Profit setback for Simcere Pharma in novel drugs quest

The pharmaceutical company’s profits have been buffeted by erratic returns on an equity stake in a fellow developer of innovative drugs

Key Takeaways:

• Simcere Pharmaceutical holds a 9% stake in 3D Medicines, making it the firm’s second-biggest shareholder. It chose not to cash out any of its holdings when the stock was surging
• Simcere slashed the price of its oral Covid drug Xiannuoxin by 27% to get the product into China’s health insurance program, which will squeeze future profits

By Molly Wen

Chinese drugs maker Simcere Pharmaceutical Group Ltd. (2096.HK) is reinventing itself as maker of novel medicines after starting out in the generics business. The strategy is producing results, but the pivot towards innovation has had some painful side effects.

In its latest earnings guidance, Simcere predicted a modest rise in annual revenue but said its net profits for 2023 would shrink by at least a fifth, hit by the falling value of an investment bet on another developer of innovative drugs, 3D Medicines (1244.HK).

Founded nearly three decades ago, Simcere is an established player in the Chinese pharmaceuticals market, known for producing an oral drug to treat Covid. The company is now looking to capitalize on a new generation of specifically targeted drugs for diseases such as cancer.  It sold assets twice in the past year and brought in substantial non-operating revenues. However, an earnings alert released last Sunday flagged up a profit drop in its next set of annual results.

Simcere predicted revenues of about 6.58 billion yuan ($914 million) to 6.64 billion yuan for 2023, an increase of 4% to 5% over the previous year. The company logged a pre-tax windfall of about 789 million yuan in the first half from its divestments in subsidiaries. But net profit was forecast to range between 685 million yuan and 745 million yuan, a year-on-year fall of 20% to 26.4%.

The company blamed the slippage on its stake in 3D Medicines, which it said would generate a net loss before tax of about 742 million yuan at fair value compared to a net profit of about 394 million yuan in its 2022 earnings.

Simcere’s shares fell 2.4% on the first trading day after the profit alert but they recovered slightly in subsequent sessions. BOCOM International said in a research report the results would lag its forecasts, citing external disruptions. But it noted that the firm was expected to submit several new drugs for marketing approval this year and is likely to launch 11 drugs by 2026.

3D Medicines, the company that weighed on Simcere’s profits, focuses on developing new cancer drugs. Its immunotherapy agent Envafolimab, administered by injection, made 353 million yuan in revenue in the first half of last year. Described as the world’s first subcutaneous injectable PD-L1 inhibitor, the drug was developed in partnership with Alphamab Oncology (9966.HK), which means 3D Medicines can only get 49% of the pre-tax profit from the sales.

Last year’s first-half earnings report from 3D Medicines showed that Simcere was its second-biggest stakeholder after the founding team, owning 9% of the firm’s shares as of the end of June.  The ratio has stayed around that level since 3D Medicines was listed, indicating that Simcere did not cash out any of its holdings at the peak of the stock price.

It was a rollercoaster ride last year for investors in 3D Medicines. The share price surged from HK$24.98 after the IPO in late 2022 all the way to HK$131.50 in July before a nosedive left the price hovering at around HK$6 recently. As a result, the value of Simcere’s investment has shrunk by more than 95% from the peak.

3D Medicines has been working on narrowing its losses. In the first half of last year, its revenue totaled 350 million yuan and the firm’s loss narrowed 41.2% to 190 million yuan. The developers of Envafolimab granted a license to an Indian partner, Glenmark, on Jan. 24 to launch the cancer drug in a host of countries and regions. These include India, Russia and countries in the Asia Pacific, the Middle East, Africa, central Asia and Latin America. 3D Medicines and Alphamab Oncology will get around $700 million upfront for the deal, along with milestone payments based on progress towards commercial launches in the targeted areas.

Otherwise, scant advances

Aside from Envafolimab, the drug firm’s remaining 11 pipelines are mostly in the early clinical stages and are still far from generating returns. Therefore, the big licensing deal did not deliver a big boost to the 3D Medicines share price.

Simcere was founded in 1995 and in 2007 became the first Chinese producer of biological and chemical drugs to list on the New York Stock Exchange.  Due to limited turnover, the company was delisted and taken private in December 2013. In 2020 the company went public again, this time on the Hong Kong Stock Exchange.

Simcere’s core revenue and profit are relatively stable, with more than 40 products in its portfolio included in China’s medical insurance scheme. In the past, Simcere focused on developing and launching generic drugs but in recent years the proportion of revenue from innovative drugs has increased rapidly, with six such products commercialized.

In the first half of 2023, Simcere posted operating revenue of 3.38 billion yuan, an increase of 25.2% from the year-earlier period. Innovative drug revenue contributed 2.41 billion yuan, amounting to 71.4% of total revenue. Net profit surged a whopping 34.7 times to 2.28 billion yuan. However, a closer look at the first-half figures reveals that a 1.15 billion yuan jump in the fair value of Simcere’s investment portfolio was powered by a rally in 3D Medicines shares.

In other words, Simcere’s bumper first-half earnings were a blip, as the subsequent plunge in 3D Medicines shares turned a paper profit into an investment loss. Looking at core income from commercialized drug sales, net operating profit rose just 0.4% to 393 million yuan in the first half of the year.

Early last year, Simcere celebrated a commercial milestone with marketing approval for its oral Covid drug Xiannuoxin, used to treat adults with mild to moderate Covid infections. The drug brought in revenues of about 250 million yuan in the first half.  However, at the end of the year the company accepted a 27% price cut to get the drug added to the list of treatments covered by China’s national health insurance, which would squeeze future profits.

Simcere recently raised 970 million yuan for a wholly owned subsidiary, Simcere Zaiming, to fund R&D for innovative drugs. The subsidiary, which focuses on cancer treatments, was valued at about 8.47 billion yuan after the fundraising, backed by institutional investors such as SDIC Investment Management, Shenzhen Zhongshen Xinchuang and Apricot Capital.

Simcere’s latest price-to-earnings (P/E) ratio is only 4 times, compared to 11 times for CSPC Pharmaceutical Group (1093.HK), which is also shifting into the novel drugs arena. By that token, Simcere could be regarded as undervalued and worthy of investor attention if it succeeds in bringing new drugs to the market this year.

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