Curb Your Enthusiasm: Chinese Pharmas Going Global Hit Speed Bumps

Ambitious and confident Chinese pharmaceutical buyers have begun to enter a new brave world of foreign M&A. However, this scenario can be littered with internal challenges and increasingly external scrutiny, less solid pre-deal asset identification and poor post-deal execution, all of which can damage their barely gained credibility, creating hurdles for future deals.

They come with big ambitions, and a deep pocket. Only to be met by potential acquisition targets who have concerns and second thoughts. The trend is nevertheless evident – the outbound investment from China is going up, year after year.

China's foreign direct investment (FDI) increased by 18.3%, reaching a record high of $145.6bn in 2015, which puts the country after only the US in the world, according to an annual FDI report released Sept. 22 by China Ministry of Commerce, National Statistics Bureau and State Administration for Foreign Exchange (SAFE).

The growth is the thirteenth in a row. By the end of 2015, China Inc. had a total of $4.37tn in capital outside China, according to the official report.

The healthcare sector, for one, has seen a steady increase of deals in which Chinese companies acquire or invest in overseas assets.

In 2016 alone, several such high-profile deals were inked, including Luye Pharma Group Ltd.'s acquisition of Swiss Acino Holding AG's transdermal business for roughly $267m, and Fosun International Ltd.'s $1.26bn purchase of Indian Gland Pharma Ltd.

Other less prominent ones include Shenzhen Hepalink Pharmaceutical Co. Ltd.’s acquisition of US biological contract manufacturer Cytovance Biologics Inc. for $205m.

M&As aside, overseas expansion is rising rapidly. Jiangsu Hengrui Medicine Co. Ltd. subsidiary Hengrui Therapeutics Inc. completed what is believed to be its Series A round from HR Bio Holdings, a joint venture created by Hengrui and an undisclosed US blue chip investment firm.

The ultimate goal for the Chinese pharmacos is a global presence, and an eventual place among the world's top 100 pharma companies. (Also see "China Firms Eye Alliances, Global Markets To Become ‘Next Takeda’" - Scrip, 8 Sep, 2016.).

By the end of 2015, China Inc. had a total of $4.37tn in capital outside China

The new crop of outbound M&As from China is aimed to "access new profit pools, capture new markets, and tap the skills of globally competitive leaders. Acquirers also view outbound M&A as a way to obtain cutting-edge technology as well as brand and management experience in overseas markets." noted analysts at Boston Consulting Group in its report on the subject.

However, the pathway is much more complex requiring more expertise beyond Chinese pharma's ambitions and newly gained confidence, experts cautioned.

The challenges come from three fronts: pre-deal asset identification, deal-closing process and post-deal execution.

Buyers' Burden

When it comes to asset identification, a gap exists between Chinese acquirers and foreign sellers.

Chinese companies are more likely to look for single assets, usually in areas considered to be hot, and work with companies that are already known.

Luye's acquisition of Acino, for one, is aimed to acquire a new system combining the latter's transdermal technology with its own new reformulations, said the company VP for international M&A and investor relations, Sammy Jiang.

Despite the promises, a more seasoned approach expanding from single assets to long-term cooperation is likely to yield more results, noted Jin Wang, venture capital partner at Shanghai-based Jianxin Capital.

"Not limiting to single product and its profits, and examining the subject company's fundamentals and prospect, will likely to deliver more surprising benefits via capital investment cooperation." Wang wrote in a March article.

The role for a middleman is also necessary and needs developing for Chinese buyers. A right middleman allows buyers to proactively scout potential assets, going beyond what they already know or familiar with.

Jiang said Luye started getting to know Acino since 2012, and the familiarity helped to seal the deal. Such ability to "name the names" of desirable companies shows that buyers need to have clear strategic targets, she added.

In the US, bankers' perception of buyers from China is now very skeptical, which is fair, they appear to be aggressive [in the beginning] but it failed to go through. – M&A director at an Investment Bank

Additionally, a blessing from the boss is usually enough to get it done in China, particularly for private companies, it takes considerably more to persuade many in Western companies, not only CEOs but chairman, board directors, etc. How to deal with individuals and how to get it done right requires reckoning, experts pointed out.

That puts the burden on the buyer's shoulders to do more, and a pursuit of latest technologies also bring more pressure on due diligence.

Chinese companies will have to do more, beyond just the top. They also need to seek out professional advice, not necessary the cheapest and put value into the equation, suggested experts.

Big And Difficult

While Chinese buyers come armed with cash and a strong desire, the high rate of deals failing to go through due to funding or regulatory issues can increase skepticism from foreign sellers, leading to a cost premium and second thoughts.

"In the US, bankers' perception of buyers from China is now very skeptical, which is fair, they appear to be aggressive [in the beginning] but [deals] fail to go through," noted a local investment bank's director of M&A.

The biggest challenge is therefore to differentiate credible buyers from the rest, he noted, adding that for overseas buyers who are more sensitive to bad news, Chinese buyers are perceived to pay top dollars and welcomed into the process, but sellers have second thoughts.

The reason lies not only in a high uncertainty in China given regulatory challenges, but also financially-driven, how do the foreign bankers know if the funding for the deal is actually there, he pointed out.

To them, China is big but difficult, the expert said. To that end, the buyers are usually disadvantaged, having to pay 20-30% premium over others.

Wang at Jianxin Capital also emphasized a need to hire professional advisors and a middleman, as well as increasing exposure to deal-making negotiations.

"Chinese drug makers have a relatively short history doing cross-border transactions, and they lack experience and talents. They need to have good lawyers, advisers, and middlemen, an expanding horizon for assets selection and collaboration opportunities."

Despite this, they may have to manage expectations on timeframe and deal structure, after the first deal is done and reputation established, subsequent deals will follow.

The differentiation of being a credible buyer also involves looking for what a seller wants out of a deal and prepare accordingly. However, both the buyers and sellers need to comprise, while Chinese drug makers need to do their homework, overseas sellers also need to spend time in China and get to know it better. "It needs both sides to make concessions; otherwise the cost of communications will be too high." Wang said, "After accumulating experiences, they will get better."

If pre-deal preparation and during-deal execution are time-consuming, post-deal integration is where most fail.

The post-deal challenge is to make sure buyers get what they desire the day following the transaction, said Luye's Jiang, who added that a three-year plan should be in place to ensure the development is on track.

Although a business transaction may proceed according to plan, the cultural gap is hard to overcome in a short time. Having a Chinese owner is still new and several domestic frontrunners have failed to successfully manage foreign workers after a merger, leading, ultimately to an M&A battleground.