China: Life sciences deals flourishing, but it’s largely a domestic story
- The value of life sciences and health care transactions in China increased by 28.8 percent in Q2 2020 compared to the previous quarter.
- Among the areas garnering the most interest were telemedicine, digital health, and vaccines and other biological products.
- Protectionist regulations implemented in major parts of the world amidst the pandemic are likely to restrict foreign direct investment in China for the time being, but the long-term opportunity in the life sciences space is still quite attractive as China seeks to liberalize its markets.
Like the rest of the world, China’s M&A activity has cooled as a direct result of the COVID-19 pandemic. Outbound deal volume in the second quarter fell 25.3 percent from the same period a year ago and inbound transactions fell 4.6 percent.
China’s burgeoning life sciences and health care industry was similarly affected. The value of life sciences and health care transactions fell by 20.4 percent to US$4.85 billion for Q2 2020 year-on-year, though the sector still saw a 28.8 percent increase on Q1 2020. However, the real story lies in the deals’ location of origin – inbound life sciences and health care transactions fell a precipitous 84.2 percent in H1 2020 compared to H2 2019, well outpacing the global decrease across the industry. A combination of protectionist regulations and tighter trade policies elsewhere, along with increasing interest among Chinese buyers, has tilted the scale toward domestic deals, particularly in some areas which are gaining renewed interest amid the pandemic.
Treating the virus
Within the industry, three areas are drawing intensifying interest as a result of the pandemic. Telemedicine and digital health is one. Use of online medical platforms was already on the rise in China before COVID-19 and had been expected to reach nearly 60 million users by the end of this year, according to Beijing-based think tank EqualOcean. But daily active users on major platforms ballooned after China’s National Health Commission on 2 February 2020 issued a notice calling on health authorities at all levels to strengthen the use of digital solutions to support the response to COVID-19. One of the more popular platforms, Ping An Good Doctor, for one, saw new registrations rise tenfold in the two-week period ended 6 February 2020.
Companies that make artificial intelligence-powered medical devices are also seeing increased attention. Chinese hospitals’ AI-related IT spending jumped 88 percent in 2019. And so far this year, AI-enabled diagnostic imaging and treatment has become increasingly relevant for COVID-19 patients. Chinese-made devices are being deployed not only within China to support the treatment of the virus, but also in Italy and Japan. Based on instructions from the China National Medical Products Administration, the Chinese Center for Drug Evaluation has introduced guidelines for fast-tracking the regulatory process for COVID-19 diagnostic kits. This has helped push through regulatory approval of AI-aided diagnostic tools that can evaluate chest CT scans in a matter of seconds.
Finally, another area in which acquisition interest is piquing is biological products. China is leading in the global race to develop a COVID-19 vaccine, with half of the vaccines that have already gone into clinical trials originating in the country. The Chinese government has committed hundreds of millions of dollars and cleared regulatory barriers to accelerate vaccine research and development, and domestic drug makers have begun ramping up production capacity.
Protectionist policies punch the brakes
Much of the attention is coming from buyers inside China. Domestic private equity firms, for instance, are sitting on approximately US$350 billion in uninvested capital and are eager to put it to work. While Western funds are still raising Asia-focused funds, U.S.-China trade tensions have had a damping effect on overall activity. Some private equity-invested companies in China have found themselves embroiled in technology-related controversies.
The United States and China signed their Phase One trade agreement in January, which reduced some U.S. tariffs on Chinese goods in exchange for Chinese pledges to purchase more American goods. Still, there are growing concerns that the drop in demand related to the coronavirus has meant China will not be able to meet the Phase One requirements, and increasing divergences between the two countries in a number of areas may mean that the remaining phases of the deal might fall apart. U.S. companies have less confidence that they will be able to manufacture products in China and market them back home without paying hefty tariffs or becoming caught in the crossfire.
Since the pandemic, many governments across the globe have moved toward a more protectionist stance in order to safeguard their domestic healthcare industries, and they also have begun to openly question the extent to which their supply chains directly or indirectly rely on China.
In March 2020, the European Union issued new guidance ahead of binding, EU-wide regulations on foreign direct investment (FDI) set for October 2020. It recommended a new screening system to address “increased risk of attempts to acquire health care capacities” through FDI, including companies that produce medical or protective equipment, and research establishments that develop vaccines and other drugs. EU member states were also authorized to retain “golden shares” with veto rights in order to block or set limits on certain types of investments. A month later, Germany followed suit by increasing its scrutiny of FDI, with a particular focus on the life sciences and health care sector. Australia has also, at least temporarily, tightened its rules on foreign takeovers amid concerns that strategic assets could be sold too cheaply as a result of the COVID-19 crisis.
In the United States, while national security scrutiny has historically focused on outbound deals, more recently we have seen increasing regulatory scrutiny of inbound FDI deals in China as well. Panelists on the Committee on Foreign Investment, which reviews transactions for national security threats, required a U.S. manufacturer of exoskeletons to end its joint venture with its Chinese business partners. The oversight panel has been increasing scrutiny on outbound business deals between U.S. companies and Chinese investors in recent years, but this was reportedly the first joint venture based in China to be prohibited. CFIUS concluded it was "unable to resolve the national security concerns with respect to the joint venture,” but the exact reasons for the decision are not publicly known. One clue can perhaps be found in the fact that the company, which makes wearable machinery that helps injured workers cope with physical disabilities and can help soldiers carry heavy loads, states on its website that it provides research to support R&D projects intended to benefit U.S. defense capabilities.
In short, there is a lot more tension between China and its main trading partners. This is making cross-border tie-ups in the life sciences and health care space increasingly challenging. However, one area that appears to be booming is the cross-border in-licensing sector. Companies in Europe and the United States have seen an opportunity to generate a royalty stream by licensing the development, manufacture and commercialization of a drug or therapy discovered in those jurisdictions to a Chinese licensee. The premise is that China’s large population, and specific susceptibilities and needs within it, may mean that orphan drugs or drugs with a more limited home market may find a second lease on life in China.
China’s growing need for foreign investment
The growing obstacles to foreign investment in China come at an inopportune time for the country, which has been trying to reduce its reliance on domestic consumption as a driver of its economy. As Beijing-based Hogan Lovells M&A Partner Liang Xu pointed out in a recent Deal Dynamics article, China is working to liberalize markets and grant more access to foreign investors, including the publication of a new 2019 law seeking to protect foreign investments.
So, while the near-term outlook may have been significantly clouded by the coronavirus pandemic and government responses to it, the longer-term opportunity remains within the life sciences and health care sector in China. Meanwhile, there are a host of Chinese companies looking at depressed markets and currencies around the world and concluding that now is the time to go hunting overseas while assets are still relatively cheap.
Whether you are a Chinese buyer looking to navigate the increased regulatory scrutiny on outbound deals or a foreign investor seeking to do an inbound deal with a Chinese counterpart in the life sciences sector, the need for regulatory insights covering both sides of the transaction is greater than ever before. Given the sensitivity of technology at the moment, it may make sense to refocus attention on the less controversial types of inbound deals, such as ones focused on pure licensing, development and manufacturing in China, rather than the more technology-heavy type deals which remain under the regulatory microscope.
Those seeking to sell businesses in Europe and the United States are still likely to be targeted by Chinese buyers, although they now tend to be more wary about doing deals in markets where national security reviews loom large. Sellers would be well advised to get familiar with the Chinese outbound investment regulatory process and to give early consideration to the relevant national security rules, so that these can be worked into the transaction timeline and documentation at an early stage. That way, everyone knows where the completion risks lie, and can make informed decisions accordingly.
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