Zai Lab Limited

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Zai Lab Limited is a biopharmaceutical company focused on discovering, developing, and commercializing innovative therapies for oncology, autoimmune, infectious diseases, and other conditions primarily in China and across the world.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Zai Lab operates in the highly regulated and competitive pharmaceutical industry, which makes moat analysis challenging. The company’s focus on innovation and regulatory pathways provides both opportunities and risks.

Business Overview:

  • Revenue Distribution: Zai Lab’s revenue is generated primarily from product sales in China, with increasing exposure to international markets. They have partnered with both global pharmaceutical companies as well as with Chinese biotechs. Their income comprises product revenue (sales of their marketed drugs) and collaboration revenue (milestones, royalties, etc) with other companies they partner with for licensing and sales agreements. In Q1 2024, the share of revenue derived from domestic products was 90%, and from partnered products was 10%, primarily from licensing revenue. Historically, the bulk of their revenue comes from ZEJULA, with a big chunk now coming from QINLOCK as well.

Geographically, almost 80% of revenue comes from mainland China, 17% from Hong Kong, and a small percentage from other geographies. As of June 2023, 98% of their sales were in China and Hong Kong.

  • Industry Trends: The biopharmaceutical industry in China is experiencing rapid growth fueled by an aging population, rising income levels, and increased healthcare spending. However, intense competition from both international and domestic companies puts pressure on pricing and market share. The regulatory environment in China is evolving, emphasizing innovation and quality. This trend creates both opportunities and difficulties for international companies operating in the Chinese market.

  • Margins: Zai Lab has gross margins of roughly 80%. However, it is investing heavily into its R&D which leaves it unprofitable.

  • Competitive Landscape: The competitive landscape for Zai Lab is intense, particularly in the oncology area. The company competes with large multinational pharmaceutical companies as well as with smaller, more nimble biotech firms. The company has chosen to pursue some drugs that have had success in other geographies and are now focusing on getting those drugs commercialized and approved in China.

  • What Makes the Company Different? Zai Lab positions itself as a bridge, bringing innovative products to China and also commercializing novel Chinese medicines in other parts of the world. The approach creates value through strategic licensing and commercialization partnerships with both domestic and international companies and is a value driver that other companies are not targeting. The company has also shown a willingness to take more risk and partner with smaller, more innovative biotechs. They have also indicated an ability to manage the Chinese regulatory environment and move drugs through the process relatively fast.

Financials:

  • Income Statement: Zai Lab has been growing revenues at a rapid pace, although its profitability remains elusive with sizable net losses. Expenses related to research and development, selling, general and administrative activities are relatively high. Zai Lab’s strategy involves an upfront investment in growth and product commercialization, leading to negative income, but also creating a possibility of high growth in the future. The company has been experiencing losses from operation and they have been reinvesting that into the business. The company expects to reach profitability from 2027, however the timing of profitability has been pushed back repeatedly, and is contingent on the success of their product pipeline. Their revenue has increased in recent times as their drugs like ZEJULA has seen growth, which has enabled a strong growth in their operational performance.

  • Balance Sheet Health: Zai Lab’s balance sheet is healthy, having 1.3B dollars in cash and equivalents, this can sustain their operations for the foreseeable future. They have good level of liquidity and a high amount of intangible assets from past collaborations and acquisitions. However, their debt remains low at around $300 million which isn’t a concern for now. The company is funded primarily via equity and thus does not face the risk of high leverage. Debt does increase the risk of bankruptcy, however it can also boost return on equity.

  • Recent Concerns / Controversies:

    • Recent earnings reports have detailed that Zai Lab is expecting to slow down on the hiring front and focus more on internal productivity.
    • Zai Lab has also reduced some of its pipeline, including R&D programs for some drugs, because some are facing headwinds and are unlikely to have approval at this point in time.
    • The company has been facing increased competition in China, particularly in cancer treatment, forcing them to lower prices.
    • Zai Lab has been trying to reduce its spending, however they are still investing very large amounts into clinical trials.
    • Zai Lab also recently announced a partnership with a company called BMS to explore the use of certain novel drugs in new indications, such as autoimmune diseases.
    • Their management also indicates that they need to focus on execution and delivering, as they had been too optimistic about the timelines for new drug commercialization.

The management expects a turnaround by 2027, and expects to achieve sustainable profits at that point in time. They are highly focused on improving margins and reducing expenses.

Moat Rating: 2 / 5

  • Justification: Zai Lab’s moat is relatively narrow given the strong competition in China and the pharmaceutical industry in general. Their main moat is their partnership structure with a lot of external partners, which could translate into higher returns in the future. Zai Lab’s strong foothold and expertise in the Chinese regulatory landscape gives them some moat, but not to the degree of a wide moat. Also, they operate in a highly regulated industry and are exposed to strong competition from other biotech and pharmaceutical companies, and thus they are still at the whims of the external players. Zai Lab also uses a capital-intensive model which means it is prone to being affected by sudden changes in capital markets.

Risks that Could Harm the Moat and Business Resilience:

  • Regulatory Changes: The pharmaceutical industry in China is heavily regulated, and changes in regulations or pricing policies could significantly impact Zai Lab’s profitability.
  • Competition: Intensifying competition from both domestic and international pharmaceutical companies could erode Zai Lab’s market share and pricing power.
  • Clinical Trial Risks: Drug development is inherently risky, with clinical trial failures or delays potentially derailing the company’s pipeline and business model.
  • Partner Risk: Zai Lab depends heavily on its collaborative and licensing agreements. If a key partner decides to stop any particular program for any reason that would cause a dent in their revenue and valuation.
  • Intellectual Property Protection: While patents are an asset, other companies are frequently able to copy products around patents. A failure to successfully protect and enforce intellectual property rights could erode Zai Lab’s competitive position.
  • Macroeconomic factors and currency fluctuations in China might have a disproportionate effect on the business. Zai Lab is dependent on the Chinese currency and any downturn in that currency will adversely impact their profits.

Understandability: 3 / 5

  • Justification: While the concept of bringing innovative medicine to market is easily understood, the science and financials behind biopharmaceutical companies can be complex and thus require some specialized understanding. This coupled with the complicated regulatory environment in China makes the understanding more challenging. Thus, a rating of 3 out of 5 is most suitable.

Balance Sheet Health: 4 / 5

  • Justification: Zai Lab has a large amount of cash and low debt, providing financial flexibility. While it is loss-making, it is expected to improve its bottom line in the coming years and thus it has a good balance sheet. The only reason for the slightly lower rating of 4 is its lack of profitability and negative free cash flows.