Viva Biotech was founded 11 years ago as a China based contract research organization (CRO) to pharmaceutical and biotechnology companies. Using its expertise in structure based drug discovery, Viva has set itself apart as a leader in the industry. The company has since gone on to add a new arm to its business model where it helps incubate small biotech startups by offering an equity for service plan for those who need help with funding. Viva listed on the Hong Kong Stock Exchange in a May 2019 initial public offering (IPO). It was then added to the China BioPharma ETF (Nasdaq: CHNA) during the fund’s August 2019 semi-annual rebalance. View all holdings of the CHNA ETF.
We visited Viva Biotech in November at its headquarters facility in the Zhangjiang Hi-Tech Park area of Shanghai. There we were invited to take a tour and see the science that was happening there, and then we sat down with Cheney Mao, Ph.D., Founder, Chairman & CEO and Simon Hua, CFO to discuss the company. Dr. Mao and Mr. Hua described the company’s history, the rationale of both its cash for service model and equity for service model, and how they describe what is happening in China to international investors. Below is a transcript of our interview, which has been edited for clarity and length.
Viva Biotech CFO Simon Hua (L) and Founder, Chairman & CEO Cheney Mao, Ph.D. (R).
CHNA ETF: Can you please introduce yourself and tell us about your background?
Dr. Mao: My name is Cheney Mao. I did my chemistry degree in China at Fudan University and graduate with a Master’s degree. I then went to the U.S. for a Ph.D. in biochemistry at Cornell and a postdoc at Duke University. Afterwards, I went to the Midwest in Minnesota for seven years to work for a small research firm for drug discovery. I was director of structural biology. We applied structural biology for structure based drug discovery (SBDD).
Back then in the 1990’s, structure based drug discovery technology just got started. People took interest in it because you can see things on your targets such as the cell surface or the inside of the cell that are causing disease and the compounds you want to come up with. Since you are seeing it, you believe it, and you know how to improve on it with something called rational design. This contrasts with traditional medicinal chemistry that relies on trial and error. The efficiency has been heightened by 90% over time. In the very beginning in the early 1990’s maybe 1% of programs utilized SBDD whereas today it is responsible for approximately 50% of the compounds in clinical trials. It is a very popular and indispensable tool now.
CHNA ETF: What year was it that you founded Viva Biotech?
Dr. Mao: 11 years ago, in 2008.
CHNA ETF: What inspired you to start the company back then?
Dr. Mao: We saw opportunities that started about 20 years ago in China for the contract research organization (CRO) business. CROs provide services like lab work, discovery work, and research to pharmaceutical and biotech companies. This includes biology assays and synthetic chemistry to help increase the efficiency of companies. We saw this business as a revenue base. Our background is in drug discovery, but it requires a large amount of money that we didn’t have back then. Since we started in 2008, which 7 or 8 years was behind compared to the first generation of CRO companies in China, we wanted to start with some highly specialized work.
CHNA ETF: How did you differentiate yourself?
Dr. Mao: Instead of providing synthetic chemistry like the large majority of CROs based in China, we focused on structure based drug discovery. Instead of competing with other companies on low pricing, we competed with the technology that we knew well. Over the last 11 years we have succeeded. We believe that if you want to work on crystal structures and to have rational drug design, Viva is the #1 company to work with.
CHNA ETF: With your focus on structure based drug discovery, is there a specific type of client that would be drawn to you?
Dr. Mao: Our clients are very high profile, including 9 of the top 10 pharmaceutical companies (as of June 30, 2019). We also have many of the leading biotechnology companies as clients and help them with their drug discovery work.
CHNA ETF: How big is the company today?
Dr. Mao: Today we have close to 400 clients, most of which are U.S. based companies with a concentration in Boston largely, San Diego, San Francisco, and other places. Over 10% of the business today is from China companies.
CHNA ETF: We just did a tour of your Viva headquarter facility in Shanghai. What other locations do you have in China? Do you see the China portion of your business growing over time?
Dr. Mao: Today we have more than 700 employees. We have facilities in several places, including 4 facilities in Zhangjiang where we are today (Zhangjiang is a technology and biotechnology focused business park in Shanghai). We also have a facility in a nearby city called Jiaxing and have started construction on a new one in Chengdu in the west of China. We have seen the boom of the biotech industry and we plan to increase our capacity as quickly as we can.
Viva Biotech’s headquarters in the Zhangjiang Hi-Tech Park area of Shanghai.
CHNA ETF: As someone who has been here and been doing business for over a decade like you have, how would you describe the way China’s biotechnology sector and drug development and research & development (R&D) has changed over that time? What was is like back then compared to what it is like today?
