Since 30 April 2018 when the Hong Kong Stock Exchange (HKEX) introduced the listing regime under Chapter 18A of the Main Board Listing Rules (Chapter 18A), pre-revenue biotech companies have been allowed to list on the HKEX’s Main Board. As of June 2020, 18 biotech companies have been listed on the HKEX.
At the beginning of the listing system reform two years ago, the first batch of the listed shares did not perform well and did not show a premium as expected by investment banks. The current highly asymmetrical valuation of biotech companies listed in Hong Kong as well as long R&D cycles, high capital investment and low success rate of product launches facing biopharma companies have become investors’ key concerns. The difficulty for investors to assess the P/E ratios and valuations of companies has led to an overall low trading volume. In order to accurately and objectively assess the valuation of a company, investors need to understand the company’s chances of successfully developing products and the potential for future value growth that the products can bring to the company. As a result, comparing with companies in other industries, biopharma companies’ prospectuses are more important.
This article introduces the key elements that sponsors should consider in their due diligence for biopharma companies during the Hong Kong listing process.
In April 2020, the HKEX updated two guidance letters (HKEX-GL92-18 and HKEX-GL85-16) and issued a new guidance letter (HKEX-GL107-20) to clarify the HKEX’s position on the suitability of listing biopharma companies and the ability of existing shareholders to subscribe for shares in an IPO, and to refine the disclosure of prospectuses for biopharma companies. The IPO Review Group of the Listing Division of the HKEX has two dedicated teams to review biotech companies, both of which are staffed by personnel with professional backgrounds in biology, medicine and chemistry.
In general, the HKEX’s guidance letters require that companies should use plain language to disclose accurate scientific data in the summary section of the prospectus to make the data more readable and easy to understand.
In addition, companies are required to disclose the development timeline of their core products in an objective manner and warn investors of the risk that they may lose all their investment due to R&D failures.
A clear and easy-to-read prospectus needs to have a clear description of a company’s business and prospects and, in particular, an adequate elaboration on the following elements:
1. The company’s core products and pipeline;
2. Clinical development;
3. Description of competition pattern;
4. Commercialization plan for the approved products;
5. Intellectual property;
6. Assessment of regulatory approaches;
7. Cooperative development agreements;
8. Risk factors;
9. Financial disclosure.
I. A company’s core products and pipelines
The essence of a biopharma company is innovation. Whether such a company specialises in chemical entities, biologics, gene therapies, cell therapies or medical devices, its prospectus should show the differences between the company’s current products and previous or similar products. When describing innovation, a prospectus should cover what investors focus on, including new mechanisms of action (overall response rate (ORR) and complete response (CR)), new mechanisms, new targets, new clinical indications, new therapeutic principles (limitations of current treatments), undiscovered medical needs, new composition of substances, or new dosing regimens. If a company’s core products are medicines or biologics, it should describe whether the products are going to be used for additional indications (e.g., hepatocellular carcinoma, colorectal cancer, renal cell carcinoma, and gynaecologic cancers) to maximize the commercial potential of its core products. Investors would like to know the company’s measures to obtain approval for marketing for candidate medicines in late clinical stages as soon as possible. For products in the preclinical pipeline developed by the company, investors want to know how many new products the company is able to put into clinical trials each year, whether it has sufficient localisation knowledge in designing clinical studies, and whether it has developed new candidate medicines in collaboration with research institutions.
II. Clinical development
Most prospectuses list product pipelines by pre-clinical, mid-clinical, and post-clinical stages in a table. The table should list the different phases (e.g. IND and NDA phases) of a product, the therapeutic area (subdivided into different indications) and the scope of a product’s commercialization rights (in China or globally). Obviously, medicines that are in or have completed Phase 3 clinical trials naturally have greater commercialization potential for investors.
