CStone’s executive reshuffle comes after company discovers questionable investment made by finance vice president in 2021

Key Takeaways:

  • CStone brought four products to market last year, and its losses have surged due to growing R&D and sales spending
  • Appointment of chairman with close ties to WuXi AppTec reveals a power struggle between shareholders and management

By Molly Wen

CStone Pharmaceuticals‘ (2616.HK) revenue fell 77% last year and its net loss climbed, as the Chinese drug company saw one-off license fees decline sharply and marketing costs to launch new drugs swell. All of this happened as the company, which is backed by Chinese pharma giant Wuxi AppTec Co. Ltd. (2359.HK), dealt with a financial investigation, an executive reshuffle and its shares being suspended from trading on the Hong Kong bourse for two months earlier this year.

The past year has been tough for pharmaceutical companies in China as investment and financing in the sector have cooled. In addition, China’s overhaul of its healthcare system to provide broader access to quality drugs for its massive population has not been lucrative for pharma companies. China’s approach to add new treatments to its National Reimbursement Drug List only if drugmakers agree to drop their prices has squeezed margins in the industry.

Even though pharma companies in China have seen more drugs approved for marketing, their bottom lines have shrunk. CStone’s 2021 financials, released on May 31, showed revenue at 244 million yuan ($36.4 million), including the sales of 163 million yuan of commercialized products in eight months. Licensing-related revenue fell 92% year-on-year to 80.9 million yuan from 1.04 billion yuan. Net losses for the year rose 57.3% to 1.92 billion yuan.

CStone started its drug commercialization last year after getting regulatory approvals for four new drugs, including three targeted therapeutic drugs of the same category, namely Pralsetinib, Avapritinib and Ivosidenib, as well as an immuno cancer drug called Cejemly. Avapritinib and Pralsetinib were launched in May and June, bringing in 163 million yuan in sales.

These product launches led to huge increases in research, development and sales costs, with R&D spending totaling 1.3 billion yuan in 2021, seven times higher than total revenue in drug sales during the year. Costs associated with selling drugs soared 156% year-on-year to 364 million yuan.

CStone is not as cash rich as before, with 740 million yuan in cash at the end of 2021 compared with 3 billion yuan in late 2020. The company has 15 product pipelines up and running, and its four commercial drugs could be approved for new indications. Most of its other self-developed drugs are either about to enter clinical trials or in Phase 1.

For a moment, it seemed that CStone had turned the corner when its shares resumed trading on June 1 and closed 6% higher. But the next day they fell 4.5%, reaching HK$5.1 per share – the lower end of the 52-week trading range. Investor confidence in the company is still low as it reels from an accounting scandal that led to a delay in announcing financial results and the stepping down of its chairman.

Chairman steps down

The company failed to release 2021 financials on time after an irregular investment totaling HK$228 million ($29 million) was discovered during its annual audit.

According to a filing made with regulatory authorities, the vice chairman of finance Weng Xiaolu advised Chairman and CEO Jiang Ningjun in June 2021 to invest in CMB International Capital and its affiliated banking group with CStone’s surplus funds. After Jiang gave the oral approval, HK$228 million was invested in July in a fund linked note (FLN) issued by CMB. It was set to expire in December 2021. Weng put in a request with CMB International Securities in November to extend the investment to October 2022 and left the company in December.

According to the investigative report, Weng told Jiang that the investment “would be able to produce good return with low risk.” But CStone logged an unrealized loss of 29% in March 2022 on the investment. The amount invested was below the $50 million threshold requiring signature authorization by management, and there was no violation of payment authorization rules. But the company’s investment policy only allows investment in specific instruments and the fund in question was not among them.

As the dust settled, the board decided to replace Jiang with non-executive director Li Wei as chairman. To make its investment policies more robust, CStone now requires signature authorization for investments above $3 million, from the previous $50 million. It also established an investment committee to assist the board to review investment performance.

The leadership change also offers a glimpse into the fight between shareholders and management. Jiang, in his 60s, is one of the founders of the company and became CEO in July 2016 and chairman in August 2018. He has been the vice global chairman of Sanofi (SNY.US) and head of R&D at its Asia Pacific business. Incoming chairman Li, who was given a board seat at CStone’s founding in late 2015 and became a non-executive director of the company in 2018, has never been involved in management of the company.

New chairman has strong links to WuXi

Li has been a co-founder and co-chairman of WuXi Healthcare Ventures since 2015, which is the biggest shareholder of CStone. He has also served as executive partner at 6 Dimensions Capital since 2017 and is a seasoned investor. These companies have close ties with Wuxi AppTec, which carved out its investment division into WuXi Healthcare Ventures in 2015. 6 Dimensions Capital was founded by Frontline BioVentures and WuXi Healthcare Ventures. Li Gei, the founder and chairman of Wuxi AppTec, is the chairman and co-founder of 6 Dimensions Capital.

Capital markets are not pessimistic about CStone’s prospects, partly because of the support it has from Wuxi AppTec. CStone’s current price-to-sales (P/S) ratio is 21 times, slightly lower than the 23 times of pharma companyZai Lab (ZLAB.US; 9688.HK), which also operates a licensing-in model, but much higher than the 7 times of Innovent Biologics (1801.HK), which has greater capacity in independent drug development.

Only time will tell whether CStone can improve its performance with a new chairman and support from a shareholder with deep pockets.

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