Chinese biotech has seen a 12-fold increase in venture capital funding in the last five years, and that's not even touching on all the ways the Chinese government has started to back the space. It's a huge opportunity for companies and patients, and investors around the world are definitely taking note.
In this episode of Industry Focus: Healthcare, analysts Shannon Jones and Simon Erickson dive into the sector, and what American investors really should know before buying in. Find out more about the tons of factors that make China so ripe for a biotech takeoff, why investing in Chinese companies is inherently a risky prospect, how the designer baby story you've probably heard about could affect this fledgling industry, and more. Plus, the analysts share two promising companies that investors might want to add to their watchlists.
A full transcript follows the video.
This video was recorded on Dec. 13, 2018.
Shannon Jones: Welcome to Industry Focus, the show that dives into a different sector of the stock market every day. Today is Wednesday, December 19th, and we're talking Healthcare. I'm your host, Shannon Jones and I am joined via Skype by a special guest, Motley Fool Explorer lead advisor Simon Erickson. Simon, how are you?
Simon Erickson: I'm doing great, Shannon! It's always a pleasure chatting with you! Thanks for having me!
Jones: Anytime! I'm super excited about you joining for this show! For our listeners that aren't aware, Simon literally scours the globe for the next big thing in his service, Motley Fool Explorer. No better person to have on the show to talk about a question I know we've gotten to Industry Focus, something that's been on the minds of a lot of biotech investors. It's one of the hottest areas of investment right now, and that is the Chinese biotech market.
Simon, I'm excited to dig into this today with you. But let's set the stage. If you're like me, I look at the Chinese market in some ways like the emerging biotech market in the U.S. in the early 90s. It was rife with problems. It really wasn't efficient, and you can see how far we've come since then. What are your thoughts on what makes China such an attractive investment right now?
Erickson: It's definitely the perfect storm right now for investors that are interested in this because there's a bunch of things that, the confluence of them all together are setting the scene for this to be a really big market. What I mean by that is, you've got the funding, you've got the policy, and you've got the people in place for biotechnology in China.
Regarding funding, five years ago, venture capitalists were putting about $1 billion a year into biotech in China. That's now $12 billion a year, so a 12-fold increase in venture capital funding from the private programs that we've seen. But the government, too, is pushing this as such a priority. They consider it a really big deal over there. The government's putting $1.5 billion into 20 different research parks around the country. They're really encouraging this. They're also encouraging, as part of their 13th Five-Year Plan, for biotechnology to account for 4% of GDP. That's off a huge base, and about double the percentage that America spends on biotech here at home.
You have that academic research, you have the government policy in place, it's also got the opportunity for the exits through biotech-listed companies on the stock exchanges there in Hong Kong and also here on the NASDAQ in the U.S. You've got the funding, you've got the policy.
Even more than that, the thing that I think I'm most excited about is the people aspect of this. China has always lagged the rest of the world because the most talented scientists were working with westernized pharmaceutical companies -- the Sanofis, the Roches, the Mercks of the world. But China, through their Thousand Talents Program, has been giving incredible incentives to lure those scientists that have clinical trial experience back to the country to work with Chinese-based companies to start progressing their own biotech industry within the country's sovereign walls.
It's really an interesting time. And for investors, there's a lot of opportunity in this industry, as well.
Jones: Diving more into the healthcare side, there's a huge market opportunity in China from a healthcare perspective. China has about 20% of the world's population. It has about 30% of the world's cancer patients, and the world's second largest pharmaceutical market. Right now, only four of 42 cancer drugs that have been approved globally in the past five years are actually available in China. That's astounding to me. The growth opportunity here is tremendous. You mentioned all the funding and all the money right now that's being poured into China.
What you've seen happen a lot is, a lot of these Chinese investors have been investing in U.S.-based biotech companies at an increasingly faster rate. On the U.S. side, now, Chinese and other Asian investors make up nearly half of all the deal flow into U.S. biotech companies, compared to just 11% in 2016. That was the 2017 stat. It'll be interesting to see what that looks like for 2018. I suspect it'll be even higher. But what a lot of these Chinese investors are doing is, they're pouring money into these U.S. biotechs, they're basically looking to generate returns to return back to China to really build up this Chinese biopharma hub, but at the same time, they're wanting to bring back the technology, as well. You see this sharing across the seas here.
