The scandal over the biggest-known bribe to get your kid into college appears to have metastasized into a broad-based investigation of the Chinese pharmaceutical industry. Three multinationals are affected as the Chinese authorities search for dirt on kickbacks over drug sales.
The chairman of Chinese traditional medicine maker Shandong Buchang Pharmaceutical SH:603858, Zhao Tao, allegedly paid US$6.5 million to get his daughter, Molly Zhao, into Stanford University. While those revelations came to light amid a college-admissions scandal surrounding college "consultant" Rick Singer, Chinese regulators have now said they are launching a nationwide audit of drug companies in China.
In all, 77 drug makers are now having their financial statements poured over by China's National Healthcare Security Administration and the Ministry of Finance. The authorities this week said they would investigate rebates for sales expenses at the companies, which they say were selected at random.
The Chinese arms of Sanofi (SNY) Eli Lilly (LLY) and Bristol-Myers Squibb (BMY) are on the list of 77 companies. So too is Buchang Pharmaceutical, which has seen its share price fall 25.1% since April 30 amid the college-admissions scandal.
The list of 77 also includes several other drug companies listed in Hong Kong and easily accessible to overseas investors. Shanghai Fosun Pharmaceutical HK:2196, (SFOSF) a unit of one of China's largest conglomerates, is also under audit.
The brokerage firm Nomura ties the investigation to public concerns about whether drug companies have been mis-reporting expenses for non-operational purposes.
"This doubt mainly arises from news reports regarding the Buchang Pharma scandal," Nomura China pharmaceutical analyst Stella Xing says in a report.
You don't always get the full explanation behind official action in China. Policy is often set unofficially, with companies finding out through hit and miss what they can do. Crackdowns can happen with no public announcement they are under way.
So, it may be that Chinese officials have moved after the great attention paid to the Stanford scandal. That's even though Zhao, the drug company chairman, issued a statement that any issues surrounding his daughter's university admission were a private matter.
"I'm the actual controller of Buchang Pharma, and I hereby state that my daughter studying in the United States is only a private action of my family, and the funding has no relation with Buchang Pharma," he said, according to a translation from the Epoch Times newspaper.
Zhao is worth US$4.6 billion, according to the 2018 Hurun Rich List of the richest people in China. He was photographed separately with both Chinese President Xi Jinping and with U.S. President Donald Trump in 2017, the year his daughter started at Stanford. That may not matter much to Trump but does not look good in Communist China under Xi's harsh crackdown on the "tigers and flies" among Chinese officialdom who engage in corruption.
Buchang Pharma, founded by Zhao's father, Zhao Buchang, has a checkered history when it comes to bribery. Zheng Xiaoyou, the former director of China's Food and Drug Administration, was executed in July 2007 after confessing to receiving bribes from eight drug companies, including Buchang Pharma. The Epoch Times has also uncovered at least five instances between 2015 and 2018 when it says sales representatives of Buchang Pharma bribed doctors or hospital presidents to sell its medicines.
There are other explanations for the crackdown on drugmakers, which should also concern investors.
Another maker of traditional Chinese medicines, Kangmei Pharmaceutical SH:600518, has also been probed directly by regulators recently. It said in April that it had overstated its cash holdings by as much as 29.9 billion yuan (US$4.3 billion).
China's stock watchdog, the China Securities Regulatory Commission, said Kangmei inflated cash deposits and income in its financial reports. The CSRC also said the company used related parties to manipulate the trading of its own shares.
In 2014, China fined GlaxoSmithKline (GSK) a record 3 billion yuan (US$489 million at the time) for bribing doctors to use its drugs. That caused great handwringing among overseas drug companies doing business in China. Some doctors say "gray revenues" of under-the-table payments are commonplace.
Novartis (NVS) paid a US$25 million fine to the U.S. government in 2016 to settle Foreign Corrupt Practices Act charges that its China-based subsidiaries paid to get their drugs prescribed.
China is also on a long-term push to drive down the cost of generic drugs. Nomura says the main outcome of the new investigation into the 77 companies may be that authorities will make use of the findings to push for further reductions in prices.
China's State Council issued a policy document outlining the path of health-care reform on June 4. It stated that the government would push through a second round of Group Purchase Organization price cuts by September.
That would put further pressure on margins for the makers of generic drugs. Investors should therefore be wary of those shares.
The other Hong Kong-listed companies on the investigation list are Hansoh Pharmaceutical Group HK:3692, the CSPC Zhongnuo Pharmaceutical subsidiary of CSPC HK:1093, Shanghai Pharmaceuticals Holding HK:2607 (SHPMY) , and a subsidiary of Sinopharm Holding HK:1099.
