Tightened IPOs and Stricter Share Sale Controls: Where Is Medical Investment Headed?

On August 27, the China Securities Regulatory Commission (CSRC) rolled out three major measures simultaneously to boost confidence and activity in the capital market. A series of significant policies aimed at “invigorating the capital market” were implemented, including a reduction in stamp duty, a temporary tightening of initial public offerings (IPOs), strict control over refinancing, and stringent restrictions on share reductions. This policy mix triggered a sharp surge in A-shares on the 28th, although the market subsequently opened high but closed lower.

For innovative pharmaceutical and medical device companies, the impact of the China Securities Regulatory Commission’s (CSRC) new regulations extends far beyond stock price fluctuations. Policies such as tighter initial public offering (IPO) approvals, stricter controls on share reductions, and stringent oversight of refinancing have significantly affected the innovative drug and medical device sectors. Given the long development cycles and high capital requirements characteristic of biopharmaceutical enterprises, many innovative drug and medical device companies listed on secondary markets are trading below their IPO prices and operating at a loss, remaining reliant on external funding. In the primary market, tighter IPO regulations have impaired exit mechanisms, with this contraction rippling through the entire financing chain, from angel rounds to Series A, B, and C funding.

According to VCBeat’s “Global Healthcare Industry Capital Report for H1 2023,” the total investment and financing in China’s healthcare industry exceeded $5.6 billion (approximately RMB 41.051 billion) in the first half of 2023, representing a year-on-year decline of over 43%. With healthcare investment already in a winter slump, will the introduction of new policies accelerate the clearing of bubbles in the innovative drugs and medical devices sector, or will it prolong this downturn? As IPO exits become more constrained, will the healthcare investment sector usher in an era of M&A boom? To address these questions, VCBeat (WeChat ID: vcbeat) interviewed multiple industry insiders.

The CSRC’s new regulations, particularly the phased tightening of IPOs, have sent shivers down the spine of the primary healthcare investment market.The China Securities Regulatory Commission (CSRC) has clarified that, to improve the counter-cyclical adjustment mechanism between the primary and secondary markets and to appropriately manage the pace of initial public offerings (IPOs) and refinancing, it will temporarily tighten the pace of IPOs in light of recent market conditions, thereby promoting a dynamic balance between investment and financing.

Signals of a tighter IPO environment had already emerged earlier, with the latest date for companies submitting prospectuses to the STAR Market remaining at June 30. Previously, there were industry rumors that the STAR Market had suspended acceptance of applications under its fifth listing criteria.

Tighter IPO regulations have significantly impacted the industry by making IPO exits more difficult, thereby intensifying financing pressures on companies and exit pressures on institutional investors.

Previously, the primary market in the field of innovative drugs and medical devices accumulated substantial financing. The pharmaceutical industry is characterized by high R&D investment and long development cycles, with most listed companies remaining in a state of continuous losses at the time of their IPOs. Around 2018, the Hong Kong Stock Exchange’s Chapter 18A and the STAR Market’s fifth listing standard removed institutional barriers for biopharmaceutical companies to go public, leading to a surge in valuations of domestic biopharmaceutical firms. In 2020, the COVID-19 pandemic triggered an influx of hot money into the healthcare sector, resulting in excessive prosperity in the primary market. As numerous companies rushed to list, it became commonplace for unprofitable biopharmaceutical enterprises going public under HKEX Chapter 18A or the STAR Market’s fifth listing standard to see their share prices fall below the IPO price (break issue price), causing an inversion between primary and secondary market valuations. Currently, investment in China’s innovative drugs and medical devices is undergoing a difficult valuation restructuring, as the market gradually clears out equity bubbles and investors’ unreasonable expectations.

Tighter IPO regulations mean it is more difficult for investment institutions to exit, resulting in greater exit pressure.The tightening of IPO exit mechanisms will also influence the investment preferences of healthcare investment firms.Since the second half of 2021, when healthcare investment entered a downturn, domestic investment firms have begun to adjust their strategies by focusing on early-stage and smaller deals, as well as sectors with stronger consumer attributes. With the introduction of new regulations by the China Securities Regulatory Commission (CSRC), many investors have indicated a growing preference for companies with positive cash flow.

The pressure from difficulties in exiting via IPOs will gradually permeate the entire investment cycle, with some investors noting that, undoubtedly, the winter chill in healthcare investment will persist for even longer.

