The trade war has reshaped global semiconductor supply chains, forcing key players such as Taiwan Semiconductor Manufacturing Co, Intel, ASML and their massive network suppliers to either face curbs in selling or confine their operations to specific locations. While fewer headlines have been spun, the trade tensions are similarly affecting industries other than semiconductors.
For example, China-based healthcare players, including drug and equipment makers, will likely face curbs from a familiar foe. Under the US Biosecure Act, US companies must cut ties with certain Chinese partners, including those in existing production chains. As such, some outsourcing traditionally undertaken by China has been moving elsewhere. “Companies are proactively reducing their exposure to Chinese suppliers, even in healthcare,” says Yann Mauron, principal at Pictet Asset Management, in an interview with The Edge Singapore.
Companies are proactively reducing their exposure to Chinese suppliers, says Yann Mauron, principal at Pictet Asset Management. / Photo: Pictet
However, the impact of such a trend varies. If the outsourcing goes back to Europe or the US, costs will increase; the reverse might happen if the shift is to other countries around China.
In any case, relative to the semiconductor industry – the main theatre of the US-China trade and tech war – shifts taking place in the cross-border supply chains of the medical industry are not as dramatic but moving at a measured pace. “The industry has, step by step, kind of compensated for that,” adds Mauron.
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There is also a need to differentiate between different segments of this massive ecosystem. Early biotech innovation has been pretty safe, and there are established channels for, say, a China-based entity transferring the later parts of drug development to a US partner to bring towards eventual commercialisation.
Ultimately, within the global pharmaceutical space, there are lower concentration risks than in the semiconductor industry, where certain entities like ASML and Taiwan Semiconductor Manufacturing Company dominate key nodes of the entire ecosystem. “China offers quality and price, but you can have alternatives,” says David Braga Malta, also of Pictet Asset Management, who is in the same team of fund managers running the Swiss bank’s private equity investments for healthcare.
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The global supply chain of pharmaceuticals has lower concentration risks, says David Braga Malta of Pictet Asset Management / Photo: Pictet
Favourable for private equity
According to the Pictet fund managers, multiple trends favour further investments in healthcare, including that from private equity. Biotech innovation has accelerated in recent years thanks to a favourable regulatory environment. However, healthcare companies, including those in the R&D of new drugs, are increasingly capital-intensive to fuel innovation. Yet, without meaningful revenue and much less earnings, most are too early to tap stock markets for additional funding.
As such, private equity comes into the picture, drawn, no doubt, by the overall performance of healthcare PE deals, which is around 560 bps better than all other industries. The investment, naturally, is designed to meet the steadily growing global healthcare market, which was already at a whopping US$9.8 trillion ($13.16 trillion) in 2021, equivalent to just over 10% of global GDP that year.
Pictet has broadly classified this whole ecosystem into five themes. The first, therapeutics, broadly refers to the R&D of biopharmaceutical products used in fields ranging from oncology, neurology, immunology, rare diseases, cardiology and mental health. The second theme is diagnostics, referring to products and techniques used in the investigation and identification of disease states. This theme includes applications in imaging, molecular diagnostics, genetic analysis, real-time data gathering and functional diagnosis.
Next is the emerging digital health theme, encompassing digital health computing platforms, connectivity, software, and sensors for healthcare and related uses. Together, these offerings improve patient empowerment, clinical workflow, research, personalised health and remote monitoring.
The fourth is medtech, which centres around medical devices and technologies that can treat patients efficiently via new technology such as instruments, reagents, services, smart implants and robotics. Last but not least, the fifth theme concerns service providers, including healthcare providers and ancillary services provided by so-called CROs (contract research organisations), CDMOs (contract development and manufacturing organisations), and hospitals and clinics.
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The first Pictet Thematic Private Equity Health fund, run by Mauron, Malta and two other colleagues, Pierre Stadler and Chiara Brambillasca, raised US$318 million by 2022 and is now 94% committed. The team is now raising the second vintage of the strategy. The fund will focus on investing in transformative healthcare companies on the cutting edge of innovation or those with clear impact outcomes.
The Pictet fund managers aim to deploy 20% of their capital in service providers and 30% in diagnostics, digital health and medtech. The single largest chunk of the remaining 50% will be in therapeutics, which includes betting on smaller R&D firms trying to come up with new compounds that can make their way into drugs that can be commercialised successfully eventually.
