With all the FDA regulation of drug approvals here in the States, it was kind of inevitable. Drugmakers are in China -- big-time -- and it doesn't look like they'll be leaving anytime soon.
Cheap labor
Just like other industries, the pharmaceutical industry has realized that China is a good place to find cheap labor. While companies may be reluctant to set up FDA-regulated manufacturing plants in China -- past performance with other industries being one reason -- they haven't been quite as apprehensive about moving other stages of drug development there.
Companies that make laboratory supplies don't have to deal with the FDA, so they've been happy to lower their costs by manufacturing in China. For example, Illumina manufactures supplies in China that not only get used by U.S. drugmakers, but also get sold to Chinese drugmakers and academic laboratories. The laboratory-supplies industry has really become a global business.
Many pharmaceutical companies have been outsourcing their preclinical research to China. Eli Lilly (NYSE: LLY ) , for instance, has transferred some of its toxicology studies in animal models to China.
Even some clinical research is being moved to the East. Companies will often use contract research organizations (CROs) to run their clinical trials in China. In fact, many regulatory agencies in Asian countries require that drugs be tested in people of Asian descent before the drugs are approved for marketing there. That's what was behind Onyx Pharmaceuticals' (Nasdaq: ONXX ) recent release of data from a trial that was almost exactly the same as previously released results.
It's not all one-sided
While American and European companies benefit from outsourcing to China, the Chinese companies benefit, too.
One example is WuXi PharmaTech (NYSE: WX ) , the leading pharmaceutical and biotechnology R&D outsourcing company in China. Shares are up 108% from the company's August debut price. It does business with nine of the 10 largest pharmaceutical companies, including Merck (NYSE: MRK ) and AstraZeneca, which helped it produce 78% year-over-year revenue growth in its latest quarter. However, the trailing P/E is an astronomical 93, but is about 40 on a forward (2008) basis. If WuXi can't keep up the growth, it could be considered overvalued.
Biotech company 3SBio (Nasdaq: SSRX ) benefits directly from the growth in China. It is essentially in the follow-on biologics business, selling drugs such as a copycat version of Amgen's (Nasdaq: AMGN ) erythropoietin drug, Epogen. Sales are mostly in China, but the company has plans to expand to neighboring countries. Another choice for generics in China is Simcere Pharmaceutical, which has its hand in the more traditional small-molecule generics.
And then, of course, there are the very traditional Chinese medicine firms, including American Oriental Bioengineering (NYSE: AOB ) and Tongjitang Chinese Medicines. Neither has found much favor with investors this year, but American Oriental has a rich history of earnings growth.
Final Foolish thoughts
While I think we're probably years away from seeing FDA-regulated drug manufacturing become a big-time presence in China, pharmaceutical companies have figured out that for now they can cut costs by doing at least some of the pre-approval work in China.
I expect companies that are currently in China -- most of them -- to move into drug manufacturing as China eventually transforms into a high-tech society. However, your guess is as good as mine as to how long that will take.
As for whether you should buy Chinese health-care companies, that depends on whether you think China's economy will continue to prosper. Since its growth is tied to what the rest of the world can afford to buy, my personal hope is that China continues to prosper.
More Chinese Foolishness:
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