For clinical trials, the HKEX requires companies to detail what indications a product is targeting, trial sites, the number of trial sites, the number of current patients, the number of patients planned to be recruited in the future, dosage, and the primary endpoint of each trial (overall survival or progression-free survival, dose-limiting toxicity, tumour response, and clinical and laboratory adverse events, etc.). Companies need to disclose how the results of clinical studies have helped to assess the safety and efficacy of the medicine.
In addition, investors pay attention to how companies accelerate the development of innovative medicines.As China has been struggling to develop innovative medicines through clinical development, most Chinese biopharma companies choose to partner with a globally renowned third-party CRO (Contract Research Organization) to conduct their trials. Whether a biopharma company regularly evaluates the CRO to ensure the safety of trial subjects, the integrity of trial data and regulatory compliance, as well as the achievement of key milestones (patient eligibility review, medical data review and serious adverse event review) need to be disclosed in the prospectus.
Investors will also assess companies’ clinical development plan, including the assessment of scientific rationale (e.g., mechanism of action, preclinical data, available clinical data, and study opportunities) and market value (the number of patients that can be treated, market analysis and competition profile). Companies should disclose the following details of the trial protocol: protocol design, study objectives and endpoints, study population (sample size and inclusion/exclusion criteria), study duration, randomization methods, adverse events and serious adverse events, quality control and quality assurance and data management; trial preparation (site selection and laboratory visits); patient recruitment (patient assessment according to the study design and obtaining their informed consent); patient dosing (daily measurements and adverse event monitoring) and outcome measurement (assessment of efficacy and safety endpoint data).
III. Description of competition pattern
It is critical to help investors understand and evaluate the competitive environment in which a company operates. The company can thus recognize product-related indications, new products in development, stages of development and company-sponsored development, as well as the types and progress of biosimilars.
Market research is the basis for evaluating the competitive environment. Market research on biopharma companies falls into the following categories: academic research, research by government agencies (e.g., FDA, CDC, and WHO), research on proprietary data (e.g., from independent research and data analysis providers such as AMR), research commissioned by companies (e.g., company-sponsored reports from third-party consultants), or research conducted by companies themselves. The HKEX requires issuers to include in the prospectus the differences between their products and competitive products in technology, indications, and target markets, and the competition facing their core products and other major pipeline products in the intended target markets (including the names, prices, patent expiration dates, and subsidy and medicine-grant arrangements of competitors’ pipeline products for the same indications).
When describing the industry to which its products belong, a company should cite industry reports describing the total incidence rate, cure rate, etc. for the indications related to their products, and may also project the market size in the next five years as well as the sales and compound annual growth rate of such products in the Chinese and foreign markets. Guidance Letter GL107-20 requires companies to introduce the names, indications, and clinical trial stages of their competitors’ products. If there are marketed medicines, companies should disclose the current sales, subsidies, medicine grant arrangements, and patent expiration status of the medicine globally or in China.
IV. Commercialization plan for the approved products
Commercialization and potential market prospects are important indicators for investors to estimate the value of a company. The key to competitiveness of a biopharma R&D company lies in its ability to capture the market in time. Whoever can take the lead in successfully developing a product and getting it approved for marketing will win in this market and reap rich profits. Whether the product is a medicine, a biologic or a medical device, it is not easy to get a head start in the market. Take tumour immunotherapy (immune checkpoint) as an example: although different biopharma companies’ products are advertised for different indications, in fact, PD-1 medicines, as biological macromolecules, though for different indications, share the same mechanism of action and basic structure in principle, and they are only different in biological preparation and structural details. These differences, however, do not change the therapeutic nature of PD-1 medicines. In the context of medical insurance cost control, the domestic market for PD-1 medicines is shrinking to a certain extent. The PD-1 market in China values at RMB 30.5 billion based on annual medical expenses of RMB 60,000 after medical insurance negotiations; if the price of PD-1 drops to RMB 30,000 on a full year basis, it is expected that the market size may shrink to RMB 23.6 billion. With a limited market size, market competition would become extremely intense. Therefore, in this case, if a company has a large number of existing competing medicines and candidate medicines, it will need to explain in great length why its products have an advantage over those of its competitors. However, considering risks and legal liabilities, most sponsors will not include in prospectuses studies on the penetration rate of patients with indications and price estimates or product models developed by companies based on these studies. For biopharma companies that have yet to make a profit, the description of manufacturing can be relatively simple. Companies should ensure the source and availability of key supply chain, describing the infrastructure and future expansion plans designed to meet Chinese and international pharmaceutical standards, and manufacturing facilities that comply with international Good Manufacturing Practice (GMP).
