Boom Times for China’s Medical Devices Market
(ED NOTE: It must be remembered, however, that barriers to introduce new medical devices in China are still onerous: there are definitely regulatory problems; clinical trials is a novel concept in China, and reagents are approved under different regulations than medical devices; but the Chinese medical device market is projected to grow about 30% every three years!)
Poised to become the world’s largest medical device market, China is a tremendous business opportunity for foreign companies, as long as they choose their partners wisely.
China used to be called the sleeping giant. Anyone who follows the IVD space knows that the giant has awoken and is climbing down the beanstalk, hungry for market share. China is gradually becoming a competitive force and evolving into the world’s fastest growing market for both domestic and foreign IVD products. China’s total IVD market, which is valued at more than $4.5 billion, doubles every three years, and it will surpass the United States to become the world’s largest IVD market within the next 10 to 15 years. The large multinationals are devising ways to partner with local Chinese companies to take advantage of this business environment, while local companies are looking to multinationals for help in penetrating developed markets. This presents opportunities and challenges for IVD manufacturers on both sides of the divide.
Let’s take a look at two factors—market growth and quality improvement—that have contributed to this situation.
China’s IVD Market Posts 30% Annual Growth
In 2007, Whitney Research visited healthcare facilities at all levels for a Gates Foundation project called Diagnostic Cost Analysis for the Developing World. In a country-by-country ranking of healthcare equality, China was fourth from the bottom. Our travels in 2007 confirmed that poor farmers and city dwellers were denied care unless they could pay. Even middle class families drained their life savings and equity and often ended in bankruptcy to care for a seriously ill family member. Healthcare was essentially limited to people who worked for the government or were employed by a registered city company that contributed to the local health insurance program, and to individuals who could pay for it out of pocket.
In response to these inequalities and growing unrest, Chinese Healthcare Reform was born. In late 2008, the government announced a $125 billion healthcare stimulus to fund the building of a more modern healthcare infrastructure augmenting the overburdened but highly profitable Class 3 hospitals and the expansion of health insurance programs that would provide more breadth and depth of coverage to a larger segment of the population.
As a result, IVD sales have grown more than 30% per year for the past four to five years and now stand at more than $4.5 billion. Many market researchers, who concentrate on large city hospitals, have missed this phenomenon. While large multinationals have grown at almost this rate, local manufacturers have benefitted most from the spending directed at lower level hospitals.
Quality, Made in China
Despite the impression of many foreign observers that the Chinese regulatory process favors local manufacturers, we have found that stringent requirements placed on both multinationals and local companies are weeding out low-cost, poor-quality producers.
All Chinese manufacturers now must comply with ISO 13485. In addition, ISO 15189 is being implemented by clinical laboratories. This standard requires internal and external quality control and documented evidence of proof of performance when installing new equipment or changing suppliers of reagents.
For many years, the national and provincial centers for clinical laboratory management have been bringing blind survey samples to the labs and reporting comparative results. This has given labs the ability to judge value, not just price.
If you have any doubts that Chinese quality is ready for prime time, consider this: last year we brought 74 Chinese IVD companies (97 from all of Asia) to the AACC annual meeting in Los Angeles, and we expect to bring even more to Houston in 2013. China was second only to the United States in the total number of exhibitors.
Opportunities and challenges in China’s IVD Space
Typically in the IVD space, the real money flows from the reagent stream, not instruments. A decade or two ago, Chinese IVD manufacturers were highly specialized either in hardware or reagents. Companies such as BioSino, Strong, Maker, Leadman, Livzon, and Kehua manufactured consumables, whereas firms such as Mindray, Dirui, and Landwind focused on the hardware.
The multinational sales strategy of placing instruments and making profits on reagents forced local manufacturers to supply both to stay competitive. Naturally, they tended to be better at one or the other and needed help either in developing state-of-the-art reagents for their instruments, or instruments to complement their existing reagent offerings. OEM manufacturers such as Laola in Nanjing became suppliers of instruments to many reagent manufacturers. Some foreign companies worked with Chinese manufacturers—Sysmex with Kehua or Biorad with Wantai, for example—to develop or distribute products. Many Chinese companies simply copied the products of foreign manufacturers. Anyone who has been involved in the development of IVD instruments or reagents knows how difficult it is to simply reverse-engineer these products. Much more goes into product quality and reliability. Eventually, reagent manufacturers gained expertise in manufacturing and servicing instruments, and instrument manufacturers achieved competency in producing reagents, but often with the help of foreign component and materials suppliers.
Class 3 hospital labs in large cities remained the domain for foreign equipment, although some inroads were made by Chinese companies in supplying quality reagents for open systems.
