Why Did One Of The World's Largest Generic Drug Makers Exit China?

Feb 3 2014, 6:36pm CST | by

The week of JP Morgan’s January 2014 healthcare conference in San Francisco, Actavis, one of the world’s largest generic pharmaceutical companies, made a splash by emphasizing its emerging market strategy, just not the way most investors anticipated.  Where most pharmaceutical companies have elevated the market opportunity in China as key to their revenue growth and profitability, Actavis made clear it views the risks in China as well beyond the potential benefits.  In a much quoted interview at the JP Morgan event, Actavis’ CEO Paul Bisaro stated “If we’re going to allocate capital, we’re going to do so where we can get the most amount of return for the least amount of risk.  And China is just too risky.”

What exactly is Actavis walking away from, and why?  In terms of market size, estimates are that by 2015, China’s generic market will be close to $82 billion.  Actavis is hardly a marginal player in the global generic space and at face value should be one of the companies well positioned to take advantage of China’s growing appetite for generic drugs.  The company is certainly not a passive bystander in shaping markets.  Under Bisaro’s leadership, Actavis has been one of the key players pushing M&A deals in an effort to consolidate the generic drug marketplace.  For a company like Actavis to back away from China publicly, a decision they began to make good on late in January when they sold their stake in a subsidiary in Foshan, China, something more is at work.

The question is what, and whether Actavis’ decision sheds any light on either China or the global generic drug market.  It is essential to distinguish between these two ideas.  Actavis’ decision may be best understood as a statement about China’s diminishing hospitality towards foreign businesses in general, and pharmaceutical companies specifically.  Or, Actavis as a business, with its unique footprint in China within the generic market, might not have been in a position to grow its Chinese market share profitably.

Because of this summer’s events surrounding GSK’s China operations, and allegations of improprieties in both its Chinese sales and clinical trial arms, global pharmaceutical and medical device companies are on-guard over new corruption crackdowns that seem to disproportionately emphasize the wrongdoings of foreign companies.  As Tracy Staton with FiercePharma quite eloquently captured it with respect to the GSK anti-corruption charges from this past summer, “while stamping out corruption was the stated intent, drug prices are the subtext. It’s a sort of price squeeze by prosecution.”  Industry watchers have been somewhat placated over the Chinese government’s recent pursuit of bribery charges against China’s largest pharmaceutical distributor Sinopharm, a domestic company.  To see a domestic company get caught up in China’s pursuit of more transparent pricing – if that is in fact what motivates the government – is encouraging to those fearful of discrimination against foreign companies.

The broader questions that Actavis’ CEO pointed towards as a rationale for the company’s exit from China are not wrong.  Surveys conducted by various American and European business groups in China all point towards worrying trends which suggest China is becoming fundamentally less hospitable to foreigners than in years past.  Favoritism towards domestic companies by government purchasing is nothing unique to China, unless you consider that China’s 144,500 State Owned Enterprises (SOE) represent 35% of the country’s industrial revenue (a percentage many economists believe greatly under-represents the economic impact of SOEs).    Add to the SOE’s position the role of the Chinese government as purchaser of great amounts of pharmaceuticals and medical devices, and you can see what the comments of Actavis’ CEO ring true to many.

In addition, the unique pressures facing businesses selling into China’s healthcare economy make the trade between market size and profit more acute and uncertain than ever.  No one doubts that demographics and disease data point towards incredible demand for healthcare goods and services in China.  What is being questioned is whether foreign companies can profitably capture the opportunity.  One of GSK’s first responses to the events of this summer was to dramatically cut prices, a move that left many wondering less about the company’s guilt and more about what was really motivating the Chinese authorities.  Companies like GSK and Actavis now understand more clearly than they did twelve months ago that healthcare in China is an increasingly political matter, that their biggest customer – the government – is also responsible for the broken funding mechanism that has made access and affordability for healthcare in China one of the most basic and pervasive broken promises the government in Beijing is singularly responsible for.

These issues are solvable.  China’s reimbursement mechanism between the Ministry of Finance and Ministry of Health, as well as hospitals and patients, can be fixed.  The basic government-provided healthcare insurance can become more sophisticated relative to what it pays for.  New drugs can be added to China’s national formulary (known as the Essential Drug List, or EDL).  And, as many overseas drug makers hope, the purchasing power and brand attachment for China’s growing middle class can ensure that, where possible, consumers choose western medicines even if these come at a higher cost.  This has always been the potential, even if the turbulence in the market over the last year has caused some to lose faith that China would develop into a viable market.

If these positive steps were to take place, then would we think differently about Actavis’ decision today?  Or, to be even more direct, are we allowing the events of the past 12 months to obscure more basic business strategy issues at play with Actavis’ specifically?  By the time the Actavis’ announcement went out in mid-January 2014, the company had around 200 employees in China, generating less than $7 in profit.  This is an extremely un-impressive performance for the world’s second largest generic drug manufacturer in what is quickly becoming the world’s largest generic market.  Actavis’ growth mode globally has been heavy on M&A activity, becoming one of the key actors consolidating the generic market.  Is Actavis leaving China now because the reasons the company goes into any market, emerging or otherwise, are not yet a factor in China?  Or, even more cynically, is Actavis’ exit evidence of a corporate strategy that emphasized M&A activity at the cost of a coherent strategy for China, the market most players believe will be the most important market for global generic manufacturers in the coming decades?

The company is widely viewed as one of the leading candidates to acquire Pfizer’s “value products business” – a euphemism for Pfizer’s prized branded generic business.  With opportunities like this to further consolidate the global generic market, is Actavis better served to focus on opportunities outside of China?  The unique pressures of the generic business in China make this question even more important to answer.  Price pressures on generics are going to further intensify.  The government is going to maintain an unrelenting and uncompromising focus on the part of its healthcare system where it believes cost controls are easiest to find, and generic pharmaceuticals top the list.  The Chinese government’s ongoing efforts to incentivize a domestic life science industry are going to further skew the commercial opportunities in the generic market initially, and the patent-protected products tomorrow, as technology transfer expectations between foreign companies and domestic Chinese actors accelerates.

In other sectors of the Chinese economy, when companies have encountered similar frustrations, CEOs have shrugged their shoulders and essentially said, “we don’t really have a choice – we have to be in China.”  Actavis clearly does not believe this, which is either a great tribute to their vision, or a decision that took advantage of a unique moment in time when the company could exit the Chinese market when Actavis’ overall China strategy would not be questioned.  If the Chinese government is successful disrupting the generic market both domestically and internationally, will Actavis sooner or later have to deal with the market forces that today led them to exit China?  If so, Actavis will need to use the next decade to shape global pharma IP standards and the market itself in ways that prevent the Chinese government’s actions from distorting not only its domestic market, but those Actavis is reliant on today.

Source: Forbes Business


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