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China Will Kill For Your Drug-Development Work

By Rob Fannon, editor Phase 1 Investor
Monday, January 14, 2008

Low prices coupled with easy access to American-trained scientists...
It's pretty easy to see why the world's biggest drug companies are turning to countries like India and China for research and development work. As I covered in Friday's edition, on average, R&D work in India or China costs 40% less than here in the U.S.
What type of work falls under the "medical outsourcing" umbrella? Everything from laboratory research to patient recruitment for clinical trials to bundling data for FDA drug applications. Generally, the work falls into two categories: discovery and clinical. Discovery work covers lab-based services, while clinical outsourcing involves designing, recruiting for, and running drug trials.
In 1997, only 35% of the pharmaceutical industry outsourced its research work. Now, 10 years later, more than 70% of drug companies ship some portion of R&D efforts overseas.
Here's why I think it will be China – not India – that becomes the "New Jersey of the East," winning the majority of the globe's pharmaceutical business (just as Jersey has in the U.S.).
First, in November, Pfizer won a six-year legal battle to defend a Chinese patent for Viagra. The high court decision, which reversed an earlier motion to dismiss, is a significant milestone for China's patent system. At last, it seems China's ready to fall inline with World Trade Organization standards for protecting intellectual property... no small feat for a country where 96% of computer software is pirated.
Now, while Pfizer is celebrating its patent victory, one of its peers – the Swiss drug giant Novartis – is deadlocked in a patent dispute of its own in India. The Indian government refuses to confer patent protection to Novartis' top-selling cancer drug, Gleevec.
The authorities claim the drug's chemical makeup is too close to a predecessor molecule. In response to the verdict, Novartis CEO Daniel Vasella pulled the plug on his company's plans to build a $100 million manufacturing and research center in India. Instead, the construction funds are headed to China...
Another recent event points to China's rising dominance in the medical outsourcing arena: On July 10, former head of the State Food and Drug Administration Zheng Xiaoyu was executed. Xiaoyu was one of several high-ranking health officials arrested for corruption and abuse of authority. While the punishment is certainly grim, there's no larger gesture of commitment to improve drug regulation than a death sentence.
Since the execution took place, scores of previous health authority certifications and product approvals have been revoked throughout China. The dozen or so agencies that had a hand in regulating food and drugs are consolidating with the China Ministry of Health and the State Food and Drug Administration. Sure, it's going to take some time to clear up the legacy of corruption and scandal, but the country is headed in the right direction.
In addition to the up-and-coming intellectual property and regulatory landscape, several demographic characteristics in China bode well for the country's medical industry. Its 1.3 billion people – belonging to 50 different ethnic populations – offer a rich pool of potential clinical trial participants, most of whom have no previous exposure to experimental medicines. Moreover, by 2025, China is slated to be home to the biggest population of type 2 diabetics in the world, 250 million senior citizens, and more than 13 million cancer patients.
On a more positive note, its rapidly expanding middle class will demand access to better medicine. Presently, 5.6% of China's GDP is dedicated to health care, which is expected to rise to 8%-9% by 2020 (the U.S. spends about 15% of GDP on health care). In terms of sales, China is the seventh-largest drug market in the world, with revenue up 15% last year. By 2010, China will jump up to the world's fifth-largest drug market.
Finally, China proved its scientific prowess in the early 2000s as the only developing country to participate in the Human Genome Project. A few months later, it shocked the worldwide scientific community by mapping out the rice genome. National R&D expenditures are growing at a 20% clip, and the country recently surpassed the research spending of Japan.
Hoping to crank up the country's R&D spending to 2.5% of national GDP by 2020, the country wants to transform "Made in China" to "Invented in China."
So what's the best way to profit on this trend?
As longtime readers of my advisories know, the safest way to invest in drug development is through contract research organizations (CROs). CROs are basically for-hire laboratories... They're experts in toxicology, drug metabolism, pharmacokinetics, and chemistry. They perform, track, and report the laboratory and clinical research that every drug is required to pass.
CROs get paid whether drugs ever get to market or not. The two biggest and best U.S.-based CROs – Covance (CVD) and Pharmaceutical Product Development (PPDI) – have been big winners in the Medical Investor portfolio, each up about 30% in less than a year.
If you're looking to profit from the "New Jersey of the East," I recommend starting your search in this sector.
Good investing,
Rob Fannon

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