Also, China has a rapidly aging population. You've got an emerging middle and upper class, so you've got some affluence. And the government is actually aiming to ensure all citizens have access to basic healthcare services by 2020. It's really no wonder why, not only is China an interesting investment opportunity, but even more so, healthcare in China specifically.
Erickson: Yeah. Every one of those statistics is a case in point. Let's look at lung cancer. China's got about 36% of the diagnoses of lung cancer in the world. But when you look at the five-year survivorship rates, in China, they're 17% lower than the global average. Forget about westernized economies, this is a country that's got big pollution problems, they've got higher smoking rates, they have regional issues that need to be addressed. And they're behind the rest of the world. They've got a lot of people and a lot of money, but historically, they've lagged more developed nations in healthcare. I think that's rapidly changing right now.
Jones: I totally agree. With that, let's turn the tables a little bit, Simon. Let's talk about, what are the risks involved with investing in China? What are some of the downsides? What are the things that make you pause when you're looking at Chinese biotech investments?
Erickson: The first, of course, for any Chinese company, is the corporate structure of these companies. You can't just go out and buy a Chinese direct equity ownership. You have to buy things called American depository shares, or American depository receipts. Those are sponsored by banks here in America that work with the brokerages to secure shares, but they're structured in a way that there's an inherent risk always that, if China's government just wants to say, "Hey, Shannon, we're pulling the plug. You no longer own any equity in this company," there's nothing to prevent them from doing that. These are variable interest entities. These are complex corporate structures that really don't give us the same say in corporate governance as we've gotten used to through proxy statements here in the United States. So, there's always a risk for Western investors of that long-tail losing a stake or having regulations discouraging Western investors.
Then, also, something that you and I have talked about in biotech, Shannon, especially in China, is regulations. This is a country that's overhauled their equivalent of the FDA in recent years. In the last two or three years, we've basically seen them overhaul the way that they reviewed new drugs that were coming to market. And there's a lot of uncertainty of how rigid that really is, and whether they're progressing the best drugs through trials through what some people would consider to be much more laxed regulations than in western countries.
Jones: Yeah, definitely. I think that's probably the No. 1 red flag when it comes to Chinese biotech, the uncertainty surrounding regulations. What I will say is, China is certainly trying to take steps to fix that. They are trying to take their version of the FDA, the CFDA, and modernize that entire agency so that it is up to international standards. That's certainly a work in progress. You also have a huge backlog of applications. Many of these Chinese biotech companies have been sitting, waiting for a response on approval or not, for years in some cases. Now, you see the government really starting to invest in staffing to help with the backlog. So, I will give them credit and say that they are making strides. But that's still a huge, huge, area of uncertainty. You want to know that when you're investing in the company, there's transparency, there's accountability, and you understand and can trust the data that comes out of these trials. That's still, I think, one of the biggest holes in the investment thesis for a lot of companies right now in China. Something to watch.
I think the regulatory framework is another one, in addition to, you always hear stories about Chinese insider trading, questionable financial statements. There's a lot to be desired, even on the financials side of things. Even on the IP side, their intellectual property protections aren't nearly as strong as they are here in the U.S. And, you have to build out a good insurance network to be able to cover a lot of these drugs, especially expensive immuno-oncology drugs. So, still a lot left to be desired there.
Erickson: Yeah, I absolutely agree.
Jones: Let's talk a little bit more on the topic of transparency and risk. For many of the healthcare investors that listen to this show, I'm sure your newsfeed has been slammed with news about designer babies. Simon, designer CRISPR (CRSP -3.57%) babies. [laughs] What do you say to all of this?
Erickson: Holy, cow! This is opening Pandora's box, Shannon. This is a science that has been around technically since the mid-90s. That's when the first abstracts and papers were coming out for what became CRISPR. It's basically gene editing. You're taking the DNA strand, you're snipping out small pieces of it, and you're removing or editing genes.