Dr. Mao: Chinese pharmaceutical companies used to work on generic drugs. Previously you could make money on that but recently China changed its policies and has put huge pressures on generic drug pricing. Many of the generic drug companies are having very difficult times now because of the pricing war. They don’t have a choice but to turn to innovative drug discovery. This means fast follower drugs, best-in-class and first-in-class companies will gain huge opportunities for development. What Viva has been focusing on is providing services to clients to help discover first-in-class medicines. That is what our SBDD technology is most useful for. So the local pharmaceutical companies are going through rapid changes and biotechnology companies are also coming up here.
I think the opening up of the Hong Kong Stock Exchange and the STAR Board (the STAR Board is a division of the Shanghai Stock Exchange, one of the two main stock exchanges in mainland China) to biotechnology companies provides an exit opportunity to venture investors in the industry. The growth of the number of innovative start-ups in the industry has been dramatic recently. Previously, there were only a handful of biotechnology companies in China but now you see hundreds or maybe even thousands. I expect there to be at least 30,000 biotechnology companies in China in the future if you simply compare the country’s population to the United States as a gauge.
CHNA ETF: Viva has an interesting business model, which offers traditional cash for services but also do venture investing – you take equity for services. Can you describe that more?
Dr. Mao: Ever since we established the company, we wanted to get involved in the drug discovery business. For the first seven years, we focused on CFS (cash for service) because we needed the revenue. Very simply, we provide the service and we get paid for it. As our technicians became more sophisticated and our reputation in the industry grew, we thought the timing was right to add on EFS (equity for service) to our model. This is to provide services to companies, especially start-ups, which do not have sufficient funds. In exchange, we get equity from them. So we can not only service companies with money, but also service startups with excellent ideas that might be short on funding. Our vision is really quite unique because we are mentoring and supporting these companies from the very beginning of their journey, when they are in desperate need of investment and resources. Today, many of our investments are a combination of the EFS and CFS as we try to be a one-stop resource center for these types of projects and add value as an investor.
Doing it early in a company’s formation is the only chance for a business like ours to get into an equity position of a biotech company. For the first three or so years, people are usually using funds from angel investors or their own money to support themselves. There are more than 1,000 funding requests to Viva per year from people like these. We saw a huge market with an unmet need for start-ups in the pre-venture capital (VC) round, thus I think it was a good chance for us to get in. We meet with several hundred companies every year and we will pick approximately 5% to support.
CHNA ETF: How do you go through all of that and evaluate the opportunities?
Dr. Mao: We understand that if you invest early, there is a big risk involved. So trying to lower the risk is critical. We have developed a couple of ways that we think lowers our risk. First, we have found that SBDD is the gateway when you launch a drug discovery program for target identification and hit identification. You have to know what compounds you can improve on and turn into drug candidates. That is what we actually call step zero. From then until the point where your work creates intellectual property (IP), that is step one. This is when you have proof of concept compounds or preclinical candidate compounds (PCC) and it takes about three years. With our technology, we are able to help clients do this work more efficiently and we can provide some cash if they need it. We found that the returns can be good in this stage and there is little competition because hardly anyone else is helping companies at this early stage except a few angel investors. The space is wide open and quite accessible.
We have assembled a group of experienced technicians in SBDD, who have prior experience working in the pharmaceutical industry in the United States, as well as more than two-dozen business partners who are the senior management of Viva Biotech. Together, collectively, they are the inventors of over 50 compounds in clinical trials and more than a half dozen drugs that are approved on the U.S. market. These are people who have been there and done it. We use them to help us tell which programs are more promising than others.
CHNA ETF: For a typical investment, how much of the stake do you take in a startup and for how long do you typically hold it?
Dr. Mao: Our aim is to work with many biotech companies in large scale which is in contrast to conventional venture capital investors. There is a fundamental difference with us. U.S. venture capital firms typically invest between $20 million USD and $50 million USD. We think for the initial stage you do not need that much. This is especially the case when using SBDD, which is our expertise. I have to emphasize that. I would say that less than $10 million is typically needed to get to the IND filing with SBDD (an IND filing is when a company asks a government regulator for permission to start clinical trials in humans).
In order to do that in large scale, I think you do not want to be taking a majority, or controlling, stake in these startups. Since the founders of the startups remain the majority stakeholder, they have the incentive to drive forward the company. We typically will own 20% to 30%. Many people like that because it keeps it in their best interest to manage and drive the company. Our selection criteria is also very important. Of course we try to pick people who know what they are doing. We are typically giving people about $5 million and in very rare cases will give them over $10 million. So our aim is to get in early, provide them services, and grow with the company and share the benefits of the upside of the intellectual property.
