Hong Kong biotech IPOs: silver lining ahead

Hong Kong’s stock exchange took a progressive step in 2018 when it allowed pre-revenue biotechnology companies to list. But the initial excitement was short lived, with the stocks’ dismal performance in the aftermarket denting sentiment among issuers, bankers and investors. Will the tide turn for the sector this year? Jonathan Breen investigates.

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Ascletis Pharma was patient zero, the first pre-revenue biotechnology company to go public in Hong Kong after the bourse, in April 2018, gave such firms permission to list. Potential issuers didn’t waste much time in showing their excitement.  

“There were many appointments of sponsors, and a lot of preliminary due diligence and reorganisation work was done in preparation to take advantage of the new rules,” says Stephen Peepels, head of US securities, Asia Pacific, at law firm Hogan Lovells. “The new rules were generating a lot of enthusiasm and publicity about what a significant opportunity this was going to be.

Asia 2019“I am fairly confident that there have been more than 100 companies that at least looked at the new regulations and wanted more information about whether or not they could pursue a Hong Kong IPO taking advantage of those new regulations,” adds Peepels.

But after all the furore, just five biotech companies made it across the finish line in 2018: Ascletis Pharma, Hua Medicine, Innovent Biologics and Shanghai Junshi Biosciences. BeiGene, which is already trading on the Nasdaq, conducted a secondary listing in Hong Kong. 

Ascletis, which focuses on anti-viral drugs, raised HK$3.1bn ($395m) from its IPO last July. It priced the 20% float at HK$14 a share, giving it a HK$15.7bn market capitalisation. 

But within two weeks of trading, things turned. The shares were listed on August 1, and by August 17 were changing hands at HK$7.28 apiece and by mid-February around HK$6.68 — raising questions about what went wrong.  

“[Our] IPO had generated strong demand and the book was multiple times covered,” Lindi Tan, Ascletis’ chief financial officer, tells GlobalCapital Asia. “However, since the IPO, the stock price has traded down alongside broader China market conditions, and a China healthcare sector market selloff in the second half of 2018 on the back of centralised procurement drug pricing concerns.”

Granted, when Ascletis went through price discovery and bookbuilding for its IPO, the Greater China healthcare market was booming. The MSCI China Health Care Index was at a record high of more than 300 points, while numerous healthcare stocks were trading at around 30 to 40 times price-to-earnings, according to Tan, a former life sciences investment specialist at Singapore sovereign wealth fund Temasek Holdings. For example, at the time, China’s largest pharmaceutical company by market cap Jiangsu Hengrui Medicine was changing hands at a valuation of around 70 times P/E.

Asia 2019Fast forward to late January 2019 and the MSCI China Health Care Index had fallen to 200 points. The Hang Seng Mainland Healthcare Index, meanwhile, was off by nearly half from its all-time high in late May 2018. 

Against such a downfall, where is the potential for the sector? 

Queuing up 

China is a market with a growing middle class around 300m-strong and with an increasing taste for western medicine and treatments. For Tan, that presents a lucrative opportunity for biotech companies. 

“We view that the China healthcare market is large and sustainable,” she says. “In Asia, there is scarcity premium for high quality healthcare and biotech companies.”

That knowledge appears to have propelled many firms to head for a listing. A pipeline of promising biotech issuers has built up in Hong Kong, with at least six or seven coming this year, according to multiple banking sources. 

Among those that have publicly sought approval are pre-revenue MicuRx Pharmaceuticals, which submitted a draft prospectus to the Hong Kong Stock Exchange in June last year and refiled at the end of 2018 after its application lapsed. The firm focuses on antimicrobial therapeutics for superbug infections and has four drug candidates in the works.

Ascentage Pharma Group International and Mabpharm filed in August 2018. Both are also pre-revenue and develop therapies for cancers and autoimmune diseases. The firms have seven and nine drug candidates, respectively. 

