The growth in available government funding for pharmaceutical companies in China is creating a snowball of investment from domestic and multinational pharma companies more willing to overcome intellectual property concerns.

In 2009, China invested $80 billion in biotech research and development, including government-built biotech hubs, labs and networks. Over the next five years, the central government plans to spend $6 billion in its first major program dedicated to early-stage drug development. Provincial and municipal governments are expected to match that amount. The Beijing government has already established four bio-venture capital funds (Also see "Government Funding Accelerates Venture Interest In China" - Scrip, 5 August, 2010.).

One question on the minds of investors is whether Chinese pharma companies enjoy a home field advantage in terms of deal-making and commercial success.

On the one hand, domestic companies may have an advantage in identifying the best local companies for acquisition, said Simcere President Yehong Zhang during the JP Morgan Healthcare conference in San Francisco in January, where emerging markets were the hot topic of conversation ('Emerging Markets Round Up From JP Morgan Healthcare Conference (Part 1 of 2),' PharmAsia News, Jan. 17, 2011).

However, in terms of dealing with the Chinese government, Zhang says local players do not necessarily have an advantage over multinationals.

The Chinese government is looking for "credible players" to interact with and support, Zhang says. "These players can be multinationals or local. ... The key thing here is that you have to have credibility."

Orbimed Senior Managing Director Jonathan Wang told PharmAsia News that Chinese companies don't automatically have a home court advantage in terms of getting government support.

"It depends on the kind of support you are trying to get from the government," he said, explaining that government grants have different conditions and criteria, but that some grants do require companies to be locally registered.

"But it's very difficult to have a clear-cut answer, partly because it's very difficult to tell if you are a foreign company or a domestic company because even if people are Chinese, they could have the company registered somewhere else or have a mother company somewhere else," Wang said.

Orbimed has invested in both foreign companies as well as local Chinese companies, and virtually all of them are hybrid with a wholly foreign-owned entity (WOFE), according to Wang, who said the WOFE is usually a shell company.

"It's definitely not black or white and you can't say that if you are foreign, you won't get government support. For the government, it doesn't matter for the most part," Wang said. "In certain cases, the government may require a company to be locally registered for certain grants, so a small percentage do prefer domestic companies, but that is only a part of the picture."

For example, Chengdu-based MRI company Alpac and Iconoclast both received $10 million from the Chengdu government and both companies have WOFEs run by returnees. For global investors, it is easier to invest in a WOFE outside of China, Wang said.

Chinese Company With Global Aspirations Could Do Well

Hutchison MediPharma, which is developing its own novel pipeline with an eye on the global market, has received non-dilutive funding from the Chinese government. Speaking during the J.P. Morgan Healthcare conference in January, Hutchison CEO Samantha Du spoke about the advantages of being a China-based biopharma with global aspirations.

She noted that most of Hutchison's clinical programs have received some kind of support from the government, which realizes that supporting innovation is key for China's growth.

Du, a former Pfizer Inc. executive, is one of the leading lights in the burgeoning China R&D space, and has assembled a team of ex-Big Pharma R&D executives who have returned to China to work for Hutchison. Among the first wave of returnees back to China, Du returned to Shanghai in 2002 to start biotech company Hutchison MediPharma (Also see "Hutchison MediPharma Founder And CEO Samantha Du On China's Drug R&D Ecosystem: An Interview With PharmAsia News" - Scrip, 19 January, 2011.).

"We also have the homegrown advantage of access to potentially the second-largest global market, and the high capital efficiency in China allows us to build a non-virtual R&D organization," Du told the JP Morgan conference.

The CEO noted that the virtual R&D "on goal" approach in the U.S. "hasn't proven to be very successful and we are very blessed to be able to create a strong portfolio with more shots on goal."

"We fully intend to retain China commercial rights and really take advantage of the fastest-growing market and the second-largest market in the world," Du said.

But even so, she disagreed that there is a home court advantage.

"If you get a new project grant, there is no clear definition of where the money goes," she said in an interview, "but most often for MNCs, the policies are more important than the funding."

Overall, the trend is that the government supports innovation and provides seed money. But it's not all about the money, Du pointed out. "It's the policy and the way the government leads the direction of the country, and the boom in the last 20-30 years, which was driven by low-cost labor, infrastructure and manufacturing.

"The Chinese market itself justifies R&D investment on its own," she said.

Innovative Models Help Divide The Pie

Government funding historically has gone to Chinese companies or Chinese institutions, but that doesn't mean that multinational companies haven't been able to get some of that money in a way that is acceptable to the Chinese government, LEK Consulting Principal Helen Chen said in an interview.

For example, there are a lot of other types of funding and not necessarily traditional options.

For example, newcomer hybrid company Ascletis Inc. recently got $100 million in Series A funding and avoided working with venture capitalists entirely. Real estate billionaire Jinxing Qi led the mammoth Series A round, investing via the firm he controls, Hangzhou Binjiang Investment Holding Co. Ltd. Qi, who is listed as a company co-founder, joined other unnamed private investors from China, the U.S., and elsewhere in the round. Ascletis took a first tranche worth $50 million, with the remainder due upon reaching milestones. The total dollar value makes Ascletis's introductory round one of the largest Series A fundings ever for a biopharma, especially one backed purely by angels (Also see "Ascletis Raises $100MM To Deploy Its U.S.-China Hybrid Drug Development Model" - Scrip, 6 April, 2011.).

Ascletis's model is two-fold. The company plans to in-license and develop clinical-stage assets developed elsewhere with a goal of commercializing them in China, while discovering new drugs and bringing them through mid-stage trials before striking revenue-generating global partnerships. For now, the company will focus on oncology and infectious diseases.