In terms of the science itself, the reason I say this is Pandora's Box being opened is because the name He Jiankui, scientist in China, has now not only genetically engineered a human embryo, but the mother actually gave birth to twins with this genetically engineered embryo. We have a genetically engineered baby that has been born. This is not just animal testing anymore. This is now very much more real than just the lab work that was being done before. This is now a science that can be incredibly innovative, incredibly progressive, and prevent a lot of genetic diseases, but that's counterbalanced because this is also a very controversial question. It's not black or white. It's not a good or a bad thing, but a lot of people are taking opposition to what's being done and questioning whether or not it was even legal for this scientist to do this in the first place.
Jones: Exactly. I believe he was actually Stanford trained, and as you mentioned, went back to China to go back and build up biotech, build up some companies there. With this CRISPR, one of the advantages of using CRISPR is that it really is a do-it-yourself kit. We even have high school students that are doing experiments with CRISPR at their schools, which is kind of insane to me. The ease of access, the ease of use of CRISPR is so intriguing. You can see it applied in many different applications. You can see it in agricultural biotech. You can also see it being used, and it's starting to be tested, here in the U.S. on human trials, not for germline editing, but for certain diseases that are occurring in adults.
One of the interesting things with this designer baby story -- it seems like new headlines come out every day -- it sounds like he was able to actually go in and do what he intended to do, or at least halfway. Basically, what he was attempting to do was to make these babies resistant to HIV, the virus that causes AIDS. Basically, the way he wanted to go about it was disabling a gene called CCR5. He was able to disable the gene in one of the little girls who was just born. But, it was interesting, because in the other little girl -- of course, we get two copies of every gene -- only one copy of that CCR5 gene was actually disabled. The other was not. So, the question is, is she actually resistant to HIV?
Also, CCR5 is a mutation that already exists. There are adults that are HIV-resistant in the world now. What's so interesting about that is that they're actually more vulnerable to diseases like West Nile virus, even seasonal flu. So now, you've got an immune system that is out of whack. We don't know what will happen long-term. When these children grow up and become adults and parents and have kids, this will pass on to their kids. And we don't know what that will look like.
For this scientist, who kind of did this in secrecy, nobody really knew about it until they came out at a conference and said, "Hey, guys, I just did something incredible," I think there's going to be a lot more questions than there are answers in regard to what happens with this. I do know that China actually came out and banned germline editing. Of course, it's illegal here in the U.S. China finally came out and banned it... but, there's no actual enforcement arm in China. As we talked about with regulatory infrastructure, they don't have a way to really monitor this. So, this is something that could continue to happen. This could be a potential downside, especially if you hear about off-target effects that happen in other trials in China, as well.
Erickson: It's a huge question mark. Like you said, it is prohibited in China legally. But people are speculating that the Chinese government might have given Dr. He special permissions to do these experiments. You haven't seen anything solid as far as prosecution of what's going to happen from this. It's an investigation that's undergoing right now.
You're also seeing some of the leading IP researchers, such as Feng Zhang down the Broad Institute in Boston, calling for a moratorium on a lot of the IP that he's created for CRISPR, saying, "Hey, there are risks we don't know about that might happen from this." Just like you mentioned about CCR5 potentially having babies more susceptible to West Nile virus. There are still off-target mutations. Even if it does work correctly, what's going to be the unintended consequences of this? And, of course, you've got the slippery slope argument. What's OK and what's not OK? I think it's going to be very difficult. In fact, I've never even heard of a globally agreed-upon framework for what is permitted and what is not permitted ethically in scientific discoveries like these. It's going to be hard to say, "This is OK, but we're not going to do this. This is a medical necessity vs. this is a designer baby." There's a lot of gray area there in the middle that is, I think, going to halt the adoption.
But I will counteract all of that, Shannon, if I can say one other thing on this subject, which is, if we go back to the year 1978 and we look at in vitro fertilization, this was something that was hugely controversial in London, when the first baby was born from an embryo that was fertilized in vitro, outside of the womb. Then the baby still came out totally normal. But this was being called the greatest threat to society since the atomic bomb at the time, and the mother that actually delivered the baby in London had to use an assumed identity because of the outrage from the public about this. Of course, course IVF has caught on since then. The creator won a Nobel Prize in 2010. There's now eight million babies that have been born IVF in the world for something that was hugely controversial 40 years ago.
So, I think that, as I've said, we've opened Pandora's box. There's a lot of controversy around gene editing today. I'm not certain that that same level of controversy is going to be there even five or 10 years into the future.