Asia 2019Also in the works is the listing of Shanghai Henlius Biotech, which is being spun-off by China’s Fosun Pharmaceuticals. The IPO hopeful is revenue generating but still deep in the red. Liaoning Chengda Biotechnology, a division of Chinese vaccine manufacturing company Liaoning Cheng Da, is gunning for a listing too. The firm is a standout from the group given it is revenue earning and profitable. Both issuers filed late last year.

In addition, AOBiome Therapeutics submitted its IPO documents last July. Its application has since lapsed, but the company is still planning an IPO in Hong Kong and is actively working with the HKEX and its sponsors, it said in an emailed statement. Meanwhile, CanSino Biologics got the go ahead from the stock exchange in February. The firm, founded by a group of Chinese vaccination industry experts from Canada, is developing 15 vaccine candidates for 12 disease areas.

That’s unlikely to be the end of it, with more IPO applications from biotech companies expected in the next six months.

“There are other companies that I think will prepare to do an IPO,” says Irene Chu, head of new economy and life sciences, Hong Kong, KPMG China. “I would say that Q1 is usually a bit quiet but in Q2 and Q3 we will start to see more applications being submitted.” 

The market has already had its first taste of biotech this year when pre-revenue CStone Pharmaceuticals sealed a HK$2.24bn IPO in mid-February. 

The dynamics of CStone’s IPO, which was covered on its first day of bookbuilding and priced just above the mid-point of the marketing range, are a good sign for the year ahead, reckons one equity syndicate head away from the deal. 


Teething

A key reason is that investors appeared to have had an informed dialogue with the issuer and syndicate about pricing, compared to the buy-side's 2018 approach of throwing caution to the wind. 

This is indicative of the main hurdle biotech companies face when listing: valuation. 

Asia 2019Once pre-revenue biotech companies got the go ahead from the exchange last year, they were keen to be the first out the gates. But investors were not as knowledgeable or concerned about the intricacies of valuing these companies as they might have been with a more traditional company. That was the biggest driver of the confusion and volatility that surrounded biotech listings in the months that followed.

Ultimately, of course, the responsibility for valuing a company falls primarily to the investment bankers bringing it to market and investors committing capital to the deal.

“It is important to be realistic, from all constituents’ perspectives, in what is an achievable valuation at IPO so that the aftermarket performance is likely to be healthy,” says Bruce Wu, Citi’s co-head of Greater China and vice-chairman of Japan capital markets origination.

“Reflecting on last year’s deals and, in particular, their aftermarket performance, one implied takeaway is that some deals actually required more pricing concession, through which better aftermarket performance could have been attained.”

Some see the lofty pricing to be a result of pre-IPO funding rounds pushing up valuations higher to reflect the commitment of private investors.

”A lot of these biotech companies, because they are not making money, the traditional metrics that are used don’t apply,” says Jenn-Hui Tan, head of capital markets and corporate governance at Fidelity International. “The private markets have funded them and because they have funded them well to a very large degree over the past couple of years, the IPO prices have been increased above the last financing round.

“This is not traditionally how you would value biotech if you were a long-only investor. It is a very technology-focused way of valuing a company, not a particularly healthcare way of valuing a company.”

In valuing a pre-revenue healthcare or biotech company, an investor should use a discounted cash flow (DCF) analysis, says Fidelity’s Tan. Typically, they would look at the company’s drug and its total addressable market and then discount backwards.

 They would also consider the drug’s potential market share and the likelihood of achieving it and then, having taken into account the risk of development and commercialisation, arrive at a risk-adjusted price.

This clearly means that the way pre-IPO investors value a biotech company is key. But as one former healthcare banker says: “The question I have asked myself is ‘do these pre-IPO investors have enough industry expertise?’”

For the biotech market to become sophisticated, the need for expertise with pre- and post-IPO investors is obvious and acknowledged.

“Most investors who have invested in China healthcare are more comfortable with more mature healthcare companies that are generally valued on a price-to-earnings model,” says Tan of Ascletis Pharma. “Over time, China healthcare investors will probably gain comfort using a DCF model approach, which is used to value biotech companies, as seen for the US and EU biotech companies.”