It is fairly easy for small domestic companies to get $3-5 million in funding, Chen said, noting that Hangzhou textiles tycoons invested money in a device company and "didn't really understand the science but were looking for a good investment." Similarly, stem cell hospitals are getting investments, and many investors are simply following the lead of the government, she said.

"There is a lot of bell money out there to be had. A lot of these companies are not going to see a return in 15 years, but someone has a good story about an unmet need in the not too-distant future," she said.

She also noted that companies can also get access to government grants by partnering with academics and gaining access to their government grants.

MNCs Get Plenty Of Chinese Money

When asked whether local companies had an advantage when it comes to government funds, Chen quipped: why does a multinational company like Pfizer Inc. need to have any Chinese money?"

Still, MNCs are getting Chinese money. For example, U.S. based SuNova Capital got funding from the Shanghai government to start up a Phase I hospital and the funding was in renminbi, Chen said. SuNova wanted to invest in an entity in China rather than the U.S., she said.

"There is the view that the Chinese market is better than the U.S. market, so investors want a China IPO. Investors are always thinking about exiting, so I don't think any of them would be investing in Pfizer or Amgen."

However, if Amgen came to China and wanted to do a JV, "there would be a line of Chinese companies that would want to partner and help them build the organization," she added.

And there are also huge benefits for MNCs from China's high-tech parks, including cheap land, use of facilities, equipment, tax breaks, plus the low cost of doing business.

Local governments offer significant benefits - such as comfortable living allowances, tax breaks and large bonuses to relocate to certain areas - to senior-level executives.

For example, WuXi PharmaTech decided to move into the center of China to Wuhan to build a new campus, and received local government funding for the building and infrastructure. "They even funded the construction of the laboratories for us," WuXi CFO Edward Hu said during the JP Morgan conference. "So it's a tremendous help for capital investment requirements up front, and then we lease back from the government."

China Hybrids Reap Benefits Too

In one example of a different funding approach, Santa Clara, Calif.-based AutekBio secured more than $100 million in venture funds from SUMA Ventures and Beijing E-Town Harvest, a venture capital group created by the Beijing municipal government. With the funds, the company plans to build China's largest biologics contract manufacturing facilities.

Beijing hopes to double its biopharma output by 2012, which is why AutekBio was courted by the city, according to CEO Julius Li, who said the Beijing government is treating the investment as a test, whether the return on investment to the city - in the form of tax revenue, job creation, and building up the city's industrial sector - is worth the significant cost (Also see "Beijing Government Views AutekBio Funding Test For Future Investment" - Scrip, 9 June, 2010.).

Explosion Of Funding For Private Companies

For private companies, there has been an explosion of funding for investment in China on both sides of the Pacific.

"On the RMB side from China, money is pouring into hedge funds, venture capital funds, the whole spectrum of investment vehicles that raise funds in the U.S.," Charles Hsu, venture partner with Bay City Capital told PharmAsia News. Some of the capital comes from government-linked sources and some comes from private funds from industrial tycoons to international conglomerates.

"How you access that money can be complicated," he said, "because there are currently controls on the export and import of money into and out of China, and if you are going to raise funds in China, you have to think about how you are going to exit."

Bay City Capital is in the process of raising a fund that will focus on investments in China. Once there is a closing on the fund, the team will be based in China and will raise funds in both dollars and renminbi.

Hsu agreed that there is a lot of money available, but said many believe there may be a bubble in prices in China.

Still, there is a lot of government and private investment alike going into domestic Chinese companies that have no international roots, but they are "very specifically looking for growth-stage companies that are already generating revenue and are cash-flow positive and in a rapid-growth phase," he said.

For example, Bay City Capital invested in China Biologics, a profitable growth-stage company in the plasma fractionation business, which is the kind of deal people are looking for.

"These companies tend not to be highly technology-driven; they are really execution plays. They have established business models, and are not R&D driven."

In the healthcare arena, drug distribution companies, medical device companies and pharmacies, are less driven by focus on a particular type of technology than by focus on financial metrics.

"So far very little investment has been going to true innovation ... the number of funds that are going into what we consider classic innovation is very slow," Hsu said.

Innovation Mostly In Business Model

"My interest is innovative business models," he said. "You frequently hear people on the conference circuit talking about how far China is from bringing innovation forward but I think those estimates are too conservative.

Hsu co-founded LEAD Therapeutics, and that model is a paradigm for the type of company he is looking to invest in.

"At the time, that type of business model was an off-the-wall concept and was met with much skepticism, he said, "and now we are seeing elements of that strategy now."

The idea behind LEAD Therapeutics was to have a core scientific team based in the U.S. with all of the wet lab work conducted in China as an outsourced, virtual company for discovery services. The idea was "heretical to the mainstream community," he said, because it went against the grain of traditional R&D that often includes a team of Nobel Prize-scientists.

"The other part of the model that was heretical was that we followed what we call a 'fast-follower' or 'patent-busting' strategy, which was to follow what was happening and feed off the science that has already been done" Hsu said. "Some people looked down their noses at us as not being sufficiently innovative enough."

Successful hybrid business models for drug development are still in the early stage. LEAD Therapeutics, for example, was sold for a disappointing $18 million upfront in February 2010.

Although the jury is still out on whether virtual or bricks and mortar are the best way to go in China, the experimentation and willingness to try new models that has ensued is leading the way to more innovative business models.

"I entered this industry thinking it was all about the science, but the humbling lesson was that there is more science out there than you know what to do with," he said. "It's mostly about who comes up with the most effective business model for harnessing that innovation."

- Tamra Sami (t.sami@elsevier.com)

Creative Funding Options For China; Investors Battle Perception of Home Court Advantage

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