Jones: Yeah, fair enough. I think that's a very good point. Before we dive into a couple of stocks that we think are worth watching, Simon, would you say holistically for, let's say, the average investor out there who's maybe considering investing in Chinese biotech, what would be your words of wisdom to that person?
Erickson: The biggest thing is, science is still going to win at the end of the day. We can be excited about China's population that needs good medicines out there. We can be excited about the people that are coming on board, and the companies that are being created, and the policy. All of that stuff is very good in terms of supporting what is still founded upon good science. At the end of the day, the most important thing is that you have really effective drugs that are based upon good technology and good science that are curing or treating these very serious diseases.
The takeaway for investors is, there are going to be a lot of headlines that you're going to see that contain that sizzle and the buzz and the excitement around what's going on in China. But at the end of the day, we still need to look at the data from those readouts that are presented from these trials and see how that's compared against the standards of care that have been used for decades in westernized countries. It's a great opportunity, but still, data is going to prove how this shakes out at the end of the day.
Jones: That's right. It all comes down to data. I would add, until the Chinese infrastructure and the regulatory reforms are really in place and we can trust it, for me, it's just making sure that if they're running trials in China, how easy is it for them to set up a trial in the western market, run those trials, and then be able to reproduce the same clinical results that they saw in China? I want to see more U.S.-based trials. From there, assuming it's a good opportunity, it's an innovative approach, and the company's management team is clear and transparent, you might be on the right track.
Alright, Simon. I'm excited to talk about this first stock. This is one that you actually brought up to me a couple of years ago. It should be no surprise in talking about hot biotech stocks to watch, immuno-oncology is one of the hottest areas in biotech right now, whether you're in the U.S. or China. Immuno-oncology is really about using the body's own immune system and super-charging it to actually fight an attack cancer. This is definitely a paradigm shift away from the chemo and the radiation. Not necessarily a chemo killer at this point, but certainly a very intriguing area to invest.
Simon, there's one stock that you've been watching. Can you school us on, first, what is this stock? And what was it about the stock that actually attracted you from beginning?
Erickson: The first thing that attracted me to it was that it had an interesting name, Shannon. The name of the company is BeiGene. Not Beijing, as in the capital of China, but BeiGene as in the genetic-focused biotech company. The ticker on this is BGNE. This is a company that's really focusing on immuno-oncology drugs. They're addressing several different forms of cancer. It's getting a lot of attention because they've got what I would describe as some very key partnerships which proved a lot of validation. They're working with larger Western pharmaceutical companies. Also, they have a really good pipeline of their own. So, originally, it was probably the name that attracted me to them. But then, when I started looking closer, I said, "Yes, this is actually a legitimate company, and they're packing a heck of a punch of what they're working on back there, too."
Jones: Yeah. This particular company is technically a commercial stage company, which is great for investors. For a lot of us, we tend to like the pre-commercial stage biotechs, especially as we're watching clinical trials. But, it was through a licensing deal with Celgene (CELG) that actually, now, technically, they are a commercial stage company. Simon, what was that deal all about?
Erickson: That's right. Shannon, as you know, Celgene likes to partner with a lot of companies, doing a lot of neat things all over the world. With BeiGene, they have licensed their drugs Revlimid, Abraxane, and Vidaza to BeiGene. By the way, the names sound similar. They both have that -gene at the end of it. BeiGene has now licensed from Celgene the rights of those three drugs to sell in China. These drugs are selling $10 billion globally right now at Celgene. BeiGene is basically starting from scratch in China. They did $38 million last quarter. That's a drop in the bucket compared to $10 billion globally. But they're growing this at 150% per year. They're starting to get regulatory approvals for these. The reimbursements are being approved for different indications, as well. So, as you see these Celgene drugs, first of all, that are commercially available, they're already being sold in China. BeiGene is pushing for those in a variety of different blood cancers and serious disorders.
The reason this is so interesting to me in the first place is, let's just assume in the longer-term, even though sales are pretty much non-existent in China today, China's got a population that's five times larger than the United States. If we assume that they can even get one-third of the sales of Revlimid in China as they did in the United States, of multiple myeloma, that'd be $2 billion peak sales in China. I think it's capable of much more than that, but let's just say $2 billion within the country's walls. If you put maybe 4X peak sales on that, as an investor, which is pretty common in biotech, 4-5X peak sales, you're already looking at a company that should be worth $8 billion in terms of valuation. That is what BeiGene is valued at today, but they've still got an entire pipeline that's being valued essentially at zero if you put that kind of multiple on it.