According to Pictet, nearly half of the new drugs approved for sale in the US come from so-called emerging biopharma and not just within the healthcare giants themselves. Big Pharmas, facing constant expiration of their existing product portfolios, rely heavily on acquisitions of smaller setups to “replenish” their product pipeline and speed up innovation to drive sales.
Growing allocation in Asia
The Pictet fund managers plan to allocate 60% of the funds to investments in the US, 30% to Europe and 10% to Asia. Mauron explains that the proportionately small exposure to Asia partly concerns the fund’s expertise. “We need to perfectly understand every market dynamic when we invest. Since we are not based in Asia, we limit our approach.”
That said, things might change. China, for one, is where many new pharmaceutical compounds are being developed successfully in a very short period. Also, many of these compounds are used in Europe and the US, forming an international supply chain ecosystem.
Another potential investing prospect might come from other emerging Asian markets, such as India, which is developing and scaling up how healthcare services and products are delivered via innovative ways that can be applied elsewhere. For example, an American in rural areas may not enjoy the same level of access to medical specialists in the big metropolitan cities and can thus benefit from such innovations.
Other attractive investment opportunities in Asia include infrastructure, especially in emerging markets: hospitals need to be built, and medical equipment needs to be purchased. The R&D of drugs, on the other hand, is growing but less mature than in the US and Europe. Nonetheless, there are interesting angles. As there are fewer legacy issues, Asia-based drug developers can be more innovative in achieving outcomes, which also suggests market potential in the mature Western markets.
Investors’ interest in early-stage Asia-based biotech companies will also be piqued if they are confident of an exit, which often means a vibrant and liquid public stock market with an appetite for such new listings. This also means that if the public market is less vibrant, it will translate into lower appetite by private equity investors to commit, the Pictet fund managers say.
Interestingly, The Shanghai Stock Exchange’s Star market — meant to support emerging and innovative firms — is shaping up to be a more liquid and attractive listing venue than, say, Hong Kong, which has also put in place friendlier rules for biotech companies, especially if they are at the “pre-revenue” stage. That was not the case as recently as five years ago.
Given the current downturn of China’s capital markets, listing on either Shanghai Star or Hong Kong won’t fetch the best valuations relative to the Nasdaq, for example. Yet, Pictet fund managers are not particularly perturbed, for it means valuations they, as private investors, need to cough out are lower as well, giving room for more upside down the road.
Economic alignment
Investors want maximum returns where possible. For some investors, investing in healthcare seems to be an easy way to do so, as patients are seemingly willing to keep paying ever steeper fees, thanks to some form of public support or insurance. However, will there be a saturation point where the market cannot absorb ever higher healthcare costs? Is there a point where the demand for expensive, newly-developed drugs tapers off?
The Pictet fund managers point out that in the US, for example, just 15% of total healthcare expenditure is on drugs — and largely similar in Europe. A third of the costs can be attributed to infrastructure and another 20% to ancillary services such as medical diagnosis. The component that contributed the most to medical inflation, especially post-Covid, was so-called direct costs, in short, manpower.
So, while the costs of developing new drugs can be significant, it must be seen from a broader perspective. For example, if a new drug can help a patient recover faster and stay in a hospital for a shorter time, that can result in overall savings for the entire economy. “As you approve a drug, you need to demonstrate the economic case as well. Otherwise, payers won’t pay for the drug,” says Malta.
Some players within the ecosystem are taking a different approach to cope with rising healthcare costs. For example, there is now more emphasis on preventive healthcare; the “reverse incentive” of rewarding medical professionals based on patient volume is also being examined. In short, if a patient receives better outcomes, the doctors get paid more, note the Pictet fund managers.
To be sure, this outcome-based incentive approach is still a “new territory”, and not everyone is aligned. However, the Pictet fund managers believe private capital owners can help create such “economic alignment” by taking control of assets and applying the nudge in the right direction. For example, some insurers, instead of merely selling policies and paying out the claims for medical bills in a constant wrestle with patients and doctors, are adopting a vertically integrated approach where they underwrite the risk and provide the care for such better alignment. “It would not happen overnight but this is one way to push towards greater adoption of value-based care,” says Mauron.
