The Disappearance of Chinese Capital in US Biotechnology

By Miyu Ono and Hannah Cabot

The United States is a leader in the life sciences industry, but through deep regulatory reform, ambitious international strategy, and a surge of financings, China has recently enjoyed a biotechnology boom that in time could challenge this competitive edge. The biotechnology industry is considered essential to US national security by the Department of Commerce, prompting the government to take actions to protect intellectual property by limiting technology transfers with foreign companies (LaRussa, 2019). In 2018 the Committee on Foreign Investment in the US (CFIUS) within the US Department of Treasury decided to increase oversight on foreign investments in several industries, including the life sciences industry through the Foreign Investment Risk Review Modernization Act (FIRRMA). This piece will examine the effects this scrutiny has had on biotechnology investments by Chinese investors within the US and analyze the potential long-term impact on industry growth. 

Chinese Biotechnology Growth

China has significant unmet health care needs due to a rapidly aging population and high incidence of noncommunicable severe diseases. For example, China has the largest diabetic population in the world at over 100 million adults, and cancer incidence is expected to increase by 97% between 2012 and 2035 (Arranz, 2018). China’s biotechnology growth in response to these issues rests on two key pillars.

Top-Down Government Strategy

Currently, China is highly dependent on importing expensive, patented drugs. To encourage the development of homegrown, affordable, and innovative medicines, the Chinese government named biotechnology as a Strategic Emerging Industry in the Made in China 2025 Plan. This spurred regulatory reforms by the China Food and Drug Administration to expedite the drug approval process. Biotechnology companies also receive incentives such as subsidized laboratory and small-scale production space, free manufacturing space for up to five years, and generous tax incentives (Berrisford, 2018). To capture domestic talent, the “Thousand Talents” program annually recruits more than 10,000 Chinese citizens working in the US to return to China (Atkinson, 2019).

China’s strategy has shown impressive results so far, such as the creation of over 110 bioscience research parks and the addition of over 340 drugs to China’s National Reimbursement Drug List to subsidize high priced, innovative therapies. Domestically, over 1,000 venture capital firms are directly funded by the Chinese government, and in general, biotech venture funding within China increased from $0.5 B in 2015 to $2.5 B in 2018 (Atkinson, 2019). Further, due to regulatory streamlining, there was a significant increase in new drug launches from 5 in 2016 to 35 in 2017 (Berrisford, 2018).

Outbound Investment

The development of China’s biotechnology sector relies heavily on interactions with multinational and foreign corporations. Chinese foreign direct investments (FDI) and outbound M&A are made in hopes of gaining the return of innovative products, services, and expertise back to their domestic market. Through this venture-IP-contracting (VIC) trend, venture capitalists buy foreign intellectual property or molecule licenses for the China market, and then subcontract the drug development to Chinese CROs and CMOs (Berrisford, 2018). 70% of biotechnology investments from China have been in biologics and contract research and manufacturing, in which they already have strong capabilities. This indicates that the investments are to reinforce existing capacities domestically rather than expand into new fields (Gryphon Scientific, 2019).

Among foreign biotechnology investments, China prioritizes providing capital to specifically US firms. Contributions to US firms grew 187% in 2017, greater than the 161% growth in broader industry groups. The increase from $519 million in 2016 across 41 deals to $1.5 billion in 2017 for 45 transactions predominantly took the form of acquisitions and startup financing (Gryphon Scientific, 2019).

These deals, while risky, benefit investors by supporting efforts to relieve China’s unmet medical needs and diversifying their portfolios. The recipients also benefit by funding novel drug discovery or reviving experimental drugs and devices previously deprioritized within company pipelines. They also establish direct relationships with China, a country that has historically been hard to penetrate (Ellis, 2018). However, this type of partnership faces challenges ahead.

The Impact of CFIUS Reforms

The Creation of FIRRMA

CFIUS was created in 1988 by the Exon-Florio Amendment to Defense Production Act of 1950 to review foreign investments and acquisitions related to national security threats. Previously, CFIUS reviewed transactions that resulted in foreign control of a US business, and filings were generally voluntary. The introduction of the FIRRMA in 2018 broadened the jurisdiction of CFIUS by subjecting even non-controlling foreign investments in companies with certain critical technologies or involved in sensitive data collection of US citizens to a mandatory declaration. Within the 27 critical technologies listed is research and development in biotechnology (Ji, 2019; LaRussa, 2019). Actions that CFIUS can take include enacting penalties up to the value of the transaction for noncompliance with filing requirements, and exclusion of certain sensitive assets from the transaction (Berrisford, 2018).

CFIUS affects all foreign countries but seems to especially target the strained economic relations between the US and China. For example, in the most recent report by CFIUS, China had the most reviewed transactions at 74, followed by Canada at 49 (Jackson, 2019).