As part of our selection criteria we also try to pick companies that have a foreseeable future. We think they ought to have a first milestone in approximately three years. That is typically how long people take in drug discovery to reach the PCC stage. Then in five to six years, based on the observations of our clients, the successful ones are usually either acquired or are listed on the stock exchange. We exit partially at the first PCC milestone and let other venture capital investors pick that up. It is not that we are giving up hope at this stage, but our business model demands that we realize a return and then are able to turn around and support more companies. This allows us to scale that up. Last year we invested in about 15 companies, this year will be around 25, and an additional 35 in 2020.
Laboratory in Viva Biotech’s headquarters in the Zhangjiang Hi-Tech Park area of Shanghai.
CHNA ETF: How do you try to maximize success?
Dr. Mao: I think this is an advantage of our business model. On the one hand, we have a stable cash flow from the CFS model. On the other, we design our exits early in the EFS side, and try to avoid the risk of the clinical trial stage entirely, which is where the highest failure rate is in drug development. Also, I think we have designed a good strategy that we call early failure strategy. We are ok with cutting our losses early or pivoting if things are not pointed in the right direction. With our participation on the service side, we get a clear view into what is going on. We also try to come up with terminate experiments earlier. With those techniques, and also the experience of the inventors of many drugs on the market who are working with us, we try to lower risk and maximize success.
CHNA ETF: You mentioned that your next sale point would be at phase two when a company might either be ready to be sold or listed on the stock exchange. What would happen then?
Dr. Mao: If an asset is being acquired, usually it is entirely being acquired so that would be a forced exit. If a company is lucky enough to be listed on the stock exchange, we can then sell.
CHNA ETF: Do you have examples of success?
Dr. Mao: Yes, last year we reported four exits. I mentioned that the first exit opportunities usually arise at the PCC stage when venture capital firms want to buy some shares from us. That happened in three of those cases. In the other case the company was entirely acquired by a large pharmaceutical company. In all four of the cases we had a return on investment of over 200%.
CHNA ETF: Viva Biotech listed on the Hong Kong Stock Exchange earlier this year. Especially with biotech being new there, how do you help investors try to value Viva?
Mr. Hua: This is a good question. As Dr. Mao explained, we have two engines. One is CFS and then there is the EFS model. There are in the markets several CRO companies listed already so we can have some comparisons with them for the valuation of the CFS part. For the equity for service model part, there are not any exact same comparable in the market. So, yes, for investors there is a learning curve about how to value this part of the business. We need to gradually educate investors about how we are performing with this EFS model and how we are going to grow and how much value there is in it. With the rapid growth of the number of biotech company projects we incubate, this becomes a larger component of our company’s value. We are patient. In the next couple of years, we aim to convince investors that we will grow and deliver a good return on these projects. Last year we exited four projects with an internal rate of return over 100% and we hope to continue to deliver.
CHNA ETF: Is this all self-sustainable? Is the revenue from the CFS business enough to cover the expenses of the venture-investing arm or will you need to raise more cash from the equity markets one day?
Mr. Hua: I think Dr. Mao has been managing the cash flow very well since the beginning of the business. For the initial projects on the equity for service side, that was all funded by the operations cash flow from the CFS business. Starting from last year with the four exits, the cash flow from the EFS model became positive and we think that it will not draw much capital in the future.
Dr. Mao: Today local investors are starting to see life sciences and gain more experience as biotech companies are listing in the region. We have to demonstrate our success. When people see companies list in Hong Kong or on the STAR Board in the future that are of our making, they will understand. I think this will take some time. Secondly, our model is technology focused and that is why our gross margins are among the top of the industry. We can use the profits from CFS to support our many biotech projects.
CHNA ETF: Viva does roadshows in the United States and elsewhere and meet with international investors. For outside investors who are still trying to learn about your company and the biotech scene here in China, what do you say to them? What feedback do you give international investors about what is going on here?
Dr. Mao: First, We have seen the emergence of a big biotech industry in China. Second, the efficiency of the CRO industry in China has been a story in the making of 20 years. It is a quite sophisticated system with a highest efficiency in the world. Thirdly, I think since the international investors we meet with are already sophisticated biotech investors and since many of the companies we are starting are based in places like Boston, they know the founders and they know the value better than many others.
Mr. Hua: Globally the CRO industry has been growing rapidly and China is doubling the speed. I think we are well positioned as a company both in the service sector as well as with the incubation model.
Thank you for your interest in the China BioPharma ETF. Please be sure sign up for email alerts below if you would like to receive notification of other news, company interviews, and research that we publish from time to time.
Opinions expressed are those of the author, interviewee, or Funds and are subject to change, are not intended to be a forecast of future events, a guarantee of future results, nor investment advice. Cash flow is the net amount of cash and cash-equivalents being transferred into and out of a business. Fund holdings and allocations are subject to change at any time and should not be considered a recommendation to buy or sell any security.