For cost and risk management reasons, early-stage biologics companies do not typically have a large sales team. If commercialization is just within 12 months, or before launching the first product, a company should have a long-term plan to scale up the commercialization team and hire a commercial team with sales, marketing and market access. Investors generally believe that an experienced commercialization team will enhance the company’s competitiveness. In addition, if the company has co-selling arrangements with international pharmaceutical enterprises, it can consolidate its competitive position in the market by leveraging these enterprises’ in-depth knowledge of the Chinese market and their long-established sales networks in the Chinese market.
Commercialization functions of biopharma companies typically include marketing, sales, medical affairs, and market access. If a company plans to begin commercialization within 12 months, it may provide specific steps, such as hether the company intends to build its sales team or to build one through partnerships. If the company is building its own team, it should describe the size of the sales team and the target institutions (e.g., specialty clinics, transplant centres, and tertiary hospitals). The commercialization plan should be developed based on the marketing strategy.
Most biopharma companies have since their inception benchmarked hemselves against the world’s leading pharmaceutical giants and set out to create a fully integrated platform for the discovery, development, CMC and production and commercialization of candidate medicines to apply their products to multiple diseases. A fully integrated platform enables different functional teams to collaborate seamlessly across key links of a candidate medicine’s lifecycle, thereby increasing the speed and success rate of development and reducing development costs. If cooperating with a research institution or a pharmaceutical company, the company need to disclose the background of such cooperation, the details of material terms, the allocation of intellectual property, the markets targeted by the product, and whether the company is prioritizing the development of any products of strategic or commercial significance. For companies that have already commercialized, pricing, insurance coverage and exclusive sales need to be discussed in detail.
V. Intellectual property
The intellectual property of biopharma companies is of great importance. Under Chapter 18A, an applicant must have a registered patent, patent application or intellectual property right in respect of its core products. From the prospectuses of listed biotech companies, it is found that in addition to their registered patents or patent applications, such companies often enter into licensein arrangements with other biotech companies involving their core products. Such biotech issuers have obtained exclusive licenses either to develop, manufacture and commercialize their core products or to market certain commercialized products.
When describing patents, the company should indicate the type and scope of protection of the patents, whether the patents have been issued or are pending, whether the company owns patents licensed to third parties, whether the patents are listed in the FDA’s Orange Book, the region in which the patents were filed and issued (whether patent protection is available in the company’s primary market for the product), and the duration of patent protection.
In addition to intellectual property, trade secrets can also provide protection for biopharma companies. Trade secrets cover a wide scope, including confidential and unpatented proprietary technology (e.g., manufacturing know-how), confidentiality agreements, confidentiality agreements limiting disclosure, physical operational restrictions (e.g., restricted access, firewalls, access rights), and exclusive, non-competitive and other restrictive contracts.
VI. Assessment of regulatory approaches
Companies should disclose in the prospectus the phases of their core and pipeline products, including preclinical development, application and review of investigational new drug (IND), Phase I, II, III and IV (post-marketing) trials, new drug application (NDA), biologics license application (BLA) and approvals, accelerated development and review process, and abbreviated new drug application (ANDA). The HKEX requires companies to disclose a summary of oral or written communications with the competent authority (e.g., the National Medical Products Administration of the PRC, the “NMPA”) regarding clinical trials, including communications at the meeting before NDA, the competent authority’s approval for the next phase of clinical trials, and whether the product is included in the priority review process. If the competent authority raises significant concerns about the clinical trial, the company also needs to give a truthful statement. If the company’s product is classified as an orphan drug or an innovative therapy, the company needs to disclose the benchmarks for the drug to meet the regulatory pathway, the exemptions granted under that regulatory classification, and the benefits of obtaining approval under this pathway.
