Since the beginning of the year, guidance for core revenues (excluding COVID revenues) from large tools players have declined ~5%, with growth expectations now in the low single digits, well below its typical high single digit rate in recent years. This alarming trend can be primarily attributed to 3 factors: 1) Cautious spending by biopharma clients, exacerbated by destocking tendencies, 2) Increasing considerations of broader economic unpredictability, 3) and economic softness in China, which we’ll address in this post.
Given its potential and evolving dynamics, the Chinese market has been a focal point for public life science research tools (LSRT) and diagnostics players during their Q2 earnings calls. As we reviewed earnings calls, we uncovered key themes shaping operations of large U.S. players in China.
1. The China Conundrum: Scale of Decline
China's healthcare market is experiencing significant flux. Some firms like Danaher report a marked downturn in revenues, attributing it to economic weakening and market challenges. Similarly, Illumina has cut its 2023 revenue guidance significantly; 25% of the cut comes from headwinds in China. Further, Danaher noted that the situation worsened in June, and Agilent added that the situation continued to deteriorate in July. However, this isn't a universal narrative. Of note, companies like Becton Dickinson have registered strong growth in the region.
“…Greater China revenue of $115 million represented a 3% decrease year-over-year or a 1% increase on a constant currency basis. In addition to persistent macroeconomic and geopolitical challenges that are impacting this region, revenue was negatively impacted by the local competitive landscape, particularly in mid-throughput…” – Illumina Q2 2023 Earnings Call
2. The Post-COVID Landscape
As the world shakes off the remnants of the pandemic, its imprints on the business world remain. Some companies have seen their non-COVID sales decline, while others report uneven recovery rates across their portfolios. The pandemic's long shadow underscores the importance of resilience and adaptability in business strategies.
“…The sequential improvement of the market that was expected is taking more time in light of the Chinese economy. So for the second half of the year, we are taking a more cautious view than at the start of '23. We are now expecting China non-COVID sales to remain flat over H22022.…” – Qiagen Q2 2023 Earnings Call
3. China's Home Advantage
China appears to gradually lean towards “nationalizing” its healthcare. Authorities favor local champions, challenging foreign companies to redefine their approach. To thrive, global companies are localizing their operations, emphasizing manufacturing and R&D within Chinese borders. As Qiagen's experience suggests, this is no longer a choice but a necessity. However, others (e.g., Danaher) believe that local competition is an issue “at the margin”.
“…Chinese authority are trying to favor local champions against foreign competitors. To cope with that situation, it is paramount in China to be able to localize manufacturing and R&D. We can do that at QIAGEN with our manufacturing and R&D site that we have in Shenzhen. […] In addition to that, we have also a second brand in China, a company which is independent operationally from our sales and marketing activities in China, which is selling Chinese-originated product mainly to Chinese companies.…” – Qiagen Q2 2023 Earnings Call
4. High Variability by Application
The intensity of competition varies across sectors. For instance, Qiagen, a giant in molecular diagnostics (MDx), faces lesser competition in MDx than in areas like immunoassays. Similarly, Agilent reported a deteriorating setup in China, particularly in pharma down 30% year on year.This market growth heterogeneity offers companies opportunities to identify niches where their expertise can shine.
“…The major driver behind our [y-o-y] decline in revenue is our China business. Excluding China, the rest of Agilent grew 2%which is better than expected. We knew we're up against a difficult compare in China and had previously guided for lower China revenues in Q3. However, the economy in China continued to weaken during the quarter, translating into amore challenging market environment than we had anticipated…” – Agilent Q2 2023 Earnings Call
5. Similarly, High Variability by Customer Type
Biopharma customers have cut spend in bioproduction, as best articulated by Danaher’s CEO.
“…China orders were down 20% in Q1, 40% in Q2, but really 50% in June. And frankly, we don't see that getting better here in H2. And that's really related to 2-3 factors. 1) the funding environment continued to deteriorate. The foreign investment in projects and capacity has dissipated, it has not returned. There are fewer projects there that are being funded. 2) over the last 2-3 years, a great deal of capacity has been built, particularly CDMO capacity, but also some with the smaller Biopharma. And so there's not a lot of additional hardware required here in the short term in H2, nor are there that many molecules that are being worked on by the CDMOs, meaning that the consumables requirements of that capacity are also lower than we saw here in H1. And 3) and part of this is related to our aggressively managing with our customers to get them to their target inventories, there are a fair number of order cancellations. So when you put all that together for China, that is a different picture in H2 than we saw in H1. And once again, we're working here, if you aggregate this to the total global biopharma business, to get as much of this as possible behind us in 2023. And just to give you a sense, our China business in 2022 was about $1.3B. We expect that to be ~$800M business in 2023, which would be about 10% of our total bioprocessing business…” – Danaher Q2 2023 Earnings Call
6. Looking Ahead with Optimism
Despite the uncertainties, U.S. companies are unwavering in their commitment to China. While Q2 commentary was “negative” overall, the overarching sentiment is clear: while the road ahead in H2 (and 2024) is uncertain, China's market holds immense promise in the long run.
“…While Q4 was a good quarter for us in China, the funding environment in China will likely be a big challenge for at least the first half of the year. But don’t doubt [ph] China’s resolved for better healthcare and we believe when the funding returns, it will come back strong...…” – Biotechne Q2 2023 Earnings Call
China remains an enigma for many global companies, with several risks and challenges. While the region typically represents only 10-15% of revenues (higher for Agilent, and lower for Thermo Fisher), abrupt market swings have a major impact on earnings. One of the industry-wide risks for U.S. LSRT companies is the inability to compete effectively in this critical growth market. In the short term, the sentiment based on mentions in the Q2 earnings calls is largely cautious / negative. However, with the right strategies, innovations, and local collaborations, they can transform these challenges into opportunities, leveraging China's growth potential in the long term.