The inclusion of biotechnology within the 27 critical industries may stem from the unprecedented growth of the Chinese market. While only 1/10th the size of the US market, its five-year growth rate is forecasted to reach 16.4% by 2021. These Chinese companies additionally play an increasingly important role in US innovation through corporate and academic partnerships, which represents an economic risk as technology transfers turn into foreign commercial success (Gryphon Scientific, 2019). Western firms are now struggling to compete against local Chinese firms due to increased domestic funding, lower pricing, and the expedited Chinese drug approval timeline. Ronald Ede, Innovent Biologic’s Chief Financial Officer, has said that he’s seen local drug makers grab as much as 85% of the market for a generic drug or medical device from global rivals within only a few years (Lyu, 2019).

Case Studies

The following two firms offer case studies of interference by the US government.

• In 2017, PatientsLikeMe, Cambridge-based online service that helps patients find people with similar health conditions, sold a majority stake to China’s iCarbonX. The goal was to combine the Chinese firm’s artificial intelligence technology with PatientsLikeMe’s customers and data sets. Currently, around 700,000 people use the website, which has generated tens of millions of data points about disease. CFIUS is now forcing a divestiture because the company collects potentially sensitive data on users who set up profiles which poses a danger to US national security. With this decision, PatientsLikeMe not only loses its principal financier, but also a critical technology partner (Farr, 2019).

• After receiving $5 million in funding from the Department of Defense, San Francisco start-up Twist Bioscience, makers of synthetic DNA, decided to expand manufacturing through a Chinese subsidiary. This prompted an amendment to Congress’s annual defense policy bill to ensure grant recipients of the Pentagon’s Defense Advanced Research Projects Agency are prohibited from partnering with entities subject to foreign company or government control. The main concern cited was the threat of the Chinese government stealing intellectual property and trade secrets from American companies (O’Keefe, 2019).

Chinese Investing Trends

It is important to note that Chinese outbound M&A is decreasing across nations. One reason is that the Chinese State Administration of Foreign Exchange (SAFE) has increased supervisions of outbound investors, requiring banks to report any overseas transfers greater than $5 million (Mintz 2018). Correspondingly, the value of all newly announced global M&A by Chinese companies dropped by 60% in H1 2019 to only $20 billion (Evans, 2019).

However, due to CFIUS, there has been an especially significant impact on available Chinese capital within the US that is only exacerbated by the slowing US economy and punitive tariffs. For comparison, FDI in Europe fell 70% from $80 billion in 2017 to $22.5 billion in 2018. Yet this was still milder than the 83% drop within the US from $29 billion in 2017 to $5 billion in 2018 (Gryphon Scientific, 2019). Further, Chinese venture investments in the US amounted to only $725 million in the first six months of 2019, down 60% from $1.65 billion in the same period last year (Hancock, 2019).

While Chinese foreign investments have decreased, Chinese biotech spending overall has not. Instead, this capital seems to fund domestic efforts and cross-border licensing now. Chinese pharmaceutical M&A had a 54% increase in deal volume, and a 16% increase in deal value at US $19.77 billion. As shown below, this was largely driven by increased engagement by domestic strategic and financial buyers, offsetting the 30% decline in outbound M&A (Tang, 2019). Further, cross-border licensing deals, which do not involve an equity stake, doubled over five years to reach 164 deals in 2018 (Neville 2019). While most deals are for rights to sell drugs domestically in China, some include global rights to carry out clinical trials and win commercial approval in the US and Europe.

Conclusion and Future Recommendations

China is still a long way from being able to compete with the US drug industry seriously, or to even meet domestic demand. However, preventing access to capital from foreign markets through CFIUS reforms could dampen rather than promote growth of the US biotech sector. Emerging businesses will struggle with limited international collaboration and lack of resources if domestic investors do not meet demand as Chinese investors are scared away or forbidden from participating in deals.
The following factors should be considered to maximize positive impacts from CFIUS and minimize negative consequences.

• The regulatory committee should be well maintained and staffed with individuals familiar with the science. The decision-making process must become more transparent, as currently the rationale for decisions are not disclosed nor appealable, which deter any investment.

• The types of technology considered at risk should be clarified within the existing mandate to distinguish better fundamental research contributing to human health and emerging technologies that could be exploited and pose plausible specific threats to national security.

• US government agencies such as the National Institute of Health, Bureau of Industry and Security, and State Department should produce guidance for universities and companies on personal data protection for US citizens, research ethics, and IP theft to better identify and report threats.

As the biotechnology industry evolves globally, new risks and opportunities will continue to emerge. Care should be taken not to stifle innovation and international collaboration when assessing and/or addressing threats from China so the US can secure its vitality and competitiveness in the global life sciences industry in years to come.

About the Authors

Miyu Ono is a Summer Analyst with the life science investment banking team at Back Bay Life Science Advisors. This fall, she will enter her third year at the University of Pennsylvania where she is pursuing a dual degree in the Jerome Fisher Management and Technology Program in Chemical and Biomolecular Engineering, and Finance at the Wharton School of Business.

Hannah Cabot is an Associate with Back Bay’s investment banking M&A team, where she collaborates on strategic growth initiatives and transaction execution for both the buy and sell side of leading life science companies. 

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