In addition to the slowdown in IPO financing, the China Securities Regulatory Commission (CSRC) has clearly stated that follow-on financing will also be slowed down on a phased basis. (1) A pre-communication mechanism will be implemented for large-scale follow-on financing by listed companies in the financial sector or large-cap listed companies in other sectors, with attention paid to the necessity of financing and the timing of issuance. (2) For listed companies exhibiting conditions such as trading below their IPO issue price, trading below net asset value, continuous operating losses, or a high proportion of financial investments, appropriate restrictions will be imposed on the interval between financings and the scale of financing. (3) Listed companies will be guided to reasonably determine the scale of follow-on financing and strictly comply with requirements regarding the interval between financings. During the review process, close attention will be paid to whether the proceeds from the previous fundraising have been substantially utilized and whether the projects funded by the previous fundraising have achieved the expected benefits. (4) Listed companies are strictly required to direct raised funds toward their core business operations, with strict limitations placed on diversified investments.

The phased tightening of IPOs, coupled with stricter refinancing regulations, will cause companies in both the primary and secondary markets to face the risk of capital chain rupture, preventing them from surviving until the next growth inflection point.

The medical and healthcare sector is characterized by long R&D cycles and substantial capital requirements. The journey from initial research to commercialization for original innovative drugs can span up to a decade, making financing the lifeblood of biotechnology enterprises. Impacted by the "capital winter" in the pharmaceutical industry that began in the second half of 2021, a significant number of innovative drug and medical device companies have started closely monitoring their cash flows and trimming their R&D pipelines. With the formal implementation of tighter IPO policies, these cash-burning innovators face even more arduous survival challenges.

On the positive side, this also means that industrial bubbles are being cleared out at an accelerated pace, forcing industrial upgrading and further purifying the industry ecosystem.

For listed biotech companies, the ability to secure additional financing before achieving full profitability is a key factor in sustaining corporate development.Even leading biopharmaceutical companies in China, with revenues reaching billions of yuan, remain unprofitable and reliant on external funding.

In the past, there was significant room for refinancing through listings on the Nasdaq. Although regulatory oversight in China’s A-share market is relatively strict, its ample liquidity has made refinancing comparatively easier for companies. Few domestic innovative pharmaceutical and medical device companies have listed in the U.S.; most have chosen to list on the A-share market. With the phased tightening of initial public offerings (IPOs) and stricter controls on refinancing, listed innovative pharmaceutical and medical device companies will face greater financing pressure.

In recent months, a number of listed innovative drug and medical device companies have withdrawn or terminated their private placement plans, including Beta Pharma, Haichen Pharmaceutical, and Keqian Biology. One investor candidly remarked, “The future for innovative drugs and medical devices will become increasingly challenging.”

The CSRC’s new regulations, which impose strict controls on share reductions, have also drawn significant attention.The China Securities Regulatory Commission (CSRC) stated that controlling shareholders and actual controllers of listed companies are prohibited from reducing their holdings in the company’s shares through the secondary market if the company’s share price falls below its initial public offering price or its net asset value per share, or if it has not distributed cash dividends in the past three years, or if its cumulative cash dividends over the past three years are less than 30% of its average annual net profit for the same period. Parties acting in concert with the controlling shareholders and actual controllers shall comply with the aforementioned requirements. For listed companies disclosed as having no controlling shareholder or actual controller, the largest shareholder and its actual controller shall comply with the aforementioned requirements. Meanwhile, the total volume of share reductions by other shareholders of listed companies shall be strictly controlled to guide them in arranging the pace of share reductions reasonably based on market conditions. Controlling shareholders, actual controllers, and other shareholders are encouraged to commit to not reducing their shareholdings or to extending the lock-up periods for their shares.

Under the new regulations, if any one of the aforementioned four conditions is met, the actual controller and controlling shareholders are prohibited from reducing their shareholdings in the company through the secondary market. The new policy implies that even after biotechnology companies complete their initial public offerings (IPOs), both actual controllers and shareholders face the risk of being unable to cash out and exit their investments.

Biopharmaceuticals represent the subsector most significantly impacted by stringent restrictions on share reductions. Unprofitable biopharmaceutical companies listed on the STAR Market under the fifth set of listing criteria have not only failed to distribute cash dividends since their IPOs due to their lack of sustained profitability, but their stock prices have also remained below the offering price for an extended period.

According to statistical data from Huaan Securities, calculations indicate that 237 pharmaceutical companies may be affected. Among them, 113 companies are trading below their IPO price, 25 are trading below their net asset value, and 161 have either not distributed cash dividends in the past three years or have cumulative cash dividends amounting to less than 30% of their average annual net profit over the same period.

