China Gives U.S.-Based Drug Distributor a Headache

American drug distributor Cardinal Health Inc. is backing away from China, or at least the country’s drug distribution industry — a sector that some insiders see as having little room for foreign players for now.

“We are exploring strategic alternatives for our service and distribution business in China,” CEO George Barrett said during an earnings call on Wednesday.

A deal for Cardinal’s drug distribution business in China, which has garnered interest from state-backed Chinese pharmaceutical firms, may be worth up to $1.5 billion, Reuters reported.

A Cardinal spokesperson told Caixin that the company has no comment on market rumors at present and will announce an update about the sale in a few months.

Barrett said the funds it secured from the potential sale “could be more effectively deployed in other parts of our portfolio.”

The company is considering sending the proceeds back to the U.S. or using them to buy back stock, Chief Financial Officer Michael Kaufmann said.

Cardinal, the U.S.’ third-largest drug distributor by revenue, entered China in 2011 after it bought peer Zuellig Pharma China, known locally as Yong Yu, which had sales channels in more than 300 cities in China. In 2013, it expanded its presence in the country by buying Guangzhou-based pharmacy chain Baiji.

In China, Cardinal is the eighth-largest drug distributor by revenue. “It has been focusing on distribution, but didn’t expand its value-added services — which is its core competency — to hospitals and pharmacies,” said Shi Lichen, founder of pharmaceutical consultancy MSKL.

In addition to drug distribution, Cardinal also helps pharmacies, hospitals and clinical laboratories reduce costs, enhance efficiency and improve quality, but the government-backed health care system has made it hard for this business to take off.

China’s drug distribution industry is dominated by the big three: China National Pharmaceutical Group Corp. (Sinopharm), Shanghai Pharmaceuticals Holding Co. Ltd. (Shanghai Pharma), and China Resources Group. Smaller local companies rely on their tangled relationships with local health care institutions, according to a report by consultancy Strategy& under PricewaterhouseCoopers.

The state of China’s drug distribution industry is a legacy of the planned-economy era, when it was entirely run by the state. Consequently, the industry’s biggest players are government-backed with strong ties to the local public health care system, said Simon Sun, a partner and specialist in China’s health care and life science industry from Strategy&.

Sun said that the industry remains “fragmented,” with each occupying part of the country, so all the distributors are trying to expand through mergers and acquisitions (M&As). For example, Hong Kong-based China Resources entered the northern market after it bought Beijing Pharmaceutical Group in 2010.

For now, foreign rivals would find it hard to expand through M&As as the smaller ones prefer more-resourceful Chinese drug distributors as parent companies; but when the buying spree eventually ends, foreign companies will stand out with more-efficient management and services, Sun said.

Cardinal said in July that it will continue to provide medical devices for diagnostics and interventional procedures to treat patients suffering from coronary and peripheral vascular diseases in China.

Kaufmann forecast Cardinal Health China’s revenue would top $4 billion during the 2018 fiscal year.

Shares of New York-listed Cardinal shed 8.2% to $70.99 on Wednesday.

Contact reporter Coco Feng (renkefeng@caixin.com)