“Hai Gui: Pharmaceutical Millions from Sea Turtles?”

By Travis Johnson, Stock Gumshoe, December 11, 2007

Don’t worry, this is not about turtle soup, or about chopping up leatherbacks and making acne cream out of them … this is about a whole different kind of sea turtle.

The “Hai Gui” or “sea turtles” of China are the returning scientists and businessmen that are driving, in part, the resurgence of the Chinese economy. These are the students who were sent abroad (adrift on the waves, like baby sea turtles — get it?) in the 1980s and 1990s, sent to European and American universities to get advanced degrees and business experience and exposure to capitalist systems, and now, as adult sea turtles, they’re coming back to lay their eggs in their homeland.

Or that’s the romantic version of the story, at least. I’ve seen these “sea turtles” referred to in a teaser before, Robert Hsu talked about them one of the many times that he teased New Oriental Education shares (which have certainly been worth buying in the long run this year — though his short term calls on the shares weren’t always right).

New Oriental Education was more of a play on creating new Sea Turtles — and about people wanting their kids to get English lessons so they can get into overseas universities. This Hai Gui teaser is the back side of that, the old sea turtles coming back.

And in this particular case, the sea turtles of import are the biologists and geneticists and scientists that are coming back to start up various contracting companies in pharmaceutical research and clinical trial management.

Apparently, according to the folks at Stansberry’s Phase I Investor ($5,000 a year, if I remember correctly), these folks are being wooed right and left by the Chinese government, because the government wants to build up high tech industries that create their own value, or that add intellectual development. They want to move up the product development cycle a few steps, essentially, getting their hands into research and design to develop businesses that rely less on outsourced contract manufacturing from Japanese and Western companies.

So, Rob Fannon and the Phase I Investor folks think that there’s potential for 550% returns in 18 months from the work of these Hai Gui — he says it’s the “one China opportunity that’s still new–and cheap.”

He gives several examples of these government-encouraged companies in the sciences, particularly in medical areas — including Mindray Medical, the medical equipment company that I know a lot of newsletters have recommended (though I’ve never seen them “tease” it in an ad, so I haven’t written about it), and a few other high tech companies that have been tremendous performers. No mention of the companies that haven’t performed well, of course, though I assume that even in a hot area like Chinese biotech there must be a few that have found ways to collapse.

And going beyond this, the tease is that some of these companies can get the returns of biotech without the risk of drug development (ie, they won’t collapse if a drug fails to get FDA approval). These kinds of companies are Contract Research Organizations, CRO’s, and there are certainly quite a few of them, in China and elsewhere.

So, the argument goes, these CROs should make money hand over fist because scientists are paid much less in China (and, in some cases at least, have somewhat comparable educational backgrounds), and because the government is supporting these companies through tax subsidies and/or direct investment.

And we can add in, though this part is largely unspoken, that it’s probably much easier to do human testing in third world countries and many of the big pharmaceutical companies run many clinical trials in Africa, Asia, anywhere there are poor sick people and friendly governments … so why not have the contractor do this reasearch in those countries, too? (that last part is clearly my surmising and connecting the dots, it’s not coming from these companies or from the Stansberry ad).

So what are the specific companies that will be covered in this analyst report? (The report won’t be released until December 27, by the way, so we’ve got some time to complete our research if we’re interested.)

Well, they sound pretty compelling in the ad, of course:

with the backing and incentives of the Chinese government, they can make investors an absolute fortune. These companies will dominate this industry for years and years to come-but right now, not 1 in 1,000 investors has heard of them.”

And then the good stuff …

“But there’s one CRO business with operations in China that offers you the opportunity to make more money than any of the others, by far.”

So what is that one? We want the best one, right? No also-rans for the Gumshoe faithful!

Well, I can’t say that this is one I can definitely pick out for you. There are a lot of potential ones, and many of them are probably appealing investments in some ways.

In truth, there are at least hundreds of these companies — from the smallest basic chemistry outsourcing firms with a few scientists, often started up after those scientists were downsized by big pharma (as is happening with Pfizer in Michigan right now … poor Michiganders can’t catch a break), to the big international firms that essentially do the discover, testing, and FDA management, practically everything but brand and market the drug. There are a wealth of these feeder fish eating off the massive cash piles of big pharma — and remember, even in these days when some of the big pharmaceutical companies are suffering on the stock market, even a company like Pfizer that nobody much likes has well over $20 billion in cash.

And this big wave of Chinese effort in basic science and in pharmaceutical research is certainly real, as is the government support for the efforts of all these “Hai Gui” — the teaser mentions an 863 program (1986, third month, so it’s not exactly new), and if you read Chinese you can check out the page that explains the program here.

OK, just kidding — the Gumshoe may be all knowing and all seeing, but he doesn’t read Chinese. Here’s the English version.

So the Chinese CROs are one possible investment — I guess maybe they’ll be the next flavor of the month, after the hugely successful Indian pharmaceutical companies of the last ten years or so that started out copying Western drugs, creating generics, or outsourcing production and are now developing their own medicines.

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In the ad’s words: “What’s nice for investors is that these CROs are low-risk, high profit margin businesses… they get paid for every test they run, whether it passes or fails.”

And they mention many relevant companies along the way in the ad, including larger ones like Covance and Parexel (both of which have operations or partnerships in China) and some newer china based firms like WuXi Pharmatech.

A few are lightly teased — like the one that won Frost & Sullivan’s “Asian Growth Strategy of the Year” last year, which is Excel PharmaStudies, which doesn’t appear to be publicly traded.

And another has been on one of those Top-50 “Fastest Growing Businesses in China” for three years in a row and was a subject of a recent Harvard Business School case study. That sounds like it’s got to be WuXi (WX).

But the favorite one of Rob Fannon, I’m afraid, is something I won’t be able to share with you yet — at least, not until they test a few other versions of this teaser and add in a few specifics. I’m not aware of any of the US-listed Chinese CROs that meet the one fairly specific clue given, that they “essentially double profits every year,” and since this is Phase 1 Investor, a publication that enjoys finding stocks that trade on overseas exchanges or are otherwise similarly obscure for American investors (though they generally trade on the pink sheets, at least), I’m afraid the Gumshoe has to lay down his keyboard on this one — if you’ve got an idea for a CRO that’s growing quickly in China, has a good position, and has recently doubled profits for a few years in a row, feel free to share.

There’s been a little bit of a discussion of this over at the forum, though no firm solutions there, either, so you might want to check that out as well (you’ll hear some cautionary words about Chinese CROs, for the most part).

So … sorry the Gumshoe’s unable to solve this one for you today — this is the first one in quite some time that’s got me stumped … we’ll get back on the horse and try again tomorrow. Happy investing, everyone!



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December 19, 2007 4:48 pm

Hi, just a note about the term “Hai Gui” This is actually a pun in Chinese. Hai means ocean/sea. Gui can mean either 1. to return 2. turtle. So “hai gui” written one way means “someone who has returned from overseas” and then “hai gui” written a second way, pronounced the same way, means “sea turtle.” eventually people started using the latter to refer to the former as slang (i.e. using the word “turtle” wrongly on purpose).
I am in China now and very bullish on hai gui-started companies.

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