The Nanalyze Disruptive Tech Stock Catalog boasts more than 450 companies. This thing is a beast, and the more we feed it, the bigger it gets. Our goal is to make it more lean and mean – trim the fat, so to speak – so it’s more easily digestible. However, when the folks who help us pay the bills suggest a stock that they like, we dig in. It also whets our appetite if that company is a competitor to one of the stocks in our Nanalyze Disruptive Tech Portfolio. And it definitely doesn’t hurt if said stock is a pure play in one of our core investment themes.
Certara stock (CERT) appears to check all the boxes. Nominated by one of our lovely subscribers, the New Jerzee-based company serves the drug development industry by offering software and services around its biosimulation platform. It claims to compete indirectly with companies like Schrödinger (SDGR), which uses a computational physics-based platform and machine learning to accelerate drug discovery. In addition, biosimulation involves creating a digital twin of a biological system to predict how drugs behave in different people. We believe the digitization of real-world processes into virtual platforms for monitoring systems and predicting outcomes is a key disruptive technology.
About Certara Stock
Certara emerged in its current form about 15 years ago when a computational drug discovery company called Tripos International acquired Pharsight Corporation, which specialized in software for strategic and regulatory services for optimizing clinical drug development. The deal was valued at $57 million at the time. The company wasn’t necessarily on a lot of radar screens when it IPO’d in December 2020, probably lost in the massive rush to the public markets at that time. It debuted with a market cap just north of $5.7 billion and has followed the rest of the tech sector on the roller coaster ride ever since.
Today, Certara is a nearly $4 billion company with 2022 revenues of nearly $336 million and more than 2,300 customers. About half of all of that revenue comes from the top 50 global therapeutics companies. While new to us, the company has a long history, claiming its top 30 customers by revenue in 2022 have been with it for more than ten years on average. Revenue growth has been at about 17% the last couple of years, though some of that involves inorganic growth through acquisitions. We’ll get into all that and more after we understand at a basic level what Certara does.
What is Certara’s Biosimulation Platform?
Certara’s biosimulation platform combines principles of biology, chemistry, and pharmacology with proprietary mathematical algorithms that model how medicines and diseases behave in the body. The company has spent more than 20 years scraping together datasets from nearly 15,000 peer-reviewed manuscripts, more than 10,000 clinical studies, and lab research. Some big-brained PhDs then turn those into various products that customers can use to conduct virtual clinical trials. For instance, Certara scientists have created 29 different virtual patient populations and advanced mathematical models for 10 organs – basically, digital twins for biological systems.
The value proposition for biosimulation is that it can reduce the size of and cost of human trials, which can take years and require hundreds of millions of dollars to fund. For example, one top ten global biopharmaceutical company (based on R&D spend), estimated that it saved more than half a billion dollars over three years using biosimulation to inform key decisions, according to Certara. Even then, there’s no guarantee government regulators will give the thumbs up. However, Certara claims that over the last 10 years, customers who use its biosimulation software and services have received 90% of all new drug approvals by the FDA. (Now, whether that’s directly related to Certara’s platform or the fact that its customer list comprises 39 of the top 40 biopharmaceutical companies in the world is a matter for debate.)
What Else Does Certara Do Aside from Biosimulation?
Biosimulation is just one piece of the business. Drug development is a highly corrupt regulated industry, so Certara also offers software and services related to dealing with the regulatory landscape. Its solution uses specialized software and natural language processing to quickly help customers work through regulatory red tape, including 300 submissions over the last five years.
In addition, the company offers software and services around a rather nebulous concept called “market access,” which refers to “strategies, processes, and activities to ensure that therapies are available to patients at the right price.” In other words, Certara helps customers communicate the value and validity behind their drugs.
How Does Certara Make Money?
We have three markets – biosimulation, regulatory, and market access – so Certara naturally tracks its revenues by software and services. We immediately see that despite the company’s assertion that its solutions are “underpinned by software as a service (SaaS)-based offerings,” only a third of revenue comes from software. Those revenues are primarily subscription-based with licenses ranging from one to three years.
In addition, these two revenue streams overlap all three markets. For example, Certara has more than 20,000 licensed software users in biosimulation and double that amount of software licenses in regulatory compliance, and market access. That makes it pretty difficult to assess traction in any one market. The same blurring of lines between markets is true for the company’s “technology-driven” services revenue.
However, we do have some other numbers to help us evaluate the overall financial picture. Here are few of the most tasty tidbits from the company’s end-year 10K and earnings call:
- The number of customers with annual contract value (ACV) of $100,000 or more increased from 299 to 370, a 24% increase between 2021 and 2022.
- The company ended 2022 with 57 customers with an ACV of more than $1 million, up 12% from 2021.
- Nearly 90% of the top 300 customers by revenue use two or more biosimulation solutions, regulatory and market access offerings, and other major solutions.
- A 91% renewal rate for 2022, which measures the percentage of software customers who renew their licenses or subscriptions. The number has been steady since 2020.
- Software revenue was up 33%, thanks to high retention and renewal rates, acquisitions, and new customers.
- Services revenue was up 10%, mostly on the strength of the biosimulation business, while the combined regulatory and market access revenue was actually down 3%.
Certara is not predominantly a SaaS firm based on the current revenue mix, which makes it less attractive to us because service revenue is usually harder to predict. However, Certara seems to have a pretty good handle on its business, with a steady 60% gross margin across both software and services. Heck, it even turned a modest profit last year.
Certara Acquisitions
However, one thing to keep in mind is that much of that growth over at least the last decade has come through acquisitions. Certara has acquired 17 companies since 2012, when it picked up a UK firm called Simcyp for $32 million. Simcyp is the source of the company’s core biosimulation software for predicting how the human body might handle a new drug (pharmacokinetics) and the drug effect itself (pharmacodynamics) without the need to test it in animals or humans. A 2015 pick up of another UK company, XenologiQ, kickstarted an additional biosimulation capability called quantitative systems pharmacology (QSP). QSP combines computational modeling and vast amounts of omics data (think genomics and proteomics) to predict outcomes for novel drug therapies. This is probably where it most directly comes in conflict with Schrödinger.
In the last two years alone, Certara has added five more companies, including a nearly $340 million payout in cash and stock for Pinnacle 21, which develops software for preparing clinical trial data for regulatory submission. Subtract Pinnacle 21 from the equation and Certara revenue growth in 2022 was only 10%. The latest addition, Vyasa Analytics, will help the company integrate deep-learning algorithms into its existing software products.
A number of other tech companies went on buying sprees over the last couple of years when money was cheap. They ended up overpaying and struggling to absorb new businesses. Time will tell if Certara suffers a similar fate.
Should You Buy Certara Stock?
Adding companies like they’re Pokemon cards isn’t necessarily a red flag, but it’s worth pointing out that Certara is carrying more than $700 million in goodwill related to those acquisitions, most of which was carried over from prior to their IPO. The company also has nearly $300 million in debt and about $236.5 million in cash. However, it appears that Certara is expecting to turn a net profit this year, with total revenue of between $370 million and $385 million. While that’s slower growth than the last couple of years, even at the high end of guidance, the financials look pretty solid for avoiding shareholder dilution in the future by selling more equity to finance their operations.
No big obvious red flags, so let’s look briefly at total addressable market (TAM) to see how far this company can go. Certara claims a TAM of $12 billion today, growing at a compound annual growth rate of between 9% to 17%. Based on 2022 revenue, market penetration is only 3%.
The current opportunity breaks down like this:
- Biosimulation: $2.8 billion
- Regulatory: $7.1 billion
- Market Access: $1.8 billion
The first two numