Seeking to join top competitor WuXi PharmaTech on the New York Stock Exchange, ShangPharma, the second-largest contract research organization in China, is looking to raise an estimated $89.9 million in an initial public offering expected to debut the week of Oct. 18.

ShangPharma plans to use the proceeds to build new labs and expand service offerings, particularly in the areas of research manufacturing and biologics services.

The Shanghai-based CRO hopes to capitalize on a growing wave of outsourcing by biopharmaceutical developers looking to reduce costs and spread risk in the wake of an R&D productivity slump. The Chinese CRO market will reach an estimated $1.3 billion in value in 2013, up from $615 million in 2009, according to consultancy Frost & Sullivan.

Although the Chinese IPO window has become narrower since a heyday in 2006-2007, Chinese biopharmaceutical companies have fared much better than U.S. counterparts in recent years. Most notably Sinopharm, the largest pharmaceutical distributor in China, was 30 times oversubscribed in a public offering last year in Hong Kong and Shanghai (Also see "The Year Of The Tiger Looking Strong For IPOs In China Following Sinopharm Success" - Scrip, 4 December, 2009.).

ShangPharma has wanted to go public for several years, but has bided its time during the global downturn looking for a window in the U.S., China watchers say. Listing in New York is more expensive, but is still considered a measuring stick for quality and liquidity, and ShangPharma's investors, particularly U.S. private equity firm TPG Capital, wanted a U.S. exit.

One-Stop Shopping?

A key ingredient in ShangPharma's strategy for growth is providing integrated services - in effect one-stop shopping - for biopharma customers. ShangPharma's core business is discovery chemistry, but the CRO has been expanding its services in recent years, adding discovery biology and preclinical development capabilities in 2007 and biologics services earlier this year.

"We believe our customers value our ability to offer a wide range of quality services to meet their drug R&D needs, and we expect to capitalize on our strong customer base and expand our service offerings along the drug discovery and development value chain," the Sept. 30 prospectus states. New service offerings in the biologics space will include molecular biology, protein production and purification, cell line generation, epitope mapping and protein crystallography, ShangPharma says.

It is a strategy that many CROs are pursuing, looking to add new services to fuel growth. WuXi PharmaTech, for instance, which is known for discovery chemistry, will shortly start its first GLP-compliant toxicity study for a U.S. biotech firm (Also see "WuXi PharmaTech Set To Compete Globally Following OECD Certification Of New Drug Toxicology Lab In China" - Scrip, 28 September, 2010.). In the China CRO space, WuXi PharmaTech is the big fish, but ShangPharma occupies a unique spot as well, alone on a second tier above smaller local competitors.

ShangPharma is "more active and more flexible in its business model, more willing to consider risk models," Helen Chen, China practice leader for consultancy LEK, said in an interview.

However, it remains to be seen whether pharmaceutical companies desire one-stop shopping from suppliers, Chen said.

In fact, one objection raised by dissent shareholders of Charles River Laboratories, which helped to scuttle its proposed acquisition of WuXi PharmaTech earlier this year, is that combining discovery chemistry and biology to create revenue synergies is an unproven proposition, and that it may not match the decentralized manner in which big pharma makes outsourcing decisions (Also see "Impromptu Objections Filed With SEC Could Threaten Charles River's Proposed Merger With China's Leading CRO" - Scrip, 11 June, 2010.).

That mindset, however, may be changing given recent challenges in the pharma industry, Chen said. It is becoming tougher for individual scientists to select a supplier as parent companies scrutinize costs more closely, and a larger CRO with more service offerings may have an easier time winning and cross-selling additional business.

At the same time, drug companies may still want to hedge their bets, said Zhu Shen, CEO of consultancy BioForesight, particularly when a supplier moves into a new service line, like biology, that hasn't been part of its core competency.

Although integrated services are "the Holy Grail," Shen says, "in reality it is hard to achieve." It may be easier, in fact, to acquire new competencies than to build them organically, Shen noted in an interview.

That was the game plan for Charles River, based in Wilmington, Massachusetts, which looked to wed its biology capabilities with WuXi's chemistry expertise. The blowup of that deal has shined a light on the China CRO industry, and by extension integrated services, leading to a vigorous debate among China watchers as to which party may, or may not, live to regret the last-minute abandonment of their proposed marriage.

Bay City Capital partner Charles Hsu is clear on which side he favors. It "was incredibly stupid for Charles River to walk away from that deal; they are going to regret it," Hsu said in an interview, quipping that one day it may be WuXi that is looking to acquire Charles River rather than the reverse.

Hsu points to another U.S.-based CRO, PPD, which has acquired two smaller China CROs, including preclinical play BioDuro, as a model for how multinationals should expand services in China (Also see "PPD Continues High-speed Expansion In Asia With Second Acquisition Of A China-based CRO This Quarter" - Scrip, 20 November, 2009.).

ShangPharma's Business

For the IPO, ShangPharma plans to offer 5.8 million American Depositary Shares (one ADS represents 18 ordinary shares). Of the total, 2.6 million ADS are from selling shareholders, including TPG Capital.

ShangPharma is targeting a price of $14.50 to $16.50 per ADS; the midpoint of that range would mean roughly $42.8 million in net proceeds for the CRO. After the offering, there will be 335.6 million ordinary shares outstanding. CEO Michael Hui's stake will be diluted from 75 percent to 58 percent.

The firm, founded in 2002, is a holding company for six subsidiaries, including Shanghai ChemPartner, Shanghai ChemExplorer, Shanghai PharmExplorer, Chengdu Chempartner, ChinaGateway Pharmaceutical Development and China Gateway Pharma Products. The number of names has led to some "brand dilution" compared to other China CROs, LEK's Chen noted.

ShangPharma's two largest customers are Eli Lilly and GlaxoSmithKline, which accounted respectively for 27 percent and 10 percent of net revenues in 2009, according to the prospectus.

ChemExplorer works exclusively for Lilly under a full-time-equivalent basis - providing a dedicated team of scientists and laboratory facilities for medicinal chemistry, discovery chemical synthesis, lead optimization and computational chemistry. It has been a key part of Lilly's Fully Integrated Pharmaceutical Network (FIPNet) strategy (Also see "Eli Lilly's China R&D Head Tony Zhang On Looking At The Universe Of Possibilities In China: An Interview With PharmAsia News" - Scrip, 29 June, 2009.).

ChemPartner, ShangPharma's flagship, offers a variety of services, including discovery chemistry, discovery biology and preclinical development (including assay development and high throughput screening), pharmaceutical development (including formulation work and process R&D) and biologics services (including therapeutic antibody generation and optimization).

More than 100 companies and academic research centers, including all of the top-10 pharmaceutical companies, are ShangPharma customers, with 81 percent of ShangPharma's net revenues coming from North American-based customers. The CRO has been looking to diversify its customer base, but its top-10 customers still account for roughly 63 percent of net revenues, down from 85 percent in 2007.

ShangPharma has four primary facilities, including a 13,000 square foot AALAC-accredited animal facility in Shanghai, a 36,000 square foot R&D center in Chengdu and a 28,000 square foot manufacturing facility in Nanhui, Shanghai.

The CRO also is building two new facilities in Shanghai:

A 460,000 square foot cGMP facility to manufacture intermediates and active pharmaceutical ingredients for preclinical testing and clinical trials (the first phase of this facility is expected to open in 2011); and
A 150,000 square foot laboratory services building for pharmaceutical development services expected to commence operations in 2011 or later.

ShangPharma plans to use $15 million of net proceeds from the IPO for construction costs related to these facilities.

ShangPharma's net revenues were $72.3 million in 2009, up from $60.5 million in 2008 and $34.7 million in 2007. Net income was $9.8 million in 2009, up from $7.5 million in 2007, the prospectus states.

Citigroup, JP Morgan, William Blair and Oppenheimer are underwriting the offer. They have an option to purchase up to 870,000 additional shares from the selling shareholders.

Competition Heating Up

In the prospectus, ShangPharma highlights increasing competition in the CRO space for both business and scientific talent. In addition to competing with WuXi across all service lines, ShangPharma competes with multinationals like Albany Molecular in discovery chemistry and Covance in discovery biology and preclinical development.

"We expect to increasingly compete against multinational companies, both domestically and internationally, as we offer more complex and sophisticated services," the prospectus states.

In addition, ShangPharma finds itself competing for Western-trained scientists with Big Pharma companies that have opened in-house R&D facilities in China, a trend that has picked up in recent years as companies from Roche to GlaxoSmithKline to AstraZeneca ramp up R&D capacity in China.

ShangPharma, which is headquartered in Shanghai's Zhangjiang Hi-Tech Park, currently has more than 1,600 scientists. The company boosts on its website: "Over 40 percent of our scientific staff have post-graduate degrees and all of our top scientific leaders have U.S. and/or European industrial experience in major international pharmaceutical and biotechnology companies."

ShangPharma also provides some interesting tidbits about how the global downturn and consolidation in the industry have impacted its business, acknowledging that some customers have reduced business or cancelled orders in the last couple of years.

"Two of our North American-based biotechnology customers experienced financial difficulties during the global financial crisis and terminated their contracts with us in late 2008," the prospectus states. "We collected all of the accounts receivable from one of the two customers and part of the accounts receivable from the other one."

U.S. Private Equity Stake

In 2007, TPG Capital acquired an undisclosed stake in ShangPharma for $30 million. As part of the deal, TPG obtained the right to fill two positions on ShangPharma's board of directors - one is occupied by TPG partner Geoff Duyk, former president of R&D at California biotech Exelixis.

In the prospectus, ShangPharma discloses that TPG currently owns roughly 25 percent of ShangPharma's ordinary shares. TPG plans to sell almost half its ordinary shares in the new offering, diluting its stake to roughly 11 percent (a figure that assumes the underwriters do not exercise their options to purchase additional ADRs).

In an earlier interview with PharmAsia News, ShangPharma CEO Hui said TPG would help the CRO attract new international customers and position it better for growth by helping lead a transformation into a fully integrated CRO. Hui also said TPG would assist ShangPharma with acquisition and integration opportunities (Also see "Shanghai ChemPartner CEO Michael Hui On Finding A Niche In China Amidst Increasing Foreign Competition: An Interview With PharmAsia News (Part 1 of 2)" - Scrip, 14 April, 2008.).

- Joshua Berlin (j.berlin@elsevier.com)

[Editor's Note: Want more analysis of China's CRO market? Leading Asia-based executives from PPD, Quintiles and PharmaLegacy are speaking at the 2nd PharmAsia Summit: Taking the Risk Out of Asia (Oct. 25-26, San Francisco). For a list of speakers and topics, click here .]

China's Second-largest CRO Seeks Initial Public Offering In The U.S.

More from Archive

More from Scrip