The short-selling company Blue Orca Capital would not have
expected that its confrontation with China Medical System Holdings
Limited ("China Medical System") actually helped the company. The
confrontation allowed investors and the whole pharmaceutical
industry in China to see the biggest CSO has quietly reached the
end of its transformation into a new empire that has established
full control over an industrial chain, from sales and marketing to
production and quality, and has jumped from the domestic market to
a company driven by global R&D innovative resources.
By reviewing the seemingly detailed report from Blue Orca Capital
("Orca") and a brief but solid response from China Medical System
issued on 7th February, as well as an interview with Mr. Lam Kong,
Chairman of the board of China Medical System, Healthcare Executive
tried to review the path of China Medical System's most essential
product upgrading experience, especially the globalized market and
operation capacity of R&D resources from its large overseas
companies groups, which was disclosed to the public for the first
time. Throughout its development in the recent decade, China
Medical System, as a leading CSO, has been revolutionizing itself
since it was listed on the stock exchange. The journey of detaching
itself from CSO and marching into the full industrial chain was
full of tensions and challenges.
01. Malicious digging exposed a brand-new China Medical System
On the morning of 6th February, Orca released a 41-page short
selling report against China Medical System. The report indicated
that the profitability of China Medical System was fictitious and
the actual net profit was 49% lower than the reported number. It
also raised doubts that China Medical System was involved in
private deals and corruption.
At 11:17 a.m. on that same day, China Medical System called for an
immediate suspension in the stock market, which did not prevent a
slump in its stock price of 12.7% in just 9 minutes. However, the
price soon bounced back by 9% in the next 14 minutes. The closing
price before the suspension was only 1.9% lower than that of the
previous day. Despite the rollercoaster, the overall price still
remained stable compared to that of companies involved in other
short selling cases.
Companies listed in the Hong Kong Stock Exchange are regularly
targeted by short sellers and these incidents have been growing
more frequently since 2019. Orca has already attacked Pinduoduo,
ANTA Sports and Kasen in the past year but these companies' stock
prices all surged after they resumed trading. ANTA, in particular,
short sellers were frustrated when Anta's share price hit a record
high after rounds of short selling. Generally, companies pinned by
the short sellers usually have much higher profit margin or much
lower costs than that of their peer companies, or they have high
continuous growth rate or burn rate. In the pharmaceutical
industry, the short sellers once targeted Genscript, the parent
company of Nanjing Legend, and BeiGene, which were both investing
high in R&D and bearing high risks.
China Medical System was also in a key stage of transformation and
the company has thus far proceeded with a stable operation and good
profit margin. On the night of 7th February, China Medical System
made a clarification announcement, providing responses to all Orca
allegations, concluding that these allegations were "groundless and
seriously misleading".
Healthcare Executive quickly reached out to Mr. Lam Kong, the
Chairman of the Board of China Medical System and set up an
interview. Surprisingly, this company with relatively low profile
decided to disclose an unprecedented amount of details, many of
which were revealed for the first time. The abundant evidence
provided by China Medical System not only crushed any allegation
made by the short sellers, but also indicated that after many years
of strategic transformation, a new China Medical System was
appearing and that this new China Medical System had new ambitions
and aspirations.
Throughout the company's history, China Medical System was referred
to as "the leading CSO". But what is a CSO? It allows
pharmaceutical promotion and sales activities based on powerful
pharmaceutical promotion capacity and network coverage. Lam Kong
barely explained the title, but it was clear that the association
of CSO with China Medical System has obscured the development logic
of the company over the past few years. This was the first time Mr.
Lam Kong shared the innovative development of China Medical System
with the public and unveiled the global competitiveness of China
Medical System hidden under the "iceberg" of pharmaceutical
marketing services.
02. The strongest fightback: up to 40% dividend for 10 consecutive
years
Orca asserted that China Medical System overwhelmingly exaggerated
its financial performance with an inflated profit of 49%. China
Medical System replied in the "Clarification Announcement" that the
company has maintained a constant 40% dividend payout ratio with
its continued investment and low debt status since it was listed.
It would be impossible for the company to realize such a high
payout rate if the reported 49% profit were false.