Clue-ing up

So what of the investment bankers leading these deals? Have they got the expertise to bring these issuers to the market? 

The need for specialised bankers is undoubtable. Selina Cheung, a managing director on UBS’s equity capital markets team, acknowledges the lack of healthcare expertise in Asia and sees banks across the street tapping their global resources to strengthen their position in the sector.

“On sell-side banking and sell-side research a lot of banks are partnering with their international counterparts, who have had relevant experience in other parts of the world,” says Cheung, who worked on a number of biotech IPOs in Hong Kong over the past year.

“We have a number of individuals on our platform that deal with biotech in other regions of the world, mostly in the US.”

Asia 2019Other firms are moving researchers to investment banking positions to get a strong foothold in the industry. In November last year, Bank of America promoted Jessica Li to head of healthcare investment banking for Asia. Li took on the job in January, transferring from her previous position as head of Greater China healthcare research.

Also last year, BofA’s former head of Asia healthcare investment banking Michael Chiu moved to Goldman Sachs, where he co-heads healthcare investment banking in Asia ex-Japan with Shawn Lee. Around the same time, Darius Naraghi moved from BofA to Goldman’s ECM desk to cover telecommunications, media and technology, biotechnology and China.

JP Morgan too boosted its China healthcare team in February 2019 with the appointment of Ling Zhang as head of healthcare and technology for global investment banking coverage in China. Before joining JPM, Zhang was chief operating officer at Shenzhen Stock Exchange-listed genome sequencing company BGI Genomics.

According to one Hong Kong-based equity syndicate head, “healthcare banker is the easiest job to get in Hong Kong at the moment”.

Among equity investors, analyst coverage is also increasing, which is helping investors build up their knowledge base. Thanks to this, there are signs of increased rationale when it comes to valuations, says KPMG China’s Chu.

“In the short run, investors will definitely be more cautious based on what we have seen and who we have spoken to,” says Chu. “But they are still quite bullish in terms of the longer-term prospects because of China being the second largest biopharmaceutical market in the world.”

Admittedly, while most of the news around the sector has been bad, there have been exceptions among biotech listings in Hong Kong. 

Innovent Biologics, for instance, priced its HK$3.3bn IPO in October 2018 at HK$13.98 a share and as of late-February, the stock was up to HK$23.2. Its success, when the preceding deals had failed. was considered a sign the market was starting to mature, in terms of deal pricing and allocation. 

Asia 2019Junshi Biosciences followed in December, pricing its stock at HK$19.38 per share. It was up around 12% as this publication went to press. 

“We have and we are investing in pre-revenue biotech firms,” says Fidelity’s Tan. “Although post listing performance of last year’s biotech listings is mixed, a few are doing well.

“The companies that have done well did so because they were priced correctly to reflect risk and were allocated correctly by the company and banks to a good solid group of shareholders that are able to take a long-term view.”

Innovent’s immediate and continued success in the secondary market shows that issuers and bankers had learnt lessons from Ascletis’ maiden transaction, adds a senior ECM banker in Hong Kong. 

Since then, other underperforming biotech stocks also received a fillip. The sector as a whole is up and can be tracked using the CES HK Biotechnology Index. Launched late last year by the China Securities Index Co, a joint venture between the Shanghai and Shenzhen stock exchanges, it tracks 16 HKEX-listed stocks, including all the biotech companies that floated last year.

CES HK Biotech opened on November 14 at 5,298.55 points, before dipping slightly toward the end of December. But it has bounced back quickly, and by mid-February was up around 20% year-to-date at 5,533.25 points. 

That has raised an important question — is the biotech rally sustainable? 


US vs Hong Kong

This depends on who you ask. Despite the upturn and clear pipeline of IPOs, some bankers fear potential business could still slip through the hands of the city’s bourse. 

