The first wave of Chinese pharmaceutical industry consolidation occurred in the 1990s and the first five years of 21^st century when a number of state-owned pharmaceutical enterprises as well as, to a lesser degree, some local private pharmaceutical groups consolidated many local state-owned pharmaceutical companies.

The result of the first wave of consolidation was the miraculous swelling of some local pharmaceutical groups which eventually led to the downfalls of some of them. Such cases are best illustrated by the stories of 999 Enterprises Group, China Worldbest and XiAn Topsun. 

Such consolidations were often motivated by irrational ambitions and wishful thinking of the leaders of these enterprises and encouraged by officials who were eager to produce "miracle" performance.

It is fair to say that the local pharmaceutical companies, especially state-owned companies, dominated the first wave of consolidation. Driven by the objective to build large scale Chinese enterprises that are competitive in the global pharmaceutical arena, these companies were encouraged and in some cases even coerced by the government to expand.

The second wave of consolidation of the Chinese pharma industry arrived in the earlier years of the 21^st century when the dominant players of the first wave began to falter and the environments of both the Chinese and international pharmaceutical markets started to change. Market pressures and challenges in new drug R&D forced the world’s leading pharmaceutical companies to look to emerging countries for both future market growth and outsourcing opportunities. As the undisputed leader of emerging markets backed by annual double-digit growth for two decades consecutively, the importance of China in the world’s pharmaceutical industry is rising even faster than predicted.

“The Chinese pharmaceutical industry will be an important force internationally sooner or later”, Liu Chuanzhi, Chairman of Legend Holdings said at the IPO of Nanjing Simcere Pharma at New York Stock Exchange.  Inspired by his prediction, the venture capital arm of Legend Holdings recently snapped 100% of Shijiazhuang Pharmaceutical Group, just a year after its acquisition of a 40% stake in Nanjing Simcere.

What inspires Legend Holdings is also motivating other venture capital companies, which are the backbone of the second wave of consolidation and the backseat drivers behind the rising number of overseas IPOs by Chinese pharmaceutical companies. 

With the exception of Goldman Sachs, all leading investment banking groups, such as Merrill Lynch, SoftBank, UBS Warburg and Credit Suisse, have invested in the Chinese pharmaceutical industry. According to local press reports, venture capital firms so far have invested in a total of 29 Chinese pharmaceutical companies, among which 12 took place in 2006. 19 out of the 29 investments were made to pharmaceutical manufacturing companies, 1 to retail pharmacy chain operator, 3 to medical and pharmacy internet startups, 2 to healthcare companies, and 4 to medical device companies.

The total investment by venture capital firms in the Chinese pharma industry is now over US$400 million, among which investment to the manufacturing sector is US$238 million and to the retail pharmacy sector is US$40 million. 

Companies that received venture capital funding are usually among the top five companies within their respective market segment.

Since 2006, a string of Chinese pharmaceutical companies including Shenyang Sunshing (3SBio), Nanjing Simcere and Guizhou Tonjitang have launched their IPOs at overseas stock markets and enjoyed popular investor support. Smaller companies without strong venture capital backing have also sought IPO at various over-the-counter stock trading venues in the US and Europe and have managed to raise the money needed to fund their growth.

Meanwhile, the stock value of pharmaceutical companies listed on the Chinese stock exchanges almost doubled in the first half of 2007 from CNY 220 billion at the beginning of the year.

Appreciation of stock value of the Chinese pharmaceutical companies further boosted the confidence of venture capital firms in the sector, so it seems at least for now the more successful companies will not be short of funds for growth even with a challenging Chinese pharmaceutical market environment as the backdrop. 

Local pharmaceutical companies with venture capital backing or cash raised from overseas IPO are likely to pursue fast growth through acquisitions.

Wang Xiaochun, Chairman of Guizhou Tongjitang, expressed to the local press that his company will focus on expansion through acquisitions following its successful IPO in the US, and he believes that the next five to ten years will be the golden time for acquisitions in the Chinese pharma sector.  Ren Jinshen, Chairman of Nanjing Simcere, also told the press that his company will spend the cash raised in acquisitions, distribution channel building and new drug R&D.

For these companies, it seems that product pipelines of potential M&A targets have become the primary driver for acquisition, compared with previous important drivers such as scale of economy or simple expansion. Local analysts believe that new chemical drugs and innovative traditional Chinese medicines are on the top of their lists for product acquisition. 

Multinational pharmaceutical companies have become increasingly active in the second wave of consolidation in the Chinese pharmaceutical industry as evidenced by a number of recent deals including joint venture deals between Alliance Boots and Guangzhou, between Suzuken and Shanghai Pharma and between Baxter and Guangzhou Qiaoguang, and Bayer Healthcare’s acquisition of XiAn Topsun’s OTC business. 

Local analysts pointed out that the drivers behind acquisitions by multinationals are more related to the sales and distribution channels in China as exhibited in the above deals. 

Multinationals are also expanding rapidly in China, but their growth is almost entirely centered on organic growth through increased investments into manufacturing, marketing and sales and R&D.

Although the second wave of Chinese pharma industry consolidation is only at its early stage and may last for a few years, yet its likely future outcome is already visible. As we predicted in an earlier article in the February 2007 issue of Pharma China, the ongoing second wave of consolidation within the Chinese pharmaceutical sector, which is primarily funded by foreign venture capital firms and overseas investors, is likely to produce a number of forceful challengers to multinational pharmaceutical companies on the Chinese market.

In the foreseeable future, such companies may become competent players in the global pharmaceutical marketplace just like India’s Ranbaxy, Dr. Reddy’s and Cipla. The only difference is that the successful Indian companies are mostly home-grown, while their likely Chinese counterparts may well be funded by foreign venture capitalists and investors.  At some stage, these companies may be transformed into multinationals themselves, just like the ongoing story of UT Starcom in the IT sector.