Letter from America part III – Biotechnology and China

In Trump’s Agenda47 Manifesto document, a whole section is devoted to the outsourced manufacturing of drugs to foreign countries in general, and to China specifically. This is not just cited as a trade imbalance issue, but one of national security. This is a topic that, once raised, becomes hard for any politician to argue against.

Pragmatically, some sort of confrontation between China and the US seems highly probable, and that it will be some sort of a trade war even more so. With this being the case, the fact that 90% of all prescriptions written in the US contain active ingredients that come from China and India is rightly a potential concern. What if China barred exports of API to the US during some spat? However, this whole discussion seems to have moved beyond one of security of supply into an almost existential debate about the future of the biotechnology industry in the United States.

The BIO industry association is making a lot of noise about the rapidity with which China is improving its biotech capabilities and the speed with which products are advancing through clinical development, often several years quicker than comparable projects based in the US and under the auspices of the FDA. This is something that is also of great concern to early stage (VC) investors, trying to assess the competitive landscape for new investments.

There are several threads to this development. One element is scale; China is a massive country with tens of thousands of PhD students and hundreds of thousands of patients who can be recruited into clinical trials. Labour costs and treatment costs are lower too, allowing, as one Chinese Biotech company suggested: “us to move 5x quicker and 5x cheaper than in America”.

Pragmatically, the only way to address this imbalance is to speed things up in the US via a thorough review of the FDA requirements for clinical development in order to simplify them, removing obstacles such as the revised phase II dose optimisation requirements for oncology drugs (Project Optimus). These changes will need to both reduce time to market and reduce costs, whilst maintaining safety standards. This is not an easy needle to thread, but that does not mean that it cannot be done and the industry is well prepared with a raft of practical suggestions.

Whilst there are a number of high profile cases of alleged IP theft by Chinese companies in the biotech industry (e.g. AbbVie suing BeiGene over the development of its drug BGB-16673, which AbbVie alleges is based on its IP around BTK degraders. This drug has fast track designation in the US and could be on the US market in 3-4 years), the broader reality is that Chinese and US companies scan IP filings and begin development of “me too” molecules that build on others work but skirt around the IP itself as soon as new frontiers become established. Medicine has always been like this.

However, this ability to move materially faster and cheaper means that Chinese companies could be first to market in novel categories on the back of US-led primary research. The anger around this issue and the enthusiastic support from some opinion leaders around the BioSecure Act was notable: “you cannot use a Chinese CRO”/”they are killing us” etc.

As noted previously, this has been described by many as an existential battle for the future of US-led bio-research. We feel this administration, perhaps more than any before it, is going to be very amenable to that narrative and to winning that battle. So, when might we begin to see changes?

In April 2025, the final report to Congress from the “National Security Commission on emerging Biotechnology” will be released. An interim report was published in January 2024, and paints a grim picture of US biotech leadership under threat from China and “its intention to win in the age of biology”. The report seems to be calling for initiatives similar to the CHIPS and Science Act and American Foundries Act that came from a similar report on semiconductor design, manufacturing and supply to shore up US capabilities.

As well as directing public and private money toward biotechnology research, the recommendations are likely to push the deployment of this capital into US-based entities, i.e. the driving of re-shoring for R&D and manufacturing facilities. This is likely to be a carrot-based approach, linking enhanced IP protections and corporate tax rates to where products are developed and manufactured and where IP is based. We also expect rapid reform of the review and approval process.

On a 3-5 year view, this could be very positive for the Biotechnology/Pharma, Tools and Services sub-sectors within US healthcare and also suggests one should be cautious on the future prospects of non-US CROs and CDMOs who have historically benefitted from securing supply contracts from US-based companies for products ultimately intending to be supplied into the US market.

We expect Chinese biotech companies to sell or fully license the IP for their products (including manufacturing rights) to US companies to exploit new products in the US market, since anti-China sentiment may make it difficult to do otherwise. This may represent an opportunity for US-based pharma and biotechnology companies across the market cap spectrum.

We have already met with one company set up by a VC and piped by major biotech investors for the specific goal of licencing novel Chinese IP for development in the United States. The VC in question is already working on a second such venture.

Finally, renewed Congressional support for the Biotech sector and related activities might also hep to stabilise things at the NIH, where chaos also seems to reign. Grant-giving has allegedly ground to a halt, potentially damaging the academic foundations upon which US innovation is built and where the positive effect of GDP multiplier effects are well established by research. Proposed changes to how grant money is spent (funding for indirect costs) adds further jeopardy, even if the proposed cuts have been injuncted for now.

When you read that venerable institutions such as CalTech are suggesting that they may halt PhD offers in 2026 if the landscape is not clearer, then we have a major problem. All knowledge-based industries need a ready supply of skilled human capital and most of the PhD students in the US are benefiting from NIH support to some degree. This issue must be addressed, and quickly. It is perhaps the most self-defeating policy decision we have seen thus far.

Taking a step back and looking across the wider biotech capital markets environment, it does seem to be in a mess; the conveyor belt for new company formation feels gummed up. Here are some sobering statistics; there are some 200 zombie companies trading at negative EVs with little prospect of a lightbulb R&D event to reignite investor interest and around 90% of the IPOs in the sector since 1 Jan 2024 are below their issue price.

We, and many other investors, have little to no interest in companies with a market capitalisation of less than one billion dollars or that are lacking in clinical-stage assets with meaningful catalysts on a 6-18 month view. In the last few years, we have also eschewed companies that do not have cash on hand to cover operations beyond those clinical catalysts.

There are now literally hundreds of companies that now fall outside the Venn diagram of these three hurdles. They may be small individually, but their collective market values add up to billions of dollars and they are a performance drag on some of the wider indices like the Russell 2000 Healthcare Index. Surely even the most optimistic VC investor is going to eschew an exit via going public in such an environment.

At the same time, levels of M&A from “big pharma” remain subdued relative to history in absolute dollar terms (although the proportion of deals that are acquisitions of private companies is much higher today than, say, three years ago).

Because of this situation, many VC funds have yet to exit investments from previous years, locking up capital that should be deployed elsewhere and potentially limiting the ability for VC investors to raise new funds to develop the next generation of companies.

Cleaning up this mess and consolidating these zombie companies as cash shells via reverse mergers has proven to be a more complex affair than one might expect, despite the interventions of some major players within the wider investment industry. Very few early-stage biotechs wind up and return their cash to investors either.

As we have noted before, many of these companies should not have gone public in the first place, but the mania for biotech during Covid and the lure of the SPAC transaction enabled a lot of stuff to sneak onto the market that probably would not be underwritten in a conventional IPO today.

In summary, and perhaps in contrast to prevailing logic, we think that the FDA will see profound and positive changes under this administration that could end up accelerating the path to market for novel therapies and, at the same time, reducing the costs as well.

Given that the poor IRR on pharma/biotech R&D has been a significant topic for investors for more than a decade, these developments would be very welcome indeed. However, it will probably take a few years for the biotech sector to clean up the detritus from the over-exuberance of recent years.