Recruiting in China

Foxconn, the electronics contract manufacturing firm that supplies products to Apple Inc. (NASDAQ: AAPL) and many other companies, is facing yet another controversy over its labor practices.

The Taiwan-based company has recently admitted to violating its own rules by employing student interns for overtime and night shifts at their factories.

Students from a university in Yantai, located in the northern coastal province of Shandong, have come forward to Chinese media claiming that more than a thousand of their classmates have been working illegal overtime hours at a nearby Foxconn factory helping in the production and packaging of the soon-to-be debuted Sony (NYSE: SNE) PlayStation 4 gaming console. Sony has confirmed that Foxconn is manufacturing the PlayStation 4, but did not confirm if they were made at the Yantai location.

“There have been a few instances where our polices pertaining to overtime and night shift work were not enforced,” Foxconn said in a statement. “Immediate actions have not been taken to bring that campus into full compliance with our code and policies.”

The students were essentially forced to work at the factory in order to fulfill their credit requirements to graduate. According to a report by Hong Kong’s Oriental Daily newspaper, the class of engineering students at the Xi’an Institute of Technology was told that participation in the internship at Foxconn was “necessary” if they wanted to receive six credits that would make them eligible to graduate on time. Foxconn said that the company has internship programs set up in various locations in China, but insisted that the experience is intended to give students an “opportunity to gain practical work experience and on-the-job training that will support their efforts to find employment following their graduation.” According to Quartz, the “internships” included performing such tasks as gluing parts together, applying stickers and boxing up accessories, earning students the same wage as entry-level employees.

Foxconn has a long and troubling history of labor woes. Just last year, the same factory that the university students have come forward about admitted to temporarily hiring under-age interns, some of whom were as young as 14 years old.

In 2010 Foxconn was under investigation after a string of factory-worker suicides (largely due to overwork and poor working conditions) drew attention from labor rights activists and the global media.

The latest allegations came just days after Foxconn CEO Terry Gou made a statement about the lack of young people interested in factory jobs. Talking to a delegation at the Asia-Pacific Economic Cooperation (APEC) Forum in Bali, Indonesia, Gou lamented on how China’s young workers were no longer lining up to work on an assembly line and instead were more interested in finding jobs in the technology or service sectors.

Newly released official data about pay rises in the 2007-2011 period has stirred online debate over the figures’ accuracy, with many believing the increases are not remarkable enough considering inflation and surging housing prices.

The Chinese Academy of Personnel Science on Thursday published a report on the development of human resources in China, showing that the average annual salary of urban employees increased from 24,721 yuan (US$4,022) in 2007 to 41,799 yuan in 2011, up 69.1 percent.

In 2012, the average yearly salary for urban employees in non-private sectors stood at 46,769 yuan, up 9 percent year on year after deducting price factors, according to the report.

The news triggered heated discussion soon after appearing on popular Chinese websites — most netizens questioned the figures in the context of their own lower salaries and deemed the data useless amid surging expenditure.

“I feel ashamed that my salary is again below the average level” was a common comment on Sina Weibo, one of China’s most popular Twitter-like services.

Microblogger “joys” said: “After carefully rechecking my paychecks, I am sure that I was ‘averaged’ with other rich workers.”

In fact, many indicated the high salaries only belong to civil servants and employees at state-owned enterprises and monopolies.

Meanwhile, the debate turned against the relatively larger growth in prices, especially in the real estate businesses.

According to the National Bureau of Statistics, China’s consumer price index, the main gauge of inflation, increased 2.6 percent year on year in August, a slight decline from 2.7 percent in July.

The CPI rose 2.6 percent year on year by the end of 2012, but it was a rise of 5.4 percent in 2011 from the previous year, well above the government’s full-year inflation control target of 4 percent.

On the other hand, driven by rapid urbanization and speculation, China’s property market has taken off in recent years, especially after the economic stimulus policies the government unveiled in 2009 to help the country weather the global financial crisis.

The China Index Academy, a leading property research institution, said the average new home price among 100 cities stood at 10,554 yuan per square meter in September, up 1.07 percent from August and an increase for a 16th consecutive month.

Taiwanese electronics giant Foxconn, which assembles products for companies such as Apple, Sony and Nokia, admitted Friday that student interns had worked night shifts and overtime at one of its plants in China in breach of its owns labor rules.

The embarrassing admission came after Chinese media reported last year that students from a university in the central city of Xian were allegedly forced to join Foxconn’s internship program at its Yantai plant in the eastern province of Shandong.

Instead of doing work related to their major, the information engineering students claimed they were assigned to assembly lines to make Sony’s PlayStation game consoles and were forced to toil for up to 11 hours a day.

