Chinese Health Care Draws Investors

This article was published by New York Times on December 10, 2014.

By Neil Gough

HONG KONG – Investing in China’s health care sector is not for the faint of heart.

The country’s pharmaceutical supply chain is rife with corruption. Doctors and hospital staff have been attacked and even killed by patients who have been refused treatment. Farmers unable to pay for surgical amputations have made headlines by sawing off their own limbs.

Despite all this, Chinese health care is quickly becoming one of the most popular sectors for investors looking for the next great untapped market. Foreign and local private equity groups, drug companies, hospital operators and even construction companies are pouring record amounts of money into China to invest in hospitals, clinics, pharmaceutical businesses and medical equipment manufacturers. Mergers and acquisitions in China’s health care sector rose to a record $11.3 billion in the first 11 months of this year, up 13 percent from the $10 billion in the same period a year earlier, according to Dealogic data.

For all the challenges of China’s health care system, demand for more and better medical products and services is surging. That is because of a combination of demographics and economics: The world’s biggest populace is both rapidly aging and increasingly affluent. The consulting firm McKinsey & Company estimates that health care spending in China will grow to $1 trillion by 2020, up from just over $350 billion in 2011.

“We’ve started noticing all sorts of players who don’t normally play in the health care space becoming very interested — they could see the demographics, the aging population,” said Mark Gilbraith, the head of PricewaterhouseCoopers’ China health care and life sciences practice, based in Shanghai. “Within China, deals are more about gaining access to untapped markets.”

The surge in deal making and investor interest coincides with a wave of sweeping overhauls that the Chinese government has introduced in recent years, as it tries to improve the accessibility and affordability of a health care system that has been widely described as being in a state of crisis. While recent decades brought a significant opening of the country’s economy, the reduction of socialist-style state funding left the health care system to fend for itself. The result is a half-liberalized but highly bureaucratic public hospital system that often compromises patient care in favor of profit.

China had 13,440 public hospitals as of October 2013, and these provided 90 percent of the country’s medical services, Xinhua, the official news agency, reported in April.

“Unlike most public hospitals in the world, Chinese public hospitals are an embodiment of both government and market failures,” Winnie Yip, a professor in the Blavatnik School of Government at the University of Oxford, and William Hsiao, a professor at the Harvard School of Public Health, wrote in an article published in August in the British medical journal The Lancet.

While the government limits to 15 percent the markup on drugs that hospitals can charge, doctors increase revenue by prescribing unnecessary drugs or unneeded and expensive diagnostic tests. Moreover, the professors wrote, pharmaceutical and medical equipment makers provide benefits to hospitals and physicians for using their products.

As a result, by 2011, China’s spending on drugs was 43 percent of the total health expenditure, compared with an average of 16 percent in the dozens of countries with advanced economies in the Organization for Economic Cooperation and Development. At the same time, drug revenue accounted for 41 percent of total hospital revenue in China.

“Many public facilities act as private entities, putting profit above patient welfare,” Professors Yip and Hsiao wrote.

The Chinese government has tried in recent years to extend basic subsidized health insurance to all its citizens and, according to official estimates, more than 90 percent of the population is covered. But the quality of this coverage varies widely across the nation, as does the ability of individuals to get access to care.

These disparities were vividly illustrated in recent news reports, including the case of Liu Dunhe, a farmer in the southeastern Anhui Province who, uninsured and lacking the money to pay for an operation, decided to perform surgery on himself. Over the course of six hours on the night of April 20, Mr. Liu, who was suffering from severe necrosis after his feet were frostbitten, amputated his feet.

Widespread corruption in the health care system, especially involving the prescribing of drugs, is also an issue, and one that has ensnared multinational investors. In September, a Chinese court fined the British pharmaceutical giant GlaxoSmithKline nearly $500 million for bribery and jailed five of its executives, including a Briton. The government had accused Glaxo of bribing hospitals and doctors by channeling illicit kickbacks through travel agencies and drug industry associations to inflate drug prices.

China’s government is increasingly concerned about the problems of the health care system. Part of its solution has been to open the door wider to foreign investment in the sector. The latest example came in August, when the authorities expanded a pilot program begun a month earlier to allow wholly foreign-owned hospitals to operate in seven major cities and provinces. Previously, foreign ownership was capped at 70 percent.

A number of recent deals have followed as a result of this liberalization. In September, the American private equity giant TPG teamed with a unit of the Fosun Group, a big Chinese investment company, in a $420 million deal to privatize Chindex International, a Nasdaq-listed operator of hospitals and clinics in China and Mongolia.

More recently, UPMC, a hospital operator based in Pittsburgh, and Massachusetts General Hospital, which is affiliated with Harvard University, said they had signed or were exploring deals to manage or build hospitals in China.

“Investing in China’s health sector faces many challenges,” said Yanzhong Huang, a senior fellow for global health at the Council on Foreign Relations in New York. He cited the large amount of capital required and the comparatively lower rates of return, as well as uncertainties over how privately owned hospitals will fit into China’s national medical care payment system.

Still, he said, more private investment would benefit the entire sector, including the troubled state-funded hospitals.

“Increased competitive pressures would incentivize the public hospitals to kick off more meaningful reform efforts,” Mr. Huang said. “Private investment can play an important, even critical, role in China’s health care reform.”