Are Health Care Investors Facing a China Catastrophe?

As Beijing looks to create its health care blacklist, companies can ill afford to find themselves in the midst of a scandal like the one that plagued GlaxoSmithKline in 2013.

Jan 3, 2014 at 9:25AM

China. It's on the mind of every big multinational company across the market regardless of industry, offering a tantalizing mix of a growing middle class and a huge population. Yet China's been a mixed bag for big pharma and other health care giants in its ascent in the ranks of the world's largest economies. While the country's offered up a taste of the kind of market potential it boasts, Beijing has made competing in China a dicey affair.

The GlaxoSmithKline (NYSE:GSK) bribery scandal in China tainted big pharma's growth in the country in 2013 and made the biggest names wary of how they'll advance in this top market. Beijing wasn't done with Glaxo, however: Just before the new year rolled around, Reuters reported that the Chinese government announced it will launch a blacklist of health care firms in the country in early March. Companies on the list could face two-year bans regionally or, if convicted more than once in a five-year span, nationally.

It's another looming incentive for firms to play by Beijing's tightening rules, but who has the most to lose from any potential setbacks in China's growing health care market? Top health care companies, from Sanofi (NYSE:SNY) to Stryker (NYSE:SYK) to Abbott Labs (NYSE:ABT), have a lot at risk.

Big pharma vs. Beijing
No doubt the opportunity in China is too big to pass up, even as the government cracks down on companies nationwide. McKinsey estimated in a recent report with the Chinese Pharmaceutical Association that the country's pharma market could see 17% annual growth through 2020, bringing the total market size in excess of $300 billion.

Still, with the government turning its focus toward foreign competitors and looking to ramp up its own domestic drugmakers into feasible rivals on its own shores, the near future could see challenges for some of the world's biggest pharmaceutical names.

GlaxoSmithKline's already taken a big blow in China. The company's China sales nosedived by 61% year-over-year in the third quarter following its bribery scandal. Glaxo hasn't given a projection on how long the blow will linger, and while investors shouldn't expect such a huge hit in every quarter going forward, it's safe to say that Glaxo likely will be feeling the pain from the mess for some time.

That blow shook Glaxo's stock at the time, and while Glaxo's stock recovered to around a 20% gain over the past year, other pharma rivals are bound to have noticed the tremors. French pharmaceutical giant Sanofi is a major player in China, and the company found itself caught up as a target of Chinese investigations in the wake of Glaxo's probe. That hit the company's China sales growth in its most recent quarter, and Sanofi can't afford to risk its dominance in emerging markets. The company derived more than 30% of its sales from developing markets in 2012. Sanofi's dueling diabetes rival Novo Nordisk for future leadership in this huge market, and a big stumble here -- for either Novo or Sanofi -- could be a massive blow to their outlooks.

Orthopedics makers facing opportunity
Big pharma isn't the only health care industry at risk, however. Medical device companies have poured money into China in recent years to counteract sluggish growth in Europe and other developed markets, and any major probe from Beijing could mean bad news for companies and investors.

Take Stryker and orthopedics rival Smith & Nephew (NYSE:SNN). Stryker's made big moves in China recently, snapping up trauma and wound management products firm Trauson Holdings early last year as the company looks to stake its claim in China's orthopedics market. That market will only grow as China's population ages and its middle class grows. Smith & Nephew, meanwhile, has made China a priority as it looks to bolster its own emerging markets profile. The company's sales in developing economies and international markets jumped by 11% in 2012, with China making up around a quarter of that region's total revenue for the year. Neither company can afford a big setback in China even as U.S. sales begin to see higher growth, so it'll be paramount that both Smith & Nephew and Stryker -- and their rivals looking to make a big splash in China -- stay off the radars of probing regulatory authorities.

The health care industry that will most need to watch its step is the nutritionals industry, however. Nutritional products, particularly baby food and formulas, have been a huge hit in emerging markets, with China's infant formula market alone expected to climb to $27 billion by 2017. While nutritionals developers weren't specified to be under the umbrella of China's new blacklist set to launch this year, it's best for leading companies like Abbott Labs to play it safe. A China product recall hindered the company to the tune of a $90 million hit in the third quarter . With nutritional sales -- Abbott's largest business by revenue -- seeing growth of more than 6% year-over-year through the first nine months of 2013, Abbott can't jeopardize its biggest growth driver with a few risky missteps in China.

Keep an eye on China
The outlook's clear: Health care companies need to tread lightly around Chinese regulators and make doubly sure their overseas units are playing by the local rules. Despite China's tightening grip on foreign firms, this market's still too underdeveloped and brimming with potential to shy away from now. Still, investors need to keep a close eye on their favorite companies in the world's second-largest economy. Beijing sure is.

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Fool contributor Dan Carroll has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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