More from GlobalPost: Foxconn to open American factories?

They were allegedly told they wouldn't graduate if they quit.

"Regarding the internship program at our Yantai campus, we have determined that there have been a few instances where our policy pertaining to overtime and night shift work were not enforced," the company said Friday.

"Our priority is to protect the rights of all workers and interns, and we will continue to monitor the program closely to ensure that such infractions are not repeated.”

Foxconn, which has been under the spotlight after a series of suicides and labor unrest at its Chinese plants in recent years, previously admitted employing underage interns at the Yantai factory.

Merck (NYSE:MRK) has announced that it will cut its workforce by 20% over the next two years, which could result in the loss of close to 16,000 jobs. This will leave the company with less than 65,000 employees which is in stark contrast to its peak strength of close to 100,000 employees following its acquisition of Schering-Plough in 2009. [1] With this restructuring, Merck intends to save $2.5 billion annually which can boost its free cash flows by almost 20%. However, the impact will be mitigated by the expected restructuring costs of roughly $2.5 billion to $3 billion. [1]

The company’s move highlights the broader problems that Merck and other big pharmaceutical firms are facing today. The R&D (research and development) productivity has declined over the years, and the strategy of developing drugs for major diseases is not working. The landscape of the global pharmaceutical industry is shifting towards more niche, innovative and genetically targeted medicines. In addition, Merck is suffering from the loss of patent exclusivity for some of its major drugs and may look for acquisition of some promising medicines to offset the failure of some of its research projects.

What Is The Problem That Merck Is Facing?

Like other major pharmaceutical companies, Merck is also battling the impact of patent expiry of its several major drugs including Singulair, Propecia, Clarinex, Maxalt, Cozaar and Hyzaar. Out of these, asthma drug Singulair has had the biggest impact and has continually weighed on Merck’s growth for the past few quarters. Worldwide sales of Singulair, a once-a-day oral medicine for chronic treatment of asthma and relief of symptoms of allergic rhinitis, stood at $5.5 billion for 2011. However, this figure declined to $3.85 billion in 2012 following its patent expiry in August same year. Merck expects that within two years following the patent expiration it will lose substantially all U.S. sales of Singulair, with most of those declines coming in the first year.

In addition, Merck’s cardiovascular division has also been hurt by the patent cliff as its drugs Cozaar/Hyzaar, which garnered over $2 billion in revenue in 2010, lost patent exclusivity in large markets including the U.S. and Europe in late 2010. As a result, sales fell by roughly 35% to $1.3 billion in 2012. Additionally, Propecia, Clarinex and Maxalt together accounted for roughly $1.5 billion in revenues in 2012. Due to patent expiries, we expect their combined sales to go down to about $1-1.1 billion in 2013.

While the big drugs are losing their sales, there is little chance for new blockbusters replacing them. The R&D productivity has significantly declined over the last decade. Although the industry’s R&D spend has increased, the number of new drugs approved by the FDA has come down. In fact, Merck is planning to terminate certain drugs in late stage development and intends to focus on acquiring experimental drugs.

What Is Merck Likely To Focus On?

There has to be a shift from developing blockbusters treating major diseases to focusing on niche therapeutic areas where although the patient population is low, pricing is quite high due to high specificity and efficacy. Major therapeutic areas are getting flooded with generics and there haven’t been any major advancements to thwart the competition. Merck has mentioned that it plans to continue investing in vaccines and diabetes, where it already has successful products.

Diabetes

Merck’s type 2 diabetes treatment drugs Januvia and Janumet saw strong volume growth in international markets and retained their market leadership with 70% share in the second quarter. [2] Excluding the impact of currency movement, Januvia saw its sales jump by 7% while Janumet’s revenues surged 17%. [3] In addition, the company is working with Pfizer to develop and commercialize its investigational SGLT2 inhibitor, Ertugliflozin, for the treatment of type 2 diabetes. With obesity on the rise, diabetes is affecting more people globally. In the U.S. alone, roughly 26 million people suffer from the condition. [4] China’s problem is even worse, as a report suggests that 11.6% of Chinese adults have diabetes and around 40% of adults between the age of 18 and 29 are on the verge of developing it. [5] That puts China’s diabetes patient count at 114 million individuals, and this figure is likely to go higher. According to IMS health, China’s diabetes market is expected to grow 20% annually and reach $3.2 billion by 2016. [6]

We currently account Januvia’s revenues under Alimentary & Metabolism drugs division, which constitutes roughly 15% to our price estimate for Merck. Januvia’s importance can be gauged from the fact that the exclusion of the drug’s sales from Merck’s revenue forecast leads to downside of about 5-10% to our price estimate. That’s a lot of value for a single drug in a diversified company like Merck.

