As Losses Narrow, Is Zai Lab Finally Finding its Winning Formula?

The biotech breaks a cycle of widening losses as it shifts towards developing new drugs

Key Takeaways:

• Zai Lab reported its loss shrank 65% in the first quarter of the year while its revenues continued to rise
• The company slashed its R&D costs by cutting licensing payments for existing drugs while spending more on finding new remedies

By Tina Yip

Zai Lab, like many pharma start-ups in China, kickstarted its business by licensing proven drugs from other companies. Investors had high hopes that it would later transform into an innovator in its own right, but nerves set in as company revenues soared while losses kept mounting.

The company’s latest quarterly results, released last week, show that Zai Lab Ltd. (9688.HK; ZLAB.US) could indeed be making steps towards becoming a laboratory for lucrative new treatments.

The company reported its first-quarter revenue surged 129% to $46.7 million while its loss shrank 65% from $233 million to $82.39 million, breaking a worrying pattern of revenues and losses rising in tandem.

Zai Lab, listed on the Nasdaq and in Hong Kong, has so far relied on supplying a stable of established drugs for sale in China, mostly for cancer, that come with a healthy revenue stream but carry hefty licensing fees, squeezing margins. Since launching in 2014, the company has aimed to transition over time to a hybrid model combining licensed medicines with independently developed drugs.

A look at the company’s results reveals that the balance between spending on licensing of drugs and investment in new products is shifting in favor of innovation, though R&D spending overall fell.

Zai Lab’s R&D expenditure fell 74% from $204 million in the same quarter last year to nearly $54 million, mostly because the company did not make any pre-payments for licensing contracts.

Discounting the licensing factor, the company’s R&D expenditure rose 30%, with most spent on current or newly initiated late-stage clinical trials as well as on hiring more research staff to boost its ability to innovate.

Flagship product prices falling

Investors have long been nervous about the reliance on revenues from its licensed range: the company’s four main commercial therapies – Zejula, Optune, Qinlock and Nuzyra – are all licensed and big earners.

Its flagship drug for ovarian cancer, Zejula brought in nearly $30 million in the quarter, up by 135% and accounting for just over 63% of total revenue. Optune, an electric-field therapy for cancer, earned nearly $13 million in the quarter, up 80% year-on-year. And Qinlock, for gastrointestinal tumors, saw its revenue surge seven-fold to $3 million. Another drug launched in December to treat bacterial pneumonia, Nuzyra, made $700,000 in revenue over the three months.

The company went public on the Nasdaq just four years after its launch, on the back of the licensing business model. It moved much faster to commercialization than most other peers still running deficits. In the three years after its U.S. share debut, the stock price rose three-fold and the company also listed on the Hong Kong Stock Exchange in September 2020.

But the drawbacks of its business model soon became obvious. Despite revenue increases, the losses kept mounting and investors began to lose patience.

A major factor has been the high licensing pre-payments, which amounted to $108 million in 2020 and $384 million last year, accounting for 67% of total R&D spending.

And when Zejula was added to the Chinese National Reimbursement Drug List it was guaranteed a distribution channel but at a reduced price. With prices of drugs falling but licensing costs still high, Zai Lab’s margin was squeezed.

And in the stock market, its share price has tumbled. It fell to HK$24.9 on the day of the quarterly results announcement, down more than 80 % from a high of HK$150 in January last year.

When it released last-year’s financials in March this year, the company was already playing down the licensing part of its business as a mere short-term strategy while it works on developing its own drugs.

Creating its own medicines will take time

In fact, the company has 11 products of its own in the works, including its ZL-1102 drug for the skin condition psoriasis, which is further along the development process than the rest, with Phase 2 clinical trials due to start later this year.

So, it’s still early days for Zai Lab’s own-brand medicines, with reliance on its standard products likely to continue for now. The company estimates that more than 15 products will hit the market by 2025, swelling its earnings. Adding in its $1.31 billion in cash and cash equivalents, it should have enough cash flow to support more independent R&D.

Still, investors continue to have doubts, despite news of the narrower loss.

Its share price fell nearly 20% the day after the results came out but bounced back 18% on Monday when analysts were more upbeat about the product pipeline potential.

JPMorgan revised down its estimated loss per share from $6.87 to $3.88 for this year and from $3.55 to $1.1 for next year, as well as giving an “overweight” rating with a target price of HK$90, implying that the stock price stands to more than double.

Merrill Lynch noted that product development is making steady headway, though expenses could rise in the short term as the company boosts its commercialization team, and the Shanghai lockdown could also weigh on sales. It kept its “overweight” rating while adjusting the target price down from HK$77.5 per share to HK$65.5.

Zai Lab’s price-to-sales (P/S) ratio is about 18 times versus 14.4 times for BeiGene, a close rival that also relies on the licensing model, indicating the market could be placing more bets on Zai Lab finding the winning formula.

The company clearly faces a challenge in weaning itself off the high-cost reliance on drugs developed by other biotechs.

But if Zai Lab manages to find the right cure for its balance sheet woes and succeeds in becoming a biopharma innovator, it could eventually give investors that long-awaited dose of profits.

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