Asia Spotlight: China's Top Drug Distributors Are Soaring

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SHANGHAI - China's drug distribution market and retail pharmacy revenue reached RMB 708 billion ($110.9 billion) in 2010, a 24.6% increase from 2009, and the top three drug distributors' market share increased by 5.8% to 26.7% through aggressive acquisitions to expand their distribution networks, according to China's Ministry of Commerce.

However, growth of China's pharmaceutical industry slowed down in the first half of this year, mostly due to price cuts, and the expansion of the Anhui tender model, which awards a single supplier for each drug on the Essential Drug List, setting up a winner-take-all bidding process (Also see "Anhui Model Suggests More Pricing Pressure From Chinese Drug Tenders" - Scrip, 13 Jun, 2011.). A new government effort to restrict use of anti-infectives also played into slower growth for pharma during the first half.

Under China's 12th five-year plan, the government plans to foster a select group of distribution companies with more than RMB 100 billion in annual revenue, and Sinopharm Group Co. Ltd. and Shanghai Pharmaceutical Holdings Co. Ltd. have no intention of slowing down their frenetic pace to acquire smaller players.

In a recurring feature, PharmAsia News combs through earnings calls to bring readers the highlights in the critical emerging markets; (Also see "WuXi Celebrates First $100 Million Quarter; Sinovac Reports 50% Revenue Increase; SciClone Not Worried About Zydaxin Cuts: China Earnings Round Up (Part 1)" - Scrip, 17 Aug, 2011.) of China's Q2 earnings round up, published in mid-August, covered WuXi PharmaTech, Sinovac and SciClone Pharmaceuticals Inc.

Sinopharm Reaching China's Far-Flung Corners

The largest pharmaceutical products distributor in China, Sinopharm reported better-than-expected first half results with 48% year-on-year revenue growth to RMB 48 billion ($7.5 billion). The revenue was offset by higher finance costs and expenses for M&A transactions, and net profits grew slower at 29% to RMB 1.2 billion.

"Drug price cuts, the changing drug tender policy will bring pressure on the rapid growth of the industry," Sinopharm Chairman She Lulin said in a statement.

Due to Sinopharm's large scale, the company looks more immune to the impact of these policies than others.

"We forecast gross margin for Sinopharm will largely maintain around 8.2% for '11 and out-years, given its large portfolio with 44,600+ products, which give[s] the company flexibility in adjusting product line, strong bargain[ing] power to suppliers as the largest drug distributor in China, and capability to provide value-added services beside distribution," Citi analyst Richard Yeh wrote in an Aug. 26 note.

Growth Shifting To Tier 2 And 3 Cities

Meanwhile, growth in China's health care market is shifting from mature markets to tier 2 and 3 cities and outlying provinces. According to Citi, mature markets such as Shanghai, Beijing and Zhejiang province reported slower growth in the first quarter compared to the same year-ago quarter. Shanghai saw 8.2% growth and Beijing's pharma market shrank 0.8%.

Sinopharm said during its Aug. 25 earnings call that the government's healthcare support is primarily targeted to prefecture-level cities, and not first-tier cities. The company currently covers less than 50% of prefecture-level cities, and 70% of the company's revenue comes from the 159 big cities it covers.

Sinopharm's distribution network already covers 87%, or 1,070, of China's top-tier hospitals. In total, the company distributes drugs to 7,802 hospitals, which account for 61% of all hospitals in China.

To reach smaller cities and provinces, the company completed 27 transactions during the first half of the year and added another seven distribution centers to its existing 39 centers. It now covers 30 out of 32 provinces. The company noted more acquisitions in tier 2 and 3 cities will be targeted.

Although Sinopharm distributes products for 30 global companies, it plans to shift some of that business to the more profitable promotional sector. For example, the company is in negotiations with Merck & Co. to commercialize Merck's human papillomavirus vaccine Gardasil. The potential deal could also be expanded to promote Merck's other vaccines and pharma products in China (Also see "Merck Teams Up With Sinopharm On Vaccines As It Gears Up For Gardasil Approval In China" - Scrip, 29 Jul, 2010.).

Shanghai Pharma Shifts To Innovative Products; Overseas Acquisition Likely

Unlike Sinopharm, Shanghai Pharma has a sizeable pharmaceutical manufacturing business in addition to distribution, with seven of its own products on the market that reached RMB 100 million ($15.6 million) in first-half sales. Due to pricing pressures on generic drugs listed on the EDL and the national drug reimbursement list (NDRL), the company is trying to shift to more innovative products through partnerships.

Shanghai Pharma reported a 36.1% YoY increase in revenue for the first half of this year to RMB 25.2 billion, largely due to its robust distribution business. Thanks to its acquisition of Citic Pharmaceutical, the third-largest distributer in Beijing, SPH's distribution revenue grew 46.2% over the same period last year. The company distributes drugs, medical consumables and vaccines for 69 MNCs, which accounts for 60% of Shanghai Pharma's distribution business.

Similar to Sinopharm's deal with Merck, Shanghai Pharma inked a memorandum of understanding with Pfizer Inc. in April to explore business opportunities, including the potential to jointly register, commercialize and distribute an innovative urology compound from Pfizer. The U.S. company also became a cornerstone investor in SPH's Hong Kong IPO in May (Also see "With Pfizer As Cornerstone Investor, Will Shanghai Pharmaceutical Be Largest Pharma IPO Ever?" - Scrip, 10 May, 2011.).

The strong growth in Shanghai Pharma's China distribution services was partially offset by a slower pharma manufacturing business for the company, which increased 11% in the first half to RMB 4.2 billion, representing 17% of total revenue.

Pricing Pressure On Generics Shifts Focus

Most of the company's products are generics and under pricing pressure by EDL price cuts coupled with a nationwide implementation of the Anhui tendering model, which could slash retail prices by 30% to 40% during the tendering process.

Shanghai Pharma produces 70% of the drugs on the EDL, and the 505 drugs that the company produces for the NDRL account for 60% of its manufacturing revenue.

Drugs on these two lists are exposed to price cuts by the National Development and Reform Commission. NDRC recently slashed prices an average 14% for endocrinology and central nervous system drugs. In March, antibiotics and cardiovascular drugs fell an average 21% (Also see "With Latest Round Of Cuts, China Continues March To Narrow Gap Between Big Pharma And Local Generics" - Scrip, 5 Aug, 2011.).

Shanghai EDL prices were cut for 688 drugs Aug. 20 by an average 39%, according to NDRC. More rounds of price cuts are expected this year in other therapy fields, including oncology.

Like Sinopharm, SPH is looking for innovative partners to offset price cuts on generics. The company is co-developing four drugs with Shanghai Fudan-zhangjiang Bio-Pharmaceutical Co. Ltd., of which SPH owns a 30% stake.

In addition, the company's chairman recently said SPH is looking for an overseas acquisition of a mid-size innovative pharma company within the next six to 12 months.

But the company is by no means abandoning distribution. In August, it paid RMB 344 million to acquire an 80% stake in Jiangsu province pharma distributor Wuxi Shanhe Group.

"We think scale is SPH's primary competitive edge. While organic growth remains instrumental, we anticipate M&A will play a large role as a growth driver," Deutsche Bank analyst Jack Hu wrote in an Aug. 19 research note. The analyst forecast gross revenue will grow at CAGR 16% and 29% for the manufacturing and distribution businesses, respectively.

By Dai Jialing