China Medical System landed on Hong Kong's capital market in 2010.
According to the financial reports, from 2010 to 2018, the
company's annual profit rose from RMB 206 million to RMB 1,844
million, a compound annual growth rate of 32.9%. Throughout the
decade, the company maintained a payout ratio of 40% of the net
profit, with the accumulated dividend of RMB 3.08 billion.
"It was like I earned 100 yuan, to which you said 49% of what I
earned never existed, and that in actuality I only ever earned 51
yuan. Then, from that 51 yuan, I paid 40 yuan to the stakeholders
as dividend. My question to you would then be, do you really think
China Medical System is that foolish? How would it be possible to
run the company and complete investments with the remaining 11
yuan? Why would I do this?", said Lam Kong.
In fact, the cash flow and the gearing ratio of China Medical
System have both been maintained at a good level. According to the
previous financial reports, only the gearing ratio in 2016 and 2017
reached 16.5% and 20.7% while those in other years stayed below
15%. Through these periods, China Medical System was buying
products. In particular, in 2016, it spent $310 million on the
commercialization right of AstraZeneca's exclusive product Plendil
in China, which has become a classic case in the industry. As Lam
Kong put it, "High payout ratio, low gearing ratio, and abundant
cash cooperation cases overseas, these are enough to prove the
profitability of China Medical System".
From the short selling report, one of the major reasons behind the
allegation of inflated profit was, "China launched the Centralized
Procurement of Drugs with targeted volume in 2018. The policy
directly forces down the price and weakens the value of marketing
network. The profits of other agents all decreased while China
Medical System's profitability was still reported to be promising
with continuous growth, which was very confusing."
This type of "presumed-guilty argument" is absurd. Based on
Healthcare Executive's observation of the industry, the
pharmaceutical industry in China is undergoing a drastic change.
Although price-reducing policies like centralized procurement of
drugs squeezed the profit of mature original drugs and generic
drugs, the innovation encouraging and medical insurance policies
are stimulating industrial growth. In the past year, multinational
pharmaceutical companies with innovative drugs like Merck, Roche
and AstraZeneca have undergone unprecedented growth. The sales of
drugs that have not been listed in the centralized procurement are
still increasing. By the advantages of its products, China Medical
System is clearly more similar to multinational pharmaceutical
companies.
So far, the products that contribute the major profits of China
Medical System have not been affected by the centralized
procurement. According to the upgraded procurement policy, it only
applies to the products with at least one original and no less than
two generics. Among the major products that China Medical System
promotes and sells, Deanxit is the only product for which there is
one generic competitor that has passed consistency evaluation. No
other product has so far been affected. This also shows how unique
and forward-looking the company is in its choice-making regarding
products selection. It is expected that in the following 1 to 2
years, the products of China Medical System will not be listed in
the centralized procurement.
Orca also reported that China started the two-invoice system in
2017, which directly affected China Medical System which lies
between the manufacturers and agents and that the company's
position in this value chain was significantly challenged. But in
fact, the two-invoice policy indicates that the national exclusive
agents of imported drugs are deemed as manufacturers. The imported
drugs, self-produced products and the products produced by the
subsidiaries of the China Medical System would not be affected. For
some non-self-produced products, the only difference is changing
from low ex-price to high, which only affects the way of financial
recording but not the profit. The allegation made by Orca not only
seems too general, but also reflects its lack of knowledge about
the pharmaceutical industry.
03. Products upgrade reflects an "alternative" path of R&D
After the release of Orca's report, the three cases of overseas
innovative drug investment, though little attention was paid to
them previously, also came into public notice. This allowed the
public to understand how China Medical System introduces products
and the logic it employs regarding product upgrade and
iteration.
Lam Kong explained that China Medical System is taking an
"alternative" path of innovative drug R&D. It is defined as
"alternative" because the common R&D path for pharmaceutical
companies is simply R&D (research and development) but China
Medical System is taking the path of S&D (search and
development). China Medical System is enriching the product lines
of innovative drugs by seeking high-quality innovative drug
projects worldwide and participating in the early-stage research
and development. In fact, in the recent two years, this pattern has
been adopted by more and more companies for innovative drugs. China
Medical System, on the other hand, has been pursuing this method of
development for a considerable period of time.
