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Simcere Pharmaceutical Group (NYSE: SCR) reported that a recent acquisition, Jiangsu Yanshen Biological Technology, committed fraud with respect to its human-use rabies vaccine. Simcere bought a controlling interest in Jiangsu Yanshen in October 2009 and shut down its operations just one month later. As soon as Simcere found out about the problem, it urged Jiangsu Yanshen’s board to cease operations and review the company’s quality control. It has complied with the official investigation into the situation.

Although the offense took place in 2008, a year before Simcere closed its acquisition of a controlling stake in Jiangsu Yanshen, the fallout from the scandal could nevertheless have a material effect on Simcere’s finances. Simcere said it will seek “all legal remedies” from the selling shareholders of Jiangsu Yanshen.

According to an SFDA investigation, four batches of Jiangsu Yanshen’s rabies vaccine, produced between July and October 2008, did not have sufficient amounts of active ingredient. The SFDA further found that Jiangsu Yanshen did not have adequate quality control in place, and compounded the problem through misrepresentation and avoiding regulatory inspection.

Employees who have been deemed responsible for the problem are under criminal investigation, and Jiangsu Yanshen’s operations remain suspended.

There have not been any adverse effects reported so far from the ineffective vaccine that was sold.

To date, Simcere has not predicted how the scandal will affect its own financial results, though Jiangsu Yanshen will be liable to administrative penalties and criminal prosecutions. No date has been set for resuming its operations, and its viability as an ongoing business remains in doubt.

Simcere announced in May 2009 that it would pay 195.5 million RMB ($28.8 million) for a 37.5% stake in Jiangsu Yanshen (see story). The purchase closed five months later. Jiangsu Yanshen's two major products were an influenza vaccine and a rabies vaccine (vero cell) for humans, with a second and a fourth largest market share in China respectively.

Last month, Simcere reported its full-year 2009 revenues rose a modest 6% to $271 million. Net income fell 66% to $17.5 million. The company attributed the decline in net income to greater spending on advertising and R&D.

Disclosure: none.

Source: Operations of Simcere's Latest Acquisition Remain Shut Down