Sector Report

Gray’s China: Anatomy of a burgeoning healthcare system

by David Li & Sandra Sun & Ethan Cui / Nov 19, 2019


Upstream, where drugs are created
China is the world’s second-largest pharmaceutical market, with a market size of Rmb1.3tn as of 2018 and a 9.3% Cagr over 2013-18. Upstream, third-party service providers in research and manufacturing are prospering given the high demand for new drug development. To tackle the rising number of applications and encourage R&D, the National Health Commission has introduced a priority review mechanism that aims to accelerate the pace of drug approvals.

Midstream, where drugs are distributed
After drugs are approved and produced, they need to be delivered to where they are needed. By nature, distributors need to have a nationwide distribution network to cover hospitals at all levels and to achieve scale. Qualified operators in China also need to provide financial liquidity services to pharma companies, which suffer from large accounts receivable. Without such support from distributors, cashflow at pharmaceutical companies would swell significantly.

Downstream service providers
As the key service providers to patients using drugs and medical devices, hospitals sit downstream in the healthcare ecosystem. They have a close relationship with public and drug reimbursement systems, which are the greatest source of revenue for state-owned hospitals. The largest public healthcare insurance funds – Urban Employees Basic Medical Insurance, Urban & Rural Residence Basic Medical Insurance and New Rural Cooperation Medical Insurance – together covered more than 95% of the total population in 2018.

How to find investment opportunities
Under China’s large healthcare framework, we believe the strong will get stronger, and that investors need to balance short-term interests with long-term returns. In the immediate future, qualified names may suffer from negative policy. However, additional revenue can quickly ramp up from strong pipelines. We expect leading companies in each major segment to benefit from market consolidation and believe that current high multiples are justified.