VII. Co-development agreements
Whether or not a biopharma company reaches the commercialization stage, its co-development of candidate medicines with major international parmaceutical companies can not only reduce R&D costs and risks, but also help the company quickly gain market advantage. Investors are very interested in the terms of the company’s cooperation agreements with such pharmaceutical companies. Except for the details of candidate medicines restricted from disclosure by the company as set forth in the confidentiality terms of the cooperation agreement, the company should describe the scope and content of the cooperation, for example, whether it is an exclusive license (with or without geographic restrictions), codevelopment, or a joint sales arrangement. Investors generally believe that cooperation agreements with top tier international pharmaceutical companies such as Lilly and Amgen reflect the high R&D level of biopharma companies. Strategic international partners can provide a strong boost to a company's expansion, including expertise and technology, speed, flexibility and a lower cost structure.
Most cooperation agreements stipulate whether the partners will share the costs of developing medicines in China and share the difference between net sales and expenses equally. International pharmaceutical companies make upfront payments to the company as consideration for medicine development and its rights and obligations under the agreement. If the net sales target is achieved, the biopharma company will be entitled to receive phased payments. Investors take notice of how the parties make decisions regarding the development and commercialization of the Chinese products, i.e., which party has the final say on the development of the Chinese products, or which party has the final decision on commercialization and development after regulatory approval of the poducts? Do the parties maintain ownership of the intellectual property under their respective development? Is there a one-way or twoway grant of certain patents, know-how and licenses (non-exclusive or exclusive)? And what is the term of the agreements (X years after the first commercial sale, or according to the patent term, or renewed on a yearly basis by region, etc.)?
VIII. Risk factors
Article 18A.05 of the Main Board Listing Rules requires biotech companies to prominently disclose to investors a warning that the relevant core product may not ultimately be successfully developed and marketed. Companies should describe the risks and uncertainties that are common to biopharma companies, especially the sustained net losses in the foreseeable future for companies in the early stage of clinical or technological development. Second, a company’s operations and prospects are heavily dependent on candidate medicines or biologics that have not yet been brought to market (and the possibility that candidate products may never enter the market). Lastly, companies should remind investors that product development and commercialization are dependent on continued financing, which the companies cannot guarantee and which could result in significant share dilution.
(I) Risks related to development and commercialization
A company should describe in the prospectus the following aspects: First, the company’s operations, clinical development, regulatory approval and review, manufacturing processes and commercialization are all still in their early stages and have not yet matured. The company’s operations and prospects are heavily dependent on its capabilities to develop medicines and to commercialize and gain general acceptance for candidate products that are not currently approved or marketed. The company should explain that as market acceptance of a medicine is capricious and it is difficult to predict the pricing of a medicine, the company therefore is not able to control market fluctuations. As a result, even if a medicine in development receives regulatory approval, it may not gain the market acceptance from physicians, patients, third-party payers and other participants that would be required to win commercial success.
(II) Risks related to regulatory approvals and compliance
Companies need to clarify that the marketability and commercial success of their products depend almost entirely on regulatory review, which is predictable, and where a regulatory hold is sufficient to undo medicine development. Companies need to make clear that there is significant uncertainty about obtaining regulatory approval for reasons including: 1) the company cannot demonstrate the safety or efficacy of the medicine or biologic; 2) there are delays or difficulties in enrolling patients in clinical trials; 3) clinical trial sites cannot be successfully opened; or 4) there are potential adverse side effects or unexpected characters of the medicine. It is likely to take a lot of time for a candidate medicine to obtain regulatory approval from the U.S. Food and Drug Administration (FDA), the PRC National Medical Products Administration (NMPA), the European Medicines Agency (EMA) or other equivalent medicine authorities. And it is time-consuming for companies to comply with increasing new regulations and policies. Companies will also have to pay a significant amount of money to cope with such ongoing compliance obligations and regulatory scrutiny. Even after the costs are incurred, companies will be subject to significant penalties if they do not comply with healthcare, fraud and other laws.