At lower-level healthcare facilities, where much of the sales growth has occurred, clinical lab and instrument knowledge is scarce. Demand for easy-to-use and low-maintenance products has resulted in explosive growth of point-of-care offerings and rapid tests. This has been a focus for local manufacturers and a weak area for multinationals.
Significant partnership opportunities exist that can help multinationals reach down to lower level markets and local manufacturers reach up to developed markets. Many local companies are cash rich and looking to acquire.
The partnership selection process entails both opportunities and risks. Two examples that have been a focus of our market research for private equity and investment firms in the past are Mindray and China Medical Technologies. Let me share what we have learned about these U.S.-listed, public Chinese companies.
Mindray Is One to Follow . . .
Mindray (NYSE: MR) was founded in 1991 by three men with particular hardware expertise, notably in patient monitors and ultrasound systems. As the business grew, Mindray entered the IVD market with hemoglobin analyzers in 1998, where the appetite for reagents was relatively weak and not a focus for the company. It placed more than 60,000 open-system hemoglobin analyzers in China. The company further expanded into IVD instruments with very simple ELISA systems and urine testers, followed by automated chemistry analyzers and associated reagents. Mindray is currently the number-one IVD company in China with more than $200 million in China sales. Recently it introduced a chemiluminescence analyzer and reagents. This was not an easy row to hoe: the technology has been in development for more than nine years and required the expertise of a former Abbott scientist, who relocated to develop the reagents.
In 2006, Mindray listed on the New York stock exchange, not because it needed cash but to enhance its image at home. Rather than aspiring to be a low-cost producer in China, Mindray’s strategy was to concentrate on quality and service and to invest in branding. As a result, it has the widest and most effective distribution system in China with a network of distributors all over the country and backup distributors cueing up, should present distributors falter. The resulting pressure on distributors makes them very effective in pushing Mindray products in China.
Mindray acquired Datascope in the United States in 2009 and expanded its sales of monitors and imaging equipment. It presently sells more products overseas than it does in China and is present in 190 countries. Like other Chinese companies, however, it has faced difficulties breaking into the IVD sector in the developed world.
Mindray is a successful, reputable company with a proven strategy that can be a game changer for the right partner.
Let’s contrast that with a company that was reported to be the second largest IVD manufacturer in China.
. . . China Medical Technologies? Not So Much
Contrasting with Mindray, our investigation of China Medical Technologies (subsidiary companies: Yuande, GP and Bio-Ekon; NASDAQ: CMED) for the largest investment firm in the world, completed in May, 2008, uncovered less-than-reputable practices.
Press releases and astute public relations had built a glowing reputation for CMED, and its books had been audited by KPMG and, later, by Price Waterhouse. It had been acquiring companies with sophisticated-sounding technologies (fluorescent in-situ hybridization, chemiluminescence, surface plasmon resonance) and was the darling of the investment community, bringing in $677 million in stock and bond sales between August 2005 and December 2010. (Merrill Lynch was last to buy company bonds in late 2010 and distribute them to its clients.) All the while, China Medical was covered by analysts at Deutsche Bank and Morgan Stanley. In the 12 months before its deregistration from Nasdaq in February 2012, analysts watching the company rated it as either a buy or hold.
At the time of our investigation in 2008, CMED stock was above $50 per share and the quarterly releases were reporting unbelievably strong sales growth, profitability, and cash flow. We looked deeper into this company and talked with its reference accounts and competitors. When we asked other IVD companies for their strongest competitors, CMED’s name was never mentioned. Yet, the sales numbers it was reporting would put them second to Mindray. Foreign IVD companies were signing co-development agreements with CMED, some of whom enlisted us to perform due diligence. By 2012 the stock was selling at 60 cents per share and the company had defaulted on payments, stopped issuing quarterly earnings reports, and was delisted by Nasdaq. It was sued in California and in the Cayman Islands, where liquidators could find only $23,000 of the reported $416 million. The liquidators filed a complaint with the police and FBI in Hong Kong against Wu Xiaodong, founder and CEO, and Sam Tsang, CFO, who are nowhere to be found. The latest we heard from a former CMED employee was that Mr. Wu is an in- law of a member of the State Council, which may explain why this has not received news coverage in China. At the time of writing, we have not been able to confirm this reported relationship.
Our investigation in early 2008 saved the investment firm millions of dollars. Unfortunately, many smaller investors and some IVD companies who partnered with CMED were not so lucky.
Choose Your Partners Well
The time is right for multinationals to partner with Chinese IVD manufacturers or to establish a wider footprint in China by investing in R&D and manufacturing directly in China. However, reliance on established wisdom from the investment community and major international auditing firms is not enough to guarantee reputable partnerships.
Nat Whitney is president of Whitney Research Inc. He can be reached at email@example.com.
Disclaimer: Mr Whitney and associates of Whitney Research do not have financial interests in any Chinese IVD companies mentioned in this article.