Eli Lilly investing $100M in China, hoping to attract research partners

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SHANGHAI — Hoping to increase sales in China's rapidly growing pharmaceutical market, Eli Lilly and Co. is charging ahead with plans to invest $100 million in venture capital in the region over the next several years.

The investment demonstrates the struggling drugmaker's recent commitment to developing partnerships worldwide as it broadens its business model. And if those partnerships help Lilly better understand the emerging Chinese mar ket, all the better.

"As 1.3 billion people get healthier and wealthier, it's a positive thing for the entire world," said Darren Carroll, senior managing director of Lilly Asian Ventures. "And it certainly augurs well for our industry."

Lilly — and its peers — could use some good news. The Indianapolis-based company's stock has tanked in recent years; shares that topped $75 in 2004 were trading for about $33 in late November.

China represents opportunity. Most of the drugs now distributed there are generics, in part because the country's intellectual-property laws are still developing.

But the long-term outlook is promising. Already, Lilly's sales in China are growing 26 percent annually, Lilly China's president, Jorg Ostertag, reported last year, projecting that it could become the world's 10th-largest drug market by 2010. The company would not disclose specific sales figures.

Indeed, the economics are compelling, especially considering the cost of a researcher in China is about 20 percent of one in the United States.

Lilly has been doing research work in China for years, but last year's launch of Lilly Asian Ventures — with $100 million earmarked for investments primarily in China — signaled a new dedication to such collaborations.

In a September speech to the Economic Club of Indiana, CEO John Lechleiter outlined a new strategy for the company: Rather than owning everything along the drug-development pipeline — and taking on the associated costs — Lilly will look to build a network of alliances to achieve the same results more efficiently.

"There are very good reasons why branded prescription medicines cost so much," Lechleiter said, citing the "astonishing cost and risk of R&D in our industry, with 1-in-5,000 odds of success, 10- to 15-year time lines, and price tags well in excess of a billion dollars on every new medicine that reaches a patient."

In hopes of reducing the cost and risk, Lilly is testing collaborations with life sciences firms in China and India, he said, explaining that Lilly scientists design compounds that are being synthesized by a firm in Shanghai or tested through "risk-sharing" deals in India.

Lilly has the right to buy back the molecules, he said, "once our collaborators succeed in establishing 'proof of concept.'"

Lechleiter said the strategy also calls for tapping private investment funds to spread the risks of late-stage research and development — and putting Lilly's money to work in biotech startups.

A sister fund of 7-year-old Lilly Ventures, which has another $175 million to invest worldwide, Lilly Asian Ventures has five employees with offices in Indianapolis and Shanghai.

Officials won't say how much the new venture fund has spent so far — or on what — but its first move in late 2007 was to make a $10 million fund-to-fund investment in BioVeda China, which it in turn invested in life sciences firms. In July, it announced plans to sink an undisclosed amount in Shanghai-based contract research firm HD Biosciences — as part of a collaboration with New York-based Pfizer Venture Investments and Hong Kong-based Morningside Group.

As is common practice in venture capitalism, Lilly builds syndicates to mitigate risk, said Carroll, the fund's senior managing director.

Unlike many traditional venture firms, however, Lilly Asian Ventures deals hands-on with the companies it invests in, requiring that it be given a board seat at each recipient firm. By working to increase collaboration, leaders hope the broader corporation's guidance can secure positive returns.

For their part, startup managers organize life sciences and biotech conferences to attract interest from venture capitalists like Lilly that are considering the Chinese market.

It was just such a conference last December that piqued the interest of Yi Shi, managing director of Lilly Asian Ventures' operation here, and led to the HD Biosciences deal this summer. Shi has worked for two years to develop an investment strategy for China.

Lilly wants to invest in promising life sciences companies with cutting-edge technology and innovative business models, but also is looking to grow its stake in China's growing prescription drug market, Carroll said.

An operation such as Lilly Asian Ventures could help the broader corporation understand just what it takes to succeed here, he said.

While Lilly Asian Ventures has not yet generated a profit, Carroll said that's just a matter of waiting for investments to mature. As some of these companies eventually begin to go public, Lilly expects to return four times its investment.

"We're not interested in building a company that can be sold within two years," he said.

Rather, executives say they're just as interested in improving the company's access to the growing pool of researchers in China as the government works to shake its image as the world's low-skill labor capital. The Chinese are giving high-tech manufacturers generous tax breaks and rolling out education initiatives aimed at training the workers needed to sustain that growth.

Many Chinese researchers who once flocked to the United States and Europe to work in Western laboratories now choose to remain in China and embrace growth at home, Carroll said.

"That doesn't mean we can't have a relationship with some of the best scientists, no matter where they are," he added.

By 2013, half of all preclinical pharmaceutical research likely will be outsourced, according to research released in August by Business Insights research group.

Its report, titled, "Strategies and Models for R&D Success," suggests that as collaboration becomes more common, companies like Lilly will be forced to share in greater chunks of risk and reward.

For Lilly and other drugmakers, there is "no alternative but to dilute its own monopoly in order to secure its very existence," according to the report.

It's a trend Henry Tsang, visiting scholar at China's Nanjing Normal University, recognizes.

Tsang, a Taiwanese-American who often lectures on trade relations between the United States and China, said education initiatives by the Chinese government have lifted the capabilities of laboratories here.

He warned, however, that in most high-tech sectors, the Chinese are still "technicians" for foreign ingenuity.

"China is not the ideas capital," he said. "It's still a work in progress."

That will require patience from Lilly and scores of other drug companies now tied to investments here. But, as Carroll said, acknowledging a responsibility to shareholders: "We can't be too patient."

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