I think there's a lot of cool stuff going on in BeiGene's pipeline that's worth a lot more than $0 for investors. This is an asymmetrical risk-reward, in my opinion, that favors investors.
Jones: Absolutely. I must say, there's one particular asset, BGB-A317, it's a checkpoint inhibitor being studied in solid tumors. This particular deal, especially with the pact with Celgene -- on Industry Focus, we've talked about Celgene a lot. As you know, they have become overly dependent on one drug. 63% of revenue is for Revlimid. One of the things they haven't really drove into as much as they should have early on was checkpoint inhibitors. You've got Bristol Myers Squibb with Opdivo, you've got Merck with Keytruda. This is potentially a $30 billion market with checkpoint inhibitors. So, now you see Celgene positioning themselves to have one of these what I call foundational drugs in their pipeline. And really, the future of immunotherapy, the future of immuno-oncology, I think, is going to be a lot of these combination therapies. You have a checkpoint inhibitor, and then you add another drug from your pipeline to make it even more effective.
So, I think for a lot of reasons, this makes sense for Celgene. This certainly makes sense for BeiGene. For those reasons and all the ones that you mentioned, Simon, this is definitely a stock to watch.
Erickson: Yeah. The one that you mentioned that's in combination with the checkpoint inhibitors, Tislelizumab is the name of that drug. They're working with Celgene to commercialize that right now. That's already filed. They've got the NDA, and they're just waiting for approval in China. If they get approval in China for this, which would target Hodgkin's lymphoma, could be also used for advanced liver cancer, some pretty serious diseases right there, if it works and it gets filed and approved in China, they want to also bring that to the U.S., which of course would be of interest to Celgene, as well. It's a great partnership. Celgene took an equity stake in BeiGene last year. They now own about 6% of the company because they see the potential for growing and getting a foothold in China, and also developing, as you said, some great cocktails for their own drugs that they're developing for a variety of different indications of cancer.
Jones: Absolutely. Overall, this is definitely one of the safer, more mature companies out there in China right now. But certainly, things to watch that we mentioned earlier on in the show that you want to be mindful of.
Let's turn the tables to our next stock. This one, definitely not nearly as safe, but one that really captivated investor attention last year at ASCO -- that's the American Society for Clinical Oncology's annual meeting. It's kind of like the Super Bowl of biotech. You get scientists, you get investors, coming to this particular conference. This particular company, it's called Nanjing Legend. We'll just call it Legend, as you'll hear it more frequently. It actually produced a late-breaker abstract. They basically, at the last minute, said, "We've got data that we want to show in relation to our drug." They came on stage and truly wowed both investors and scientists.
I'll go back a little bit and say, Legend is actually a subsidiary of its parent company, a company called GenScript. This is listed on the Hong Kong Stock Exchange currently. Nanjing Legend is not currently listed, although there is talk that at some point, it could be listed on the Hong Kong Stock Exchange in the near future. GenScript actually became the first company to earn approval from the Chinese government to begin clinical trials for a type of cancer treatment called CAR-T therapy -- chimeric antigen receptor T cell therapy. Basically, it's taking a patient's T cells, genetically modifying them in a lab, and then giving those cells back to the patient to then fight cancer.
For me, this was a stock that really shook me, one, because of its target. For our listeners, we've been talking about CAR-T stocks. The two that are approved right now, Yescarta and Kymriah, are CD19 CAR-T therapies. They are targeted and indicated for lymphoma. But, what you see is this next generation of CAR-T therapies coming out, and one of those is BCMA. It's targeting a completely different antigen. It's not targeting CD19. Two, Legend's drug, which is LCAR-B38M, believes that it may even be differentiating itself from other rivals, too. So, you've got Celgene, again, and bluebird, who have bb2121, it's also a BCMA. But this one in particular, Legend likes to describe it like ripping a basket. With their particular construct, basically, it's got two hands on the basket rather than one. What this does is, potentially, make the drug more potent, more effective. We'll have to wait and see what that looks like.