“I’m hoping investors won’t be scared by what happened with biotech last year and will continue to trust the Hong Kong market,” says Cheung. “I don’t want all this business that could potentially come to Hong Kong to go back to the US.

“But we need to grow as fast as we can as a region, both from sell-side and buy-side, to make sure we get a piece of the pie. That is what I think is important and the message that is important to deliver.”

Unfortunately, some companies are already heading to the US, which many ECM bankers in Hong Kong have attributed to issuers getting cold feet after the poor early performance of biotech firms in the city. 

US-headquartered Stealth BioTherapeutics let its Hong Kong listing application lapse in January, instead floating for $78m on the Nasdaq on February 14. The company did not respond to a request for comment on its decision to list in the US over Hong Kong.

California-based biotech firm Grail had also been considering a Hong Kong listing, according to bankers, but has since refocused on a US IPO. The company said in an emailed statement it does not comment on market speculation or its financing plans. Grail, a cancer detection start-up, is backed by heavy-hitters including Amazon’s Jeff Bezos, Microsoft co-founder Bill Gates, Google and Tencent Holdings.

Asia 2019“The challenge for 2019 is that whilst there are a number of biotech IPOs in the pipeline, there are a number of issuers now thinking about whether they will continue to consider Hong Kong as a listing venue or alternatively consider whether the US would be a better venue for listing,” says Cheung.

One company that Hong Kong nearly lost to the US was Shanghai-based Hua Medicine, which has developed a proprietary, third generation diabetes drug. The firm had yet to generate any revenue and was in need of capital last year at the time of its IPO. 

Since 2017, Hua Medicine’s chief financial officer George Lin had been advocating that the HKEX allow pre-revenue listings by technology companies. But as nothing was changing and the need to list was building, the firm prepared to head for the US.

“Then in early 2018 the [Hong Kong] stock exchange called me and said ‘stay tuned’,” says Lin, an 18-year investment banking veteran who also serves on a biotech advisory panel created by the HKEX last year.

Once the HKEX gave the go ahead for pre-revenue biotech companies to float, Hua Medicine pulled the trigger for its IPO. A big factor in the company’s decision to list in Hong Kong was proximity to China, its main customer base.

“For us it seemed like a very good thing to list in China because that was our main market, but we could list in Hong Kong as well and it had the benefit of being bilingual,” says Lin.

This kind of consideration is likely to be a big factor for other firms too as they juggle different listing venues. But Hua Medicine serves as an example of how Hong Kong has started to stem the flow of mainland biotech companies heading to the US.

“Nasdaq is always going to be an attractive listing destination for certain companies because it is a huge centre of liquidity and you already have that base of biotech investors and availability of comparables for valuations,” says Tan of Fidelity. “But Hong Kong definitely has a role to play for certain companies, particularly for companies that rely on brand recognition that are looking to create markets among Chinese consumers. They will have a natural bias towards listing in Hong Kong.

“So within this bigger picture, in our view, the exchange was right to create a chapter that allows these companies to list in markets that are close to their development home, to reflect that home country bias.”


The future for the HKEX

A question that gets to the heart of what the future flow of biotech listings in Hong Kong will look like is: why come to the public markets at all? Among various answers, the simplest is a need for capital.

Hua Medicine launched around eight years ago and went through five private funding rounds, mainly with US investors before Chinese capital came in as well. But it was, and still is, not enough. 

“We are starving for capital,” says Lin. “Hua Medicine is probably not going to generate any revenue until the end of 2020, so having that market to be able to raise capital is crucial.”

The public markets provide biotech start-ups with many benefits but primarily they are an alternative method of fundraising, offering access to a pool of capital much deeper than what can be found privately.

The buy-side can, of course, cash in. Hua Medicine, as a late-stage biotech company that is relatively near to commercialisation of its drug, is a good example. Its stock, listed at HK$8.28 apiece, was trading around HK$8.8 in late February.

“We have a broad and diverse group of investors who have made very good returns and new investors who are looking to make more,” says Lin.