2228.HK
The newly floated biotech can boast big-name backers and counts more than a dozen biopharma heavyweights among its customers, but it is still awash with red ink.

The newly floated biotech can boast big-name backers and counts more than a dozen biopharma heavyweights among its customers, but it is still awash with red ink

Key Takeaways:

  • QuantumPharm’s revenues have grown at a compound annual growth rate of 66.7% over the past three years, powered by a bumper contract with Eli Lilly  
  • But the company struggles with client retention, shedding a big chunk of its customer base each year

 

By Molly Wen

The biotech world is abuzz about its potential and investors have been keen to place early bets, wagering that artificial intelligence will help unlock formulas for exciting new drugs.

The commercial stakes are high and can now be tested on the stock market. One Chinese leader in the field of AI drug discovery, QuantumPharm Inc. (2228.HK), has just raised HK$990 million ($127 million) in a Hong Kong IPO, valuing the biopharma company at HK$17.9 billion.

The IPO drew a strong response at the subscription stage after shares were priced at HK$5.28, in the lower half of the indicative range. In the market debut on Thursday, the shares opened 2.1% higher and were up 12.3% at the midday break, as more investors bought in.

QuantumPharm became the first company to debut on the Hong Kong Stock Exchange under a new rule that grants entry to specialist technology companies worth at least HK$10 billion, even if they have not achieved profitability.

The company enjoys ties with many big names in the global drugs business, which helps to explain how the IPO was 102 times oversubscribed, despite a generally flagging market for new Hong Kong listings and investor jitters about the cash-guzzling biotech sector.

Founded in 2015, QuantumPharm carries out contract research for the pharmaceutical industry and the materials science sector using technologies such as AI and quantum physics. According to the prospectus, its client list features 16 of the world’s top 20 biopharmaceutical companies by revenue, and the company has built long-standing relationships with drug powerhouses such as Pfizer (PFE.US), Johnson & Johnson (JNJ.US) and Merck (MRK.US).

Drug discovery is one of QuantumPharm’s two main businesses. In the other, it helps clients automate or standardize chemical processes and other systems.

Most of the pharmaceutical work focuses on small- and large-molecule drugs, using its platforms for intelligent drug discovery and antibody research. For this, the company earns down payments, milestone income or royalties from its partners.

The second income stream comes from selling intelligent automation solutions to the drugs sector and other science-based industries, for procedures such as chemical synthesis, drug crystallization screening, crystalline structure analysis and process development.

The company’s revenues have been trending upwards in recent years, with the help of one big order.

QuantumPharm’s turnover rose at a compound annual growth rate of 66.7% in the last three years, with revenue of 62.8 million yuan in 2021 rising to 133 million yuan a year later and 174 million yuan in 2023. However, the main driver was a deal with Eli Lilly (LLY.US) struck in May 2023. The partners agreed that the Chinese drug researcher would use its proprietary platform to discover potential candidates for small-molecule drugs, while Eli Lilly would take care of eventual testing and commercial launches of resulting products.

The upfront sum and potential milestone payments add up to as much as $250 million, making it the biggest financial collaboration for a single drug pipeline so far in China’s AI-powered pharma sector.

QuantumPharm’s drug discovery business brought in 87.73 million yuan in revenues last year, while intelligent automation solutions made 86.69 million yuan. But about 90% of the drug discovery revenue comes from what are called “investee customers”, who pay through equity exchange rather than cash.

The Equity for Service (EFS) model is common in the contract research industry. For example, Viva Biotech (1873.HK) has invested in several startups using this method. But an industry downturn can slash the value of the shareholding and hurt financial performance. QuantumPharm revealed in its prospectus that it had incubated and invested in several companies operating upstream and downstream in its key industrial chains and technologies.

The company plans to spend about 75% of the IPO proceeds on enhancing its R&D capability and solution delivery, including upgrading a technology platform based on quantum physics, building a generative AI model for the biomedical business, and recruiting talent. The prospectus said about 15% would go towards bolstering its commercialization efforts internationally and in China, with the remaining 10% was earmarked for working capital and other corporate purposes.

Cause for concern

As one of China’s top AI drug discovery firms, QuantumPharm raised $732 million in eight financing rounds before the IPO. After the last round in July 2021, the company was valued at $1.97 billion. QuantumPharm is backed by a roster of well-known names in the investment community, led by Tencent (700.HK) with a 13.7% pre-IPO stake. Other stakeholders include Sequoia China, SoftBank’s Vision Fund, Sino Biopharmaceutical (1177.HK) and Google’s parent Alphabet (GOOGL.US). The listing also introduced eight cornerstone investors, including Peter Lee, co-chairman of Henderson Land (0012.HK), as well as Biocytogen Pharmaceuticals (2315.HK) and Guosheng Capital, which subscribed for about HK$340 million worth of shares between them.

Despite its illustrious backers, QuantumPharm is still set to struggle with profitability. It made annual net losses of 2.14 billion yuan, 1.44 billion yuan and 1.91 billion yuan in the past three years. Meanwhile, costs were on the rise over the same period, with R&D spending going from 214 million yuan in 2021 to 359 million yuan in 2022 and jumping nearly 34% to 480 million yuan last year.

Moreover, customer retention is proving to be a challenge. From 2021 to 2023, the company’s client numbers rose from 75 to 120 and 187, but the retention rates for the same years were 67.5%, 51.4% and 64.9% respectively, indicating a loss of about 30% of the existing base each year. In contrast, WuXi AppTec (2359.HK; 603259.SH), a market leader for contract research, can boast a loyal core clientele, with a retention rate of 100% for its top 10 customers.

InSilico Medicine, which is also targeting a Hong Kong IPO, ranks as the company’s closest rival in China’s AI-assisted pharma business. InSilico was valued at $895 million after its latest financing in August 2022, far below QuantumPharm’s market capitalization. While AI drug discovery has generated a lot of excitement, investors should keep paying close attention to QuantumPharm’s financial performance, as the market may lose faith with biotechs that are saddled with chronic losses.

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