Acquisition Strategy

It appears that Merck will trim down its R&D expenses, and instead focus on acquiring drugs externally. This way, the company will assume the role of pharmaceutical private equity/venture capitalist firm to a certain degree. In addition, we believe that it can pursue orphan drugs, and novel therapies including higher focus on gene therapy, stem cell research etc.

Cancer Treatment

Cancer treatment is a growing market for the pharmaceutical industry. The opportunity comes from the fact that global incidence of Cancer is likely to increase from about 12.7 million in 2008 to 21.3 million in 2030. [7] In addition, the number of deaths are likely to show a similar growth trajectory as depicted in the chart below. Cancer is a not a single disease, it has in fact more than 200 types and thousands of subtypes affecting more than 60 organs. That gives an opportunity for Merck to develop novel therapies and capture niche markets.

Our price estimate for Merck stands at $51.60, implying a premium of about 5-10% to the market price.

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Notes:
Merck to Cut Staff by 20% as Big Pharma Trims R&D, The Wall Street Journal, Oct 22013 [?] [?]
Merck’s Q2 2013 Earnings Transcript [?]
ref:1 [?]
National Diabetes Fact Sheet, 2011, CDC [?]
China ‘Catastrophe’ Hits 114 Million as Diabetes Spreads, Bloomberg, Sept 4 2013 [?]
China Diabetes Triples Creating $3.2 Billion Drug Market, Bloomberg, Nov 5 2012 [?]
J&J’s Investor Presentation [?]

Electronics manufacturer Foxconn, which became notorious after a string of workers’ suicides in 2010, has admitted that student interns worked overtime and night shifts at a factory in northeast China in violation of company policy.

Students told Chinese media that more than a thousand of their classmates worked on basic tasks such as putting together and packaging parts for Sony’s forthcoming PlayStation 4 consoles. The college programme at the factory in Yantai, Shandong province, was a graduation requirement, they said.

The admission is a blow to the Taiwanese company most famous for assembling Apple products, and comes in the same week as Terry Gou, its founder and chairman lamented that young Chinese are shunning monotonous, low-paid assembly line jobs.

The same factory last year admitted to having temporarily hired underage interns.

“There have been a few instances where our policies pertaining to overtime and night shift work were not enforced. Immediate actions have been taken to bring that campus into full compliance with our code and policies,” said Foxconn in a statement.

Foxconn have not confirmed or denied that they make the PlayStation 4 at Yantai. Last year, it said the factory did not produce Apple products. Sony confirmed that Foxconn is assembling the PlayStation 4, but did not specify at which factory.

The Taiwanese company, listed in Taipei under the name Hon Hai Precision Industries, last year found that students as young as 14 had been working at the Yantai campus for a few weeks. It pledged at the time to investigate how workers younger than the minimum age of 16 came to be working at the plant.

Foxconn and other contract manufacturers regularly employ students as temporary workers to give the students a chance to gain skills. The programmes are sometimes criticised by labour activists, who say the students often make up for staff shortages and are not offered meaningful training.

Under Foxconn’s policies, interns are not allowed to work overtime or nights and have the right to leave the programme at any time.

As part of its work with the Fair Labor Association – independent inspectors brought in by Apple to audit some Foxconn factories, not including the Yantai facilities – Foxconn has also pledged to ensure that interns’ work matched their educational programmes, according to FLA’s report on its work.

Analysts and news reports in Taiwan and mainland China indicate that other electronics manufacturing companies have been facing staffing shortages as production on new popular products such as the iPhone 5c and 5s ramp up and distributors stock up ahead of the winter holiday season.

Pegatron, which manufactures for groups including Apple and Sony, has been facing “severe” staffing shortages near its Shanghai factories, said analysts at Nomura in a recent note.

A total of 577 people applied for enterprise registration at the newly-launched Shanghai pilot free trade zone (FTZ) on Tuesday, the first day for registration, according to an official statement.

Meanwhile, 1,480 people visited the zone's service lobby asking for advice and information on Tuesday, according to the statement.

Sun Baohua, a businessman from Wenzhou City of neighboring Zhejiang Province, was the first person to apply for a registration.

Sun, who owns micro-financing company, has rented a 20-square-meter warehouse in the zone as his office. He is expected to get his business license within four days.

"The financial institutions allowed to run businesses in the zone are all big companies," said Sun. "While my company caters for medium and small-sized enterprises with lower interest rates."

The Chinese government officially inaugurated the 29-square-km Shanghai FTZ on Sept. 29.

Testing of a convertible yuan, wider opening of 18 service sectors, a negative list approach in governing foreign investment, among other initial steps, are expected to unleash economic potential in the zone in the coming two to three years.