Benjamin Graham had a dim opinion of initial public offerings. Believing they were often a signal that the stock market had reached its peak, he quipped that the term IPO really stands for "it's probably overpriced."
Well, the action of the markets over the past few weeks has pretty clearly shown that we're not currently at the top, so maybe there are some recent IPOs whose stocks are worth considering. I think one of them might just be WuXi PharmaTech (NYSE: WX), which made its debut on Aug. 8, with 13.2 million American depositary shares priced at $14 apiece. In the first day of trading, the stock took a nice 33% jump and closed the day at $18.70.
Headquartered in Shanghai, WuXi is the biggest of more than 300 biotech companies in China. It sells biotech research services as an outsourcing organization for biotech companies. Nearly 2,000 employees work for the company, including more than 1,300 scientists. Among its properties are a 630,000-square-foot research-and-development facility and a 220,000-square-foot process development and manufacturing plant in Shanghai, and a 130,000-square-foot R&D center in Tianjin.
With those 1,300 scientists on board, WuXi has the capacity to synthesize libraries of compounds and test them in biological assays, and it can also assist in developing manufacturing routes to active pharmaceutical ingredients.
I think the outsourcing of biotech research makes for a great business model. Biotech research requires substantial infrastructure, including chemistry and biology labs, lots of specialized equipment, environmental permits, and a highly trained staff. For entrepreneurs with a great idea, the ability to get started without having to first acquire all of this infrastructure saves a great deal of time and money.
What's more, nearly every major pharmaceutical company outsources work to China, and it's not just Big Pharma: smaller, cutting-edge research companies such as Abgent, Ambit, and Kalypsys of San Diego are also getting some of their work done in China. And why not? Chinese biologists and chemists have the same credentials as American ones -- and in some graduate science programs in the U.S., they even outnumber Americans. Ge Li, WuXi's CEO, holds a Ph.D. in chemistry from Columbia University, while Chief Scientific Officer Shuhui Chen has a Ph.D. in chemistry from Yale University.
The outsourcing of biotech research become popular in the U.S. in the late '90s, with providers such as CombiChem, Discovery Partners, ArQule (Nasdaq: ARQL), and Tripos springing up to allow bigger companies to outsource their research. Salaries at these smaller companies were lower than at the big pharmaceutical companies, so there was a cost-savings benefit for those who used them. But ultimately, these outsourcing companies just couldn't compete on price with similar Chinese companies, and now most of these "molecule mills" have vanished. ArQule still exists, but it has shifted its focus to original research.
Trying to match on price with the Chinese is not a fair fight, and as a result, these U.S. outsourcing companies never had a chance. Not only do Chinese companies enjoy a huge advantage in terms of wages, but they also profit from loose enforcement of environmental regulations, tax breaks for foreign direct investment, and a pegged currency. And with cost-cutting a constant concern among pharmas everywhere, outsourcing to China is only going to increase.
The economic forces here are unstoppable. Biotech offshoring is just in its infancy and is going to grow drastically. China, meanwhile, has made great strides in becoming an industrialized nation, and while it still has a long march ahead of it, WuXi is indeed a great company positioned for explosive growth over the next few years. And I definitely like investing in growing companies, regardless of where they are.
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Fool contributor Andrew R. Vaino, M.B.A., Ph.D., once won 600 of Ben Stein's dollars on Win Ben Stein's Money and doesn't have a position in any company mentioned in this article. He also writes on biotech stocks at www.peternavarro.com.
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