This extensive list includes numerous companies such as Topchoice Medical, United Imaging, Blue Sail Medical, Zhifei Biological Products, Walvax Biotechnology, CanSinoBIO, Sino Biological, BeiGene, Tinavi Medical Technologies, and Andon Health.

For the industry, stringent regulatory controls will undoubtedly curb the listing activities of “speculative” enterprises, impose higher requirements on founders and shareholders of innovative pharmaceutical and medical device companies, steer the industry back to its innovation-driven essence, and promote long-term, healthy development.

However, in the short term, listed innovative drug and medical device companies are facing heightened difficulties in exiting post-IPO. In light of the four conditions stipulated under the new regulations on share reduction, it will be significantly challenging for actual controllers and controlling shareholders of these enterprises to reduce their holdings in the future, resulting in a substantial accumulation of equity assets at the exit stage.

With Exit Channels for the “Moveable Feast” Blocked, Primary Market Institutions Face Renewed Pressure; One Industry Insider Exaggeratedly Warned: In the Worst-Case Scenario, GPs Could Be Overwhelmed by LPs Demanding Capital Returns.

With the implementation of a series of measures by the China Securities Regulatory Commission (CSRC), transfers of existing shares and exits through mergers and acquisitions (M&A) will become more prominent exit channels in the near future. Mergers, acquisitions, and restructurings are important avenues for optimizing resource allocation, promoting industrial consolidation, and stimulating market vitality.

With new regulations limiting IPO pathways, will the pressing need for capital exit fuel a surge in M&A activity within the healthcare sector?

An industry insider stated:There is no causal relationship between the M&A boom and the tightening of IPOs. The M&A market is often driven by transformations in industrial structure, intensified competition in niche sectors, and prosperity in the capital markets.In the healthcare industry, anti-corruption campaigns and phased policy shifts may prompt some companies to pursue capitalization through mergers and acquisitions (M&A) or accommodate the exit demands of institutional investors. This creates a temporary window of opportunity, leading to a phased increase in M&A activity. However, this is merely an expedient measure; for M&A to truly flourish, it must still be underpinned by the fundamental logic outlined above.

There is no doubt that the number of mergers and acquisitions (M&A) will increase, but ultimately only a small fraction of enterprises will be acquired. M&A activity will remain concentrated in the hands of a few large corporations with strong cash flows, rather than becoming widespread, and the barriers to entry in the M&A market are by no means low.

An investor stated bluntly, “Many biotech companies are essentially formed by former pipeline assets and teams laid off by large pharmaceutical firms that have returned to China. Who would acquire them? Although the biomedical industry is characterized by severe information asymmetry, large enterprises possess deep industry expertise. In M&A transactions, acquirers either target established distribution channels or technologies with strong market competitiveness. However, domestic biotech firms are predominantly focused on ‘me-too’ drugs, resulting in highly homogeneous pipelines. Consequently, only a small fraction of these companies will be acquired. Drawing on the exit experiences of overseas venture capital (VC) and private equity (PE) firms, the proportion of VC-backed companies that ultimately liquidate through bankruptcy or other means reaches as high as 90% during market downturns, and remains at 60% even during market booms.”

Undoubtedly, the CSRC’s new regulations have delivered a significant shock to the innovative drugs and medical devices sector. However, at their core, these issues stem from inherent problems within the sector itself; the new regulations have merely brought them into sharper relief.

Amid the shock of the CSRC’s new regulations, the healthcare industry is not necessarily doomed to pessimism. Viewed over a ten-year cycle, China’s innovative drug and medical device market remains in an early stage of development. The NASDAQ Biotechnology Index has also experienced multiple rounds of bubbles. The core reasons why innovative drugs and medical devices remain favored by the market are the inelastic nature of healthcare demand and the continuous emergence of technological innovations within the industry; short-term policy fluctuations have not altered this fundamental reality. In effect, the new regulations serve as a radical remedy to purge systemic issues, and will promote the healthy, long-term development of the industry.

References:

Dialogue with MicuRx’s Yuan Zhengyu: China’s Innovative Drug Industry Will Emerge from the Capital Winter in About Two Years — VCBeat New Medicine

He Juying, CSC Financial: Pharmaceutical Sector Valuations Are Reasonable; Focus on Investment Opportunities in the Innovative Drug Segment

How Do the New Share Reduction Rules Affect IPOs and M&A for Unprofitable Biotech Companies? — Yicai