The three "corruptive deals" raised by Orca were the products deals
with three startup R&D companies, Helius, Faron and Neurelis,
which Orca revealed all ended in failure.
China Medical System replied that the company's requirement for its
products is in global perspectives, to meet the clinical needs. It
is well-known that this kind of products possess relatively high
R&D risks in the early stages. The listed company is usually
very cautious about this kind of investments due to concerns of
stability. Therefore, as the major stakeholder of China Medical
System, Lam Kong spent his own money to pay upfront for purchasing
these products. And he also undertook the risks of investment
failure. Lam Kong would not transfer the product (including the
intellectual property and sales rights) to China Medical System
until the product had achieved substantial progress. Lam Kong even
joked that it was really rare to see such a good stakeholder being
so loyal to the company, personally taking responsibility for all
of the risks while giving all of the benefits to the listed
company.
Besides, these investment cases are not exactly the "disastrous
investment" described in the short selling report. In 2015, when
Lam Kong was investing in Neurelis, the drug had not yet reached
the clinical stage and was highly uncertain. As China Medical
System announced on 13th January 2020, the U.S. FDA has approved
Neurelis' diazepam nasal spray for marketing in the U.S. market by
epileptic patients of 6 years of age and older, who suffer from
intermittent and stereotypic epileptic seizures. This product has
recently received the clinical trial notice from NMPA. After five
long years of tireless efforts, Lam Kong had achieved his first
overseas investment success.
It is clear that Lam Kong had already made attempts in introducing
R&D innovative products overseas while the company remained
focused on the sale and promotion of drugs in 2015. His vision and
strategic pace were a step ahead of the industrial development.
According to him, the transformation of China Medical System
started as early as 2013.
In February 2013, China Medical System had already acquired the
exclusive sales rights for at least 9 products including Deanxit,
Ursotalk, Ganfule, Stulln and Xinhuosu. By then, Lam Kong noticed
that the market for Ganfule, a product treating liver cancer, was
constrained by upstream manufacturers. To make a comprehensive
market plan for Ganfule, China Medical System spent RMB 81.10
million acquiring the manufacturing plant of Ganfule, Lengshuijiao
Pharmaceuticals, and thereby obtained full control of the product.
Since then, the company has continued to pursue product rights,
including those for Lamisil, Parlodel, MOVICOL, Combizym, Hirudoid,
Stulln and DanShenTong. The company even started a war with Tibet
Pharmaceuticals for the controlling rights of Xinhuosu, eventually
bringing this product into its product line as well.
From then on, China Medical System has gradually introduced a
pattern of introducing products covering exclusive sales rights,
rights control, equity cooperation and self-production, enabling
the company to gain more and more control over the product. This
has become known as the "China Medical System pattern" within the
industry. This pattern was best exemplified when the company bought
Plendil from AstraZeneca in 2016, proving that China Medical System
had established a deep cooperation with major multinational
companies.
Since 2015, Lam Kong has noticed the innovative trend in the
Chinese pharmaceutical market and got down to the business of
introducing innovative drugs, which opened the second stage of the
transformation. This process was conducted by the personal and
stakeholder investment, like the Neurelis project mentioned
above.
In 2017, as the overseas business development team was growing
mature, considering the high risks of on-going R&D drugs, Lam
Kong and China Medical System each handled half through equity
investment. Once the investment succeeded, China Medical System
could obtain 100% of the drug's rights and take over the global
R&D resource and talent resources. According to the annual
report, in 2018, China Medical System strategically invested in
several R&D companies from the U.K., France, Switzerland and
America and acquired the rights of 5 major innovative drugs in
China and part of Asia-Pacific markets. The company also purchased
the exclusive rights of two products in China from an Israel
biopharma company.
