The Biotechnology Industry in Korea: Ripe for Investment

Korea has emerged over the past decade as one of the major industrial markets in the Asia-Pacific region, which accounts for 24% of the world’s population, 19% of global production, and 13% of international trade volume, making it a clear hub in the global economy. Asia’s share of global GDP, measured in purchasing power, has increased from 26.8% in 2001 to 33.8% in 2010 and is expected to rise to 38.9% by 2016. Pharmaceutical sales in Asia have more than doubled from USD97 billion in 2001 to USD214 billion in 2010 and are expected to reach USD386 billion by 2016. Korea is favorably located at the center of the Asia-Pacific region, which is a geographic advantage for Korean and locally-based foreign companies serving the major East Asian markets such as China, Japan and the ASEAN countries, which together account for 31% of global international trade demand. Korea’s strong economic growth, increasingly favorable environment for foreign direct investment, and rapid transformation into a knowledge-based information society have resulted in a growing number of attractive investment opportunities for both domestic and international institutional investors.

Currently, there are hundreds of companies that make up Korea’s biotechnology industry. As the health profile of South Koreans is already on par with their counterparts in industrial countries, the domestic demand for health-care and biotechnology products is primarily due to increasing household resources available for higher-cost medical treatments. The expansionary pressures of the domestic drug market are also driving demand for newer and better therapies, which is a reflection of South Korea’s public healthcare system that features universal access and relatively low out-of-pocket payments. This has fueled significant growth in recent years for the biotechnology and broader healthcare sector in Korea. In fact, Korea’s health care sector is one of only a few sectors whose collective market capitalization has continued to grow after 2010 with a current market cap of approximately W35 trillion compared to W21 trillion in 2010 and W12.5 trillion in 2005 (Figure 1).

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Furthermore, Korea’s biotechnology sector has been experiencing significantly faster growth than its pharmaceutical and medical technology sector peers (Figure 2).

In many ways, the Korean pharmaceutical and biotechnology sectors appear to be on the verge of an upward re-rating similar to the re-rating that occurred with Japanese pharmaceutical companies in the 1990s. The rapid growth of Japanese pharmaceutical companies two decades ago was the result of several factors. First, the 1990s was an era of innovation for drugs to treat chronic conditions such as hypercholesterolemia, hypertension, and diabetes with many new drugs gaining widespread use globally. It is well known that Takeda led diabetes drug development by launching Actos, but less well known is that Takeda’s proton pump inhibitor, Prevacid, for peptic ulcer disease was launched not long after AstraZeneca’s omeprazole. Although Takeda was an innovator in diabetes, it was more of a fast-follower in peptic ulcer disease. Japanese companies sent researchers to universities in the United States and Europe to study the most recent advances in disease biology and then took these new findings and developed better drugs in the same mechanistic class through innovative medicinal chemistry, which allowed them to be successful fast-followers. Second, the pharmaceutical market in the United States was growing at double digits in the 1990s, and the U.S. Food & Drug Administration approved many drugs quickly. Since the U.S. pharmaceutical market was growing fast, if Japanese companies were able to form partnerships with U.S.-based companies that allowed them to build their own U.S.-based commercial subsidiaries, these companies gained deep access into the fast-growing U.S. market. Notable alliances during this time period included Takeda with Abbott, Takeda with Lilly, Astellas with Abbott, Daiichi Sankyo with Johnson & Johnson, and Eisai with Pfizer. Similarly, Korean pharmaceutical exports have also been steadily growing over the past decade, albeit at a lower overall rate but at a similar trajectory to Japanese pharmaceutical exports, which also indicates that Korea is moving in the right direction (Figure 3).

The impetus for Korean pharmaceutical and biotechnology companies to expand into Western markets is high given the current state of the domestic pharmaceutical market in Korea. Pharmaceutical sales in Korea are expected to grow <6% per annum in the next three years, which is below the historical average of 9%. This slow domestic sales growth is a function of three structural factors: (1) new regulation of drug promotion and rebates; (2) likely implementation of a regular price cut system; and (3) doctors’ behavioral changes in writing fewer prescriptions. These negative drivers are overshadowing growth related to Korea’s aging population. New laws in Korea have been enacted recently that place unfavorable taxation on sales promotion expenses. Specifically, Korean tax regulators have started applying stricter guidelines on entertainment expenses, imposing additional taxes on several pharmaceutical companies including Dong-A ST (W84 billion), Kyungdong (W9 billion), and Samjin (W13 billion). In addition to these new taxes, the Korean government has implemented a dual punishment system that penalizes rebate payers such as pharmaceutical companies and their beneficiaries including doctors. So far hundreds of doctors have been charged and penalties have been assigned including fines and suspensions of medical licenses. Also in 2011, a compulsory drug price cut related to illegal rebates was implemented as a powerful regulatory tool to reduce illegal rebates. More recently in November 2013, the Korean government also implemented a sales-volume-based price cut system that targets drugs with strong sales (+10% YoY or +W5 billion YoY). If a drug meets these criteria, the government can negotiate with the manufacturer for as much as a 10% price cut. Finally, because the Japanese government recently stated that it is targeting a 20% ceiling on pharmaceuticals as a percentage of total healthcare spending, the Korean government is also considering a similar move to reduce pharmaceutical spending to 24% of all healthcare spending from its current 26.6%. All these measures indicate that Korean pharmaceutical and biotechnology companies will have to look abroad for growth.

Accordingly, the next step is for Korean pharmaceutical and biotechnology companies to build sustainable businesses from their own discoveries through direct revenue recognition of their products rather than a royalty stream. The first step in this process however requires significant capital, which is where the investment opportunities arise. Conducting successful clinical trials is the single most important step to developing and launching new drugs in any market. Thus, completion of late-stage clinical trials overseas would increase license-fee income with higher royalty streams. However, Korean pharmaceutical and biotechnology companies have historically not had sufficient capital to conduct overseas clinical trials. In the prior two decades, blockbuster drugs were broadly-used primary care products whose commercial potential was primarily based on broad adoption and enormous sales volume. This represented a significant barrier for Korean pharmaceutical and biotechnology companies because compared with their average W700 billion equity base, the cost to run one Phase 3 trial in the U.S. for a primary care product could be as high as USD200 million. Note that this compares with a W17 billion (USD15 million) clinical trial cost in Korea according to KDRA. For example, Celltrion, a Korean biotechnology company, spent USD200 million to conduct their clinical trials for a biosimilar Remicade, which recently gained regulatory approval in Europe. Not many Korean companies are able to fund clinical trials of this magnitude themselves. In recent years, however, many U.S. and European biotechnology companies have seen tremendous success developing targeted drugs for orphan diseases and cancers that are refractory to current treatments with very small clinical trials that have average costs on par with the costs of running a clinical trial in Korea. Furthermore, there is an industry-wide transition to using contract research organizations to run clinical trials for pharmaceutical and biotechnology companies with all the requisite regulatory and clinical development expertise residing within these contract research organizations. This represents a tremendous opportunity for Korean pharmaceutical and biotechnology companies to run their own clinical trials for their own products to become commercial entities in Western markets.

Korean pharmaceutical and biotechnology companies have also been transitioning from a licensing-based business model to models based more on broader partnerships and joint ventures with U.S. and European pharmaceutical companies. This transition is important because if Korean biotechnology companies discover global blockbuster drug candidates, monetizing them in the global market through their own subsidiaries would allow them much greater participation in the overall franchise revenue potential and thus lead to company and sector upward re-ratings. Relying on licensees to commercialize their drugs for them in foreign markets greatly limits the upside potential from such blockbuster therapies. The case of Dong-A ST’s Tedizolid is an example of the limitations of these out-licensing business models. Dong-A ST is a Korean pharmaceutical company that currently receives only 7% of total Tedizolid global sales, which are approximately USD1 billion whereas its commercial partners take 93% of the USD1 billion because they market the drug for Dong-A ST. Therefore, the next logical step in the evolution of Korean pharmaceutical and biotechnology companies is to establish joint ventures overseas that will allow them to build their own overseas subsidiaries, vertically integrate them with R&D centers abroad, and commercialize their products themselves. The Korea Drug Research Association highlights that 29 Korean pharmaceutical companies have signed out-licensing contracts for 91 drugs in the past three decades, which has given credibility to Korea’s R&D efforts. In addition, several Korean pharmaceutical and biotechnology companies have recently forged significant strategic alliances with global partners, which has given credibility to the entire sector (Figure 4).

In the near-to-intermediate term, Korean biotechnology companies have a clear edge over their pharmaceutical peers in terms of revenue growth. For the major pharmaceutical companies such as Dong-A ST, Green Cross, Yuhan, and LG Life Sciences, the average projected revenue growth forecast is +13% for this year, slowing to +8% next year due to low domestic pharmaceutical market growth. In contrast, biosimilar-maker, Celltrion, stands out with an expected +45% growth in revenues this year while stem cell companies such as Medipost and Pharmicell are also expected to see higher top line growth as recent launches gain traction. Earnings growth for the larger pharmaceutical companies should also be solid as exports and increasing royalty revenues allow for better leverage in their income statements. Celltrion, Dong-A ST, and Green Cross are all set to deliver mid-to-high-teens earnings growth this year while Yuhan is forecasted to grow earnings +40% this year albeit from a low base. For Korean biotechnology companies in general, earnings growth this year will be higher on a relative basis than many of their peers by market-capitalization in the United States, which also argues for greater money inflows from growth investors (Figure 5).

So in overview, the Korean pharmaceutical and biotechnology sectors have seen some promising developments that are becoming increasingly investable. In particular, immuno-oncology and stem cell therapies are well-developed, with many late-stage pipelines nearing approval or already approved. Indeed, stem cell treatments have reached clinical maturity for acute heart attack, degenerative cartilage disease, and Crohn’s Disease with patients now having access to approved stem cell treatments. Company pipelines on established platforms include treatments for stroke, spinal cord injuries, and Alzheimer’s disease, some of which are in latestage trials. All of these developments represent significant opportunities for investors to capitalize on the enormous potential within the pharmaceutical and biotechnology sectors in Korea. W

May 5, 2014

Han W. Choi, M.D., LL.M.

Oracle Investment Management, Inc.,

Greenwich, Connecticut, U.S.A.

Dr. Choi is a Principal at Oracle Investment Management, where he is responsible for global healthcare investments. Prior to joining Oracle, he held positions of increasing responsibility at Pharmacia Corporation and Bristol-Myers Squibb Company and also served as a public health officer at the U.S. Centers for Disease Control and Prevention. Dr. Choi received his M.D. from the Mount Sinai School of Medicine and trained in General Surgery at New York University Medical Center. He also holds law degrees from Oxford University and Harvard Law School and is a member of the New York State Bar, Third Judicial Department.

Paul Kim

Managing Advisor | CEO

Posco Bio Ventures | Medivate, Korea

Paul was Head of Novartis Venture Fund Korea (NVFK) – first global pharmaceutical fund to focus solely on emerging Korean biotech investments. Paul started his 18 years of healthcare investment & product development experience starting with Genentech and J&J in San Francisco Bay Area. Paul most recently served as Vice President of ViroMed, a leading public biotherapeutics company, overseeing the company’s corporate & strategic affairs. In 2001, Paul cofounded POSCO BioVentures – Venture Fund focused on US & EU biotech investments on behalf of POSCO - $40B Steel Conglomerate.