2015 to $1.49 trillion by 2020 and $2.32 trillion in 2030.
China not only has to worry about “getting old before it gets rich,” it also needs to worry about getting very sick before it gets rich. Changes in urbanization, diet, and the environment are causing an epidemic of non-communicable “diseases of civilization” among Chinese citizens, including coronary disease, obesity, hypertension, diabetes, and auto-immune and respiratory disorders. As an example, the incidence of diabetes has gone from under 1% of the population a few decades ago, to over 10% of the population today. With 110 million diabetics and 500 million pre-diabetics, China now leads the world in this unfortunate condition and dwarfs the U.S. population of 29 million diabetics. Asthma now afflicts over 10% of the population in some Chinese cities, and China’s asthma mortality rate is the highest in the world.
As an increasing percentage of Chinese move to cities, both the disease burden and the expectation for better healthcare services have increased, meaning that the higher quality, Tier 3 urban hospitals have been flooded with patients. This is contributing to a fiscal crisis, given that 70% of healthcare expenses are fielded by provincial level governments, which only receive 30% of overall tax revenues. While the Chinese government has taken bold steps to extend health insurance schemes to now cover over 95% of the population, the majority of these plans have very high co-pays and stringent caps on annual benefits, meaning that the effective coverage is quite limited for those with chronic diseases.
Wealthier, urban patients have come to expect (and have the means to pay for) access to high-end private hospitals, advanced medical devices and treatments, and global pharmaceuticals. Private and foreign-owned hospitals currently serve just 10% of the population, but the Chinese government has set a goal of increasing that to 20% in order to promote adoption of advanced medical technologies, introduce new private insurance models, and relieve part of the fiscal burden from local governments.
China’s Demographic Time Bomb
The biggest driver of healthcare demand is China’s rapidly shifting demographic profile. China’s total fertility rate, even with the recent relaxation of the one-child policy, is now 1.05, or half the 2.1 rate required to sustain the population. As a result, by 2050 the cohort of working-age Chinese will decline by one-third, or 212 million people, while the population of those over 65 will more than double to 348 million seniors – which is more than the entire population of the United States. The same issues of declining workforce participation, spiraling medical costs, and inter-generational equity that have crippled growth in Japan and Europe will be several magnitudes more severe in China. This army of urbanized, ailing, but longer-living seniors is going to be dependent on a shrunken base of workers and tax payers to finance their basic healthcare.
Thus, the opportunity in the Chinese healthcare can really be thought of as two separate markets. On the one hand, there is a growing upper middle-class to wealthy population that is well-informed and is coming to expect access to developed world advanced medical care, potentially through private insurance schemes and hospitals. At the same time there is a gargantuan mass market that requires innovative, technology-enabled solutions that can drive chronic disease care down the cost curve and scale to patient populations in the hundreds of millions. There will be enormous opportunities for cross-border collaboration at both ends of this barbell shaped market.
Looming Industry Consolidation
China’s pharmaceutical industry, already the second largest in the world, is forecast to experienced continued strong growth in revenues in the coming years and surpass the size of U.S. by 2020, according to Frost & Sullivan. But price competition for non-differentiated, smaller-scale players is unbelievably intense – such that most of the 5,000 drug manufacturers can expect to be out of business within a decade. Consumer confidence in the safety and quality of Chinese manufactured drugs remains low. And the government is seeking to wean away hospitals from drug sales as their primary revenue model, given the impact on both over-prescription and corruption. Several companies have set up M&A funds targeting domestic competitors, with Shanghai Fosun and Sihuan Pharmaceutical snapping up hospitals to gain stronger control of the distribution channel. But to accelerate innovation will require looking outside China’s borders.
For this reason, an increasing number of Chinese healthcare companies are pursuing overseas acquisitions as a means to access world-class technology, trusted brands, and platforms to expand into overseas markets where profit margins are more attractive. Humanwell Healthcare Group, which makes anesthetics and contraceptive drugs, bid $550 million for U.S. generic drug maker Epic Pharma. Chinese baby formula producer Biostime paid $988 million for 83% of Swisse Wellness Group, an Australian vitamins & supplements company. China’s Creat Group Corp. paid $1.2 billion to buy Bio Products Laboratory Ltd., a UK manufacturer of human blood plasma-based products, from Bain Capital. Fosun Pharmaceutical Group Co. is spending $1.3 billion to acquire India’s Gland Pharma Ltd., which focuses on injectable drugs. The chairman of Luye Group Pharmaceuticals, which recently snapped up companies in Australia, Singapore, and Korea, has said the company is on a global shopping spree for specialty hospitals whose services can be replicated in the China market.
Whereas just a few years ago China’s pharmaceutical industry was largely inward-focused, having a viable “go out” strategy is fast becoming essential to a viable and profitable business. The sweet spot for such outbound acquisitions is currently for companies with $100 to $300 million in sales, but we can expect to see larger deals as Chinese buyers gain confidence and experience integrating overseas assets. Given the dramatically lower costs for drug development and trials in China and strong government support for developing the industry, such hybrid models have strong potential for success.
Sinofication as New Entry Strategy
While global healthcare players are enticed by China’s mouthwatering growth rates, developments in the last few years have also highlighted the risks of operating within Chinese distribution system in which most drugs are sold through state-owned hospitals, approval for new drugs can be very slow, and where the government aggressively pushes for price reductions and generic acceleration. Pharma companies including GlaxoSmithKline and SciClone have found that both the Chinese and U.S. authorities are eager to make examples out of multi-national companies that pursue distribution “incentives” to doctors and hospitals that are normal course of business for many Chinese companies.
As a result, overseas players may need to engage in partnership strategies that put a Chinese face on their operations in the PRC, while protecting their core IP and market position outside of China. For example, U.S. oncology company Juno Therapeutics partnered with WuXi AppTech to form a new company JW Biotechnology with at 50-50% ownership structure to develop cell-based immunotherapies specifically targeted to the needs of China market. These types of partnerships may prove the most effective way to leverage global innovation while tapping into government financial support and local market knowledge required to monetize new drugs in a very different market. The “Made in China 2025” plan that was promulgated by the State Council singles out both biotechnology and next generation medical devices as areas for investment.
Laboratory for Healthcare’s Future
The unique scale and economic constraints of China’s healthcare market have the potential to drive enormous innovation as the existing model of public hospital-based, drug intensive treatment simply cannot keep up with the collision of demographics, disease prevalence, and fiscal constraints. China will by necessity become a laboratory for the future of scalable, low-cost, automated approaches to diagnostics and treatment if it is to meet this emerging, multi-dimensional crisis.
This will create a multitude of opportunities for new technologies, new service models, and investment including solutions focused on areas including:
- Drug prescription management/cost containment.
- Health service delivery via mobile health and wearable devices.
- Long-term managed care facilities and businesses.
- Private hospitals for upper-tier “opt out” patients.
- Medical tourism for elective healthcare.
- Outbound acquisitions to bolster intellectual property, brands, & talent.
As a result, Morgan Stanley recently identified growth in healthcare market as the #1 secular investment theme for China. But as with everything in China, the devil is in the details. And the most interesting opportunities are likely to be for strategic investors who bring unique intellectual property to the table, are able to successfully develop hybrid sino-centric business models, and navigate the complexities of partnering and government relations. China’s entry as a major player in global M&A is a harbinger for a future larger role in shaping the economics of healthcare in both the developing and developed world. Healthcare players who fail to develop a China strategy quite simply lack a strategy for the future of healthcare.