In 2019, the centralized procurement policy was released and
quickly spread. Though China Medical System' products were not yet
affected, Lam Kong still expected to increase the pace of business
innovation and introduce more good quality products to the Chinese
market. China Medical System started to purchase some products
approved by the FDA but not yet launched in China. For example, it
bought the exclusive licensing rights of two innovative drugs and
five generic drugs from Sun Pharma in India and signed another
contract with Sun Pharma for the licensing rights of five
innovative drugs including Paclitaxel injection concentrate in
November.
This is the strategic map of the acquisition journey China Medical
System has followed. It is also a history of how its products
structure has evolved in response to changes in relevant policies.
By investing in the overseas innovative R&D companies, China
Medical System was also able to arrange its resources for global
innovative research institutes and talents while also extending its
business to cover the full medical industrial chain including
R&D, production and marketing. Starting from a CSO company,
China Medical System has been detaching itself from CSO and
transforming to a "well-established, innovation-driven specialty
pharma with a focus on sales & marketing in China."
To Lam Kong, the logic is very simple, "The purpose of research is
for the products, rather than the research itself. There are many
ways to meet the unmet clinical needs and get the valuable drugs.
Overseas business development is also a capability." Driven by the
innovation and the policy of centralized procurement, China Medical
System has always been leading the way in the development of the
pharmaceutical industry under tight regulations. Making
preparations before everything becomes apparent makes a wise
man.
04. Under the iceberg: establish a global industrial chain
system
Over the past half month, China Medical System spent the busiest
Spring Festival ever with its global partners. After the outbreak
of the new coronavirus, China Medical System immediately called
upon its global partners and purchased 200,000 N95 masks and 50,000
children masks from overseas. The supplies were transported and
successfully passed through customs thanks to its global business
supply chain. With its digital marketing platform, 20,000 N95 masks
were delivered to 10,000 doctors in just one day.
China Medical System's global supply chain system is currently
demonstrating its power. In such an urgent time, there are surely
not many companies that are able to personally distribute global
supplies to the hands of doctors.
"Many only see our CSO businesses in China, but that is just a tip
of the iceberg. Like an iceberg, a major part of our businesses,
like our capability for global arrangement and the control of a
full industrial chain, is actually located "under" the visible
plane", said Lam Kong. He also commented that those who are engaged
in the overseas business development all know that buying drugs
overseas is not simply about "buying." Besides overseas MAH
conversion, reselection of manufacturing factories, re-control of
the factory quality and so on, the understanding of overseas
business cultures and law systems directly affects the success and
efficiency of the negotiation. Quality management, production
management and control management, as well the entire global
logistics supply chain, present big challenges to a company's
capabilities.
For example, Lamisil that China Medical System introduced from
Novartis in 2014 has completed the localization and now is produced
by China Medical System in its production site in Hunan. The
localization covers a series of complicated procedures including
MAH conversion.
"What the public knows about China Medical System is only our CSO
businesses in China. But the whole China Medical System group also
includes the global industrial chain formed by our overseas groups,
like those in Malaysia. The entirety of China Medical System is not
a CSO company", said Lam Kong.
According to the interim report of 2019, by 30th June 2019, China
Medical System had owned 13 innovative products in the fields of
ophthalmology, dermatology, neurology, oncology, immunology,
gastroenterology, anti-infection and endocrinology. Some of
products have acquired marketing authorization from the FDA, EMA
and Health Canada, respectively. The domestic R&D, development
and sales of these products are also underway.
Products are the soul of pharmaceutical companies. A portfolio of
products with differentiated advantage is the most important factor
for a pharmaceutical company to become a global innovative one.
Driven by policy and technology, the Chinese pharmaceutical
industry is undergoing a great, game-changing transformation and
upgrade. The industrial development focus on the clinical needs and
the transformation will be no less than an earthquake in the
industry before it is done.
Hardship brings success. Leading the transformation along with a
decade of deployment, this new iteration of China Medical System is
thriving. When a brand new China Medical System appears in the
Chinese medical industry, the biggest inspiration is its inner
logic and path: one is to develop innovative products that could
offer Chinese patients new treatment solutions through a global
vision, and the other is to deepen the national academic network to
consolidate the academic differentiation of the current
products.
By Yong Tan and Xinyuan Yang of Healthcare Executive
Copyright 2020 JCN Newswire . All rights reserved.
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