But really, Simon, for me and this particular drug, it was all about the study results that came out of that ASCO meeting.
Erickson: Yeah, absolutely! It's got the right name, Shannon, Legend. That has to be a good one, right?
Jones: You can't beat that! Looking at the conference, what they did is, they presented an early clinical trial. 33 out of 35 patients, that's 94%, with multiple myeloma who had failed or relapsed on previous treatments, actually went into clinical remission within two months of receiving Legend's CAR-T drug, which is amazing. Even more amazing, though, and what really caught investors' attention was that there was an objective overall response rate of 100%. That means every single patient had some sort of response. You don't generally see that. You may see maybe upwards of 80%, but you don't see 100%. So that's what really took investors by surprise.
They did give a recent update at this year's ASH conference, the American Society of Hematology conference, just earlier this month. We did start to see the effectiveness come down just a bit, but you tend to see that as they run these trials over the long-term. In 57 patients now who received the treatment, the overall response rate was 88%, with 74% having a complete response. There was, I guess you could say, some hesitation even on these numbers. There was some thought that maybe they weren't showing all the patients in the trial. Also, the patients that did respond, it looked like the median lines of treatment -- like, how many treatments they had actually failed -- was three. If you compare that to bluebird and what they're doing, these are actually much healthier patients. bluebird had, about seven median lines of treatment before they started their therapy. It could be that the results that Legend is seeing is because you just have a healthier patient base to start with. We'll have to see how that plays out over the long-term. Nonetheless, pretty impressive numbers.
But, Simon, you mentioned how important partnership is when it comes to biotech. Legend is no different. After they presented their initial data at ASCO, by December of that year, actually, J&J inked a licensing deal with Legend. They paid $350 million upfront. Basically, J&J, and Janssen, which is their biotech arm, gets global net sales outside of China 50/50 cost sharing agreement. And then, of course, all the biobucks and royalties that go with it. So, they attracted the behemoth J&J.
First of all, I like the clinical trial results. I love the partnership aspect here. With that being said, like with any company, there's always drawbacks, too.
Erickson: Absolutely! This is going on my watchlist, Shannon. I heard about it from you here today. I'm putting this on my watchlist now!
Jones: Yeah, absolutely put it on your watchlist. I will say for me moving forward, there are a couple of things I know I'm going to be watching. As I mentioned, I want to see U.S. trials under way. I want to see them be able to reproduce this data in the U.S. setting, just to make sure that we're seeing the same things. Also, this could potentially be an M&A candidate moving forward. I mentioned that Nanjing Legend could become its own listing on the Hong Kong Stock Exchange. We'll have to see there. Also, how it stacks up with bluebird and Celgene moving forward.
All in all, I think that sets up for a really interesting 2019 for this company. Really interesting companies to watch here. Simon, any final words for our listeners today about investing in Chinese biotech stocks?
Erickson: It's such an interesting market right now, Shannon. You've got China throwing ¥1 million bonuses -- that's about $150,000 -- to anybody that has clinical trial experience that's a researcher to come to China and set up shop there. They've got immediate access to government grants. They've got teams of people at life science parks that they're building across the country. They've got the momentum to bring some serious IP and some serious know-how within the country. I think that, more than anything, is inciting this biotech revolution within China right now.
They've also got twice as many hospital patients than the U.S. and Europe combined that are eager to get therapies to these serious diseases that maybe they didn't have access to before. Like you said, just a small percentage of FDA approved drugs are even available in China before the last couple of years. So, I think this is setting the scene. As investors, this is something that, yes, it has its controversy. Yes, there are definitely risks investing in China, especially small-cap biotech companies. But I think that there's also a lot of very positive tailwinds and momentum behind this that could be something we're talking about in 2018, then also 2019 and 2020, too. I think this is one of those long-term trends that I see developing as an investor.
Jones: That means you have signed on to do another show with me, Simon Erickson, in 2019, so we can follow up on Chinese biotech! Is that right?
Erickson: Absolutely! Anytime, Shannon! Thank you for having me!
Jones: Thanks so much for joining me today, Simon! And thank you, listeners, for joining in! As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. This show is produced by Austin Morgan. For Simon Erickson. I'm Shannon Jones. Thanks for listening and Fool on!
