By Adam Jourdan
SHANGHAI (Reuters) - A crackdown on corruption and pricing in China's fast-growing pharmaceutical market has squeezed profits and margins, raising a red flag to global Big Pharma that the days of easy growth in the country may be over.
A Reuters' analysis of more than 60 listed Chinese healthcare firms shows average profit margins declined to around 10 percent last year from 15 percent in 2012. Average net profits fell 2.1 percent, down from close to 20 percent growth in previous years.
China has been a magnet for the big global pharmaceutical companies and other healthcare firms as growth slows in Europe and the United States. It is the largest emerging drugs market and is set to be the global number two overall within three years, according to consultancy IMS Health.
While global drugmakers withhold their China profit figures, the analysis suggests profit growth is harder to come by - a concern as many global firms look to China as a future growth driver.
"Most companies, local and foreign, have enjoyed an easy growth phase for 5-6 years as money was thrown at the healthcare system to improve access," said Alexander Ng, Hong Kong-based associate principal at McKinsey & Co. "Now China is more into cost containment mode... and the squeeze on pricing and margins is a lot more apparent."
Over the past year, China has cracked down on high prices and corruption in the healthcare sector. Authorities probed drugmakers over pricing in July, while a high-profile investigation into British drugmaker GlaxoSmithKline Plc (L:GSK) led to executives at the company being charged with bribery earlier this month.
Industry and legal sources said the investigations into the sector are likely to grow more intense, meaning downward pressure on profits is likely to remain.
SALES DRAG
The climate of investigation has stymied sales growth, with some doctors saying they are worried to meet pharmaceutical reps, fearing being caught in the glare of China's watchdogs.
In 2013, Chinese authorities visited global drugmakers including Novartis AG (VX:NOVN), AstraZeneca Plc (L:AZN), Sanofi SA (PA:SASY), Eli Lilly & Co (N:LLY) and Bayer AG (DE:BAYGN) as part of a broad investigation into the sector.
GSK, which saw its China revenues plunge 61 percent in the third quarter last year, has since overhauled its management structure in China, stopped payments to healthcare professionals and changed its incentive systems for drug reps.
"Of course there will be an impact on sales. The pattern of selling through bribing definitely won't work anymore," said a Shanghai-based sales executive at another global drugmaker, speaking on condition of anonymity.
The Reuters' analysis showed combined revenue growth in the sector fell to 17.9 percent last year, from 22.6 percent in 2012 and more than 28.8 percent in 2011.
PRICING PRESSURE
Price cuts are also putting a strain on profits and margins as China's leaders look to cut a healthcare bill that is set to hit $1 trillion by 2020, according to McKinsey & Co. Combined profit growth dropped to around 5.2 percent last year from 23.9 percent in 2011, according to the Reuters' analysis.
While authorities have made some moves to step back on price caps, Chinese healthcare procurement still puts the main emphasis on cost, creating an incentive for firms to push prices lower to beat rivals to contracts.
"The industry is in a very competitive stage, where firms want to take market share to stay in the game, but at the same time can't deal with the low prices," said Yu Mingde, president of the Chinese Pharmaceutical Enterprises Association, an organisation supervised by China's cabinet.
The crackdown on pricing has pushed some Chinese firms out of business and forced global drugmakers to rethink their China strategy, industry sources and analysts said, putting greater emphasis on high-tech drugs which command greater pricing power.
International drugmakers have long banked on being able to charge a steep premium in emerging markets for branded generic drugs that have gone off patent in their home market.
Generics specialist Actavis Plc (N:ACT) pulled out of China this year, saying the market was too risky and not a business-friendly environment.
"When you have 5,000 competitors you have to be special, and being a foreign company is no longer enough," said Guillaume Demarne, Shanghai-based business development manager at healthcare research body Institut Pasteur.
M&A DRIVER
Rising competition in the market will also likely spur a round of consolidation as firms look to strengthen in terms of scale or technology to stay ahead of rivals, analysts said.
Bayer said in February it would buy Chinese traditional medicine maker Dihon Pharmaceutical, while Shanghai Fosun Pharmaceutical Group Co Ltd (SS:600196) said last month it plans to take U.S.-listed Chindex International Inc (O:CHDX) private in a $461 million deal with equity firm TPG.
"The level of industrial concentration will rapidly increase by way of acquisitions and reorganisations," Fosun Pharmaceutical said in a statement with its annual earnings.
M&A activity this year has so far outstripped 2013, said Phil Leung, China healthcare head and Asia Pacific M&A head for consultancy Bain & Co, noting that local and global firms were looking at acquisitions, joint ventures and other tie-ups.
Drugmakers with advantages of scale, low-cost production or unique, in-demand products should hold their own, he said, while others would struggle to survive.
"In this environment, the strong will get stronger and the stragglers will be more exposed."
(Additional reporting by Li Hui in BEIJING and SHANGHAI newsroom; Editing by Ian Geoghegan)