Potential U.S. targeting casts shadow over WuXi AppTec family

Proposed U.S. legislation could ban federal agencies and federally funded institutions from buying devices and services from Chinese biotech companies

Key Takeaways:

• WuXi AppTec, which could be banned from doing business with federal agencies under proposed legislation, derived 65% of its revenue from the U.S. in the first half of last year
• The provider of outsourced services to drug makers said it has never sponsored Chinese military projects or received any direct military investment

By Li Shih Ta

China-U.S. competition is shifting from the tech, trade and financial fronts to a new frontier: the biotech realm.

Late last month, shares of Chinese providers of outsourced services to drug makers, known as CXOs in the industry, plunged on word that a bipartisan group of U.S. congressmen had drafted bills to prohibit federal agencies from buying devices and services from certain biotech companies.

The news took a toll on WuXi AppTec Co. Ltd. (2359.HK; 603259.SH) and its related companies, including Wuxi Biologics (Cayman) Inc. (2269.HK) and WuXi XDC Cayman Inc. (2268.HK), which all tumbled on China’s domestic A-share markets and in Hong Kong. WuXi AppTec plunged 26% from HK$76.20 to HK$56.30 over three days, and fell 22% in Shanghai. Wuxi Biologics lost 31%.

The new bill introduced in the House of Representatives, called the Biosecure Act, noted that China is seeking to dominate biotech as a future industry, and that its biotech companies have worked with entities of the country’s military many times. It added that government authorities have the power to force such companies to hand over their data, which often includes work being done for their customers.

A similar bill introduced in the Senate said Chinese biotech companies were currently gathering genetic data on millions of people around the world through medical tests, including many U.S. citizens whose blood was drawn without their knowledge of who could access their DNA and other sensitive data. With further advances in the biotech sector, China will be able to amass such data in troves and seize an upper hand in its tech competition with the U.S., the bill added.

The legislation directly named WuXi AppTec as a sponsor of cross-sector military-civilian activities, and as a recipient of funding from military-civilian funds. It said sister company Wuxi Biologics’ CEO Chen Zhisheng is a professor at the Chinese People’s Liberation Army Academy of Military Medical Sciences.

Responding to the allegations, WuXi AppTec said points about the company in the legislation were “both inappropriate and inaccurate,” reiterating that its development would not pose a risk to any country’s national security. It added the company had not sponsored any military projects, nor had it received any investment directly from any military funds.

Political grandstanding?

Wuxi Biologics also published a statement clarifying that Chen’s title at the Chinese People’s Liberation Army Academy of Military Medical Sciences was an honorary one he received upon giving a lecture in 2013. “It was a mere gesture and a common practice by Chinese higher-education institutions,” said the statement. “Chen has not worked for the Academy or any institutions with military background and has not been compensated by any such institution.”

Chen noted the Biosecure Act was just proposed legislation, and said it was extremely unlikely to become law. And even if it ultimately becomes law, that process could take years. Despite his words, essentially saying the legislation might simply be political grandstanding, the company’s stock continued to fall even after the statement’s issue.

Some 82% of WuXi AppTec’s revenue came from overseas in the first half of 2023, with the US market taking up 65%. By comparison, the company’s home China market accounted for just 17% of revenue. WuXi Biologics was similar, getting 54% of its revenue from North America in the first half of last year.

Drug services giant

WuXi AppTec and its subsidiaries are quite possibly some of the biggest drug services providers you’ve never heard of, performing similar outsourced services for major drug makers in the U.S. and Europe to what Taiwan’s Foxconn does for Apple. While pharmaceutical companies focus on R&D, branding and sales, outsourcing contractors like WuXi AppTec handle lower-profile but necessary services like drug verification and production.

Since most of the largest pharmaceutical companies are based in the West, Chinese CXO companies naturally look overseas for most of their business, a status quo that is likely to continue for the foreseeable future.

Despite optimism among many Chinese analysts that the bill is unlikely to become law, 2024 is also an election year when China-U.S. strategic competition will become a hot topic on many levels. Companies like WuXi AppTec and its subsidiaries with major U.S. business ties will inevitably get caught in the crosshairs.

In fact, a chorus of voices against Chinese companies participating in the U.S. biotech industry surfaced last November as well when 16 conservative groups sent letters to the Senate and House on the matter. They called for adding a provision to the National Defense Appropriation Act to bar government departments or agencies from signing any contract with “adversarial biotech companies,” specifically citing BGI Genomics (300676.SH).

Tech cooperation and transfers relating to China drew major attention in the final version of the 2024 National Defense Authorization Act, especially in key areas including new energy, biotech, aviation and aerospace. Regardless of the outcome of any of this legislation, a curtailment of U.S. cooperation with China in biotech seems increasingly like a foregone conclusion.

Real political risk

Despite all the commotion, some investment banks think the market is overreacting. Morgan Stanley published a report saying that even if the latest bill becomes a law, it will only preclude federally funded projects from being contracted to foreign companies. Daiwa Securities actually upgraded its rating on WuXi Biologics from “hold” to “overweight,” citing a different development in late 2022 that saw the company removed from the U.S. Department of Commerce’s unverified list.

Demand for WuXi AppTec’s services is likely to remain strong, since drug development is still a fast-advancing field. Following the selloff, the company’s price-to-earnings (P/E) ratio is down to 15 times. That’s lower than WuXi Biologics’ 21 times, but still higher than the 7 times for Asymchem Laboratories (6821.HK; 002821.SZ) and 9 times for Hangzhou Tigermed (3347.HK; 300347.SZ), showing investors still believe WuXi AppTec is a leader in its field.

The company is also expected to benefit as demand for outsourced drug services grows in China. China’s CXO market is expected to rise from 131.2 billion yuan ($18.4 billion) in 2022 to 336.8 billion yuan by 2026, growing 26.6% annually, according to Frost & Sullivan.

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