(III) Risks related to manufacturing and third-party R&D
Whether conducting preclinical studies and trials with third parties or manufacturing medicines in development with CMOs, most biopharma companies rely to some extent on cooperation agreements. If these third parties fail to fulfil the contractual agreements or reach the expected targets, companies may not be able to obtain regulatory approval for or commercialize their medicines, and their medicines in development and business may thus be impaired.
(IV) Risks related to intellectual property
Companies need to pay attention to deficiencies in IP protection or exclusivity, such as inadequate patent protection periods. If a company licenses out third party IP, it should full consider the possible risks of noncompliance with obligations under the license agreement. Companies need to point out to investors the risks posed by the differences in IP protection in different countries or regions. If IP protection is insufficient, competitors will develop and even commercialize in advance the products and technologies similar or identical to those of the company, and compete directly with the company, thereby undermining the company’s production prospects.
IX. Financial disclosure
In response to the widespread concern of investors as to whether the proceeds from an IPO are sufficient to reach the next tipping point, the HKEX requires that the IPO proceeds need to cover at least 125% of the company’s costs (including general administrative costs, operating costs, and R&D costs) for at least 12 months after its IPO. In addition, the company is required to disclose the following information in the prospectus:
(1) the valuation of each round of financing prior to the IPO, with an explanation of significant valuation fluctuations in previous rounds in light of product development and competitive advantages;
(2) the background of senior investors and their performance record of investment in the biotech sector;
(3) any net liability arising from significant changes in fair value during the performance record period as a result of the conversion of the convertible debenture to net assets at the time of listing;
(4) capital consumption rate, i.e. the ability to survive with or without proceeds from listing during a reasonable period;
and
(5) a schedule for the next round of financing based on the capital consumption rate.
Biopharma companies rely on ongoing equity financing. Under international accounting standards, convertible and redeemable preferred shares and put options on the issuance of common shares are financial instruments and are calculated at fair value, and their changes are accounted for as other financial liabilities in the income statement. For changes in the fair value of financial instruments, in addition to the disclosure that the company should make based on the results of each evaluation round by private equity investors, it is sometimes necessary to refer to the valuation reports of international commercial valuers. Preferred shares will be automatically converted into shares at the time of the IPO and the company may need to revalue the preferred shares prior to pricing. Such changes (losses) in the fair value of the preferred shares may have a material impact on the company’s finance and performance and therefore need to be disclosed in the prospectus.
Most of biopharma companies’ products have not yet been approved for commercial sales and therefore the companies do not generate sales revenue. The vast majority of a company’s operating losses are incurred by R&D expenses, administrative expenses, business development expenses and financing costs. Investors pay close attention to the composition of the company’s significant expenses and operating losses in future years, which generally consist of further preclinical R&D for candidate medicines, continued clinical development and pursuit of regulatory approval, commercialization activities for the launch of pipeline products, and the hiring of additional personnel to operate a fully integrated platform with advanced pipeline products for clinical candidate medicines.
Conclusion
High barriers, big investment and long cycles pose opportunities and challenges to most biopharma companies when they list in Hong Kong. China’s biotech companies have great potential. Despite a considerable gap between China and developed countries in the R&D of innovative medicines, China is seeing an improving R&D environment and has released policies to support medicine R&D, such as encouraging innovation and opening up green channels for the approval of innovative medicines. The R&D and review period of innovative drugs has been further shortened, extending the effective life cycle of products. A large number of premium biopharma companies have been listed in Hong Kong. Since the release of Chapter 18A in 2018, Hong Kong has become the second largest biotech financing centre in the world. A good and readable prospectus can not only meet the requirements of Hong Kong listing rules and U.S. securities laws, but also fully demonstrate a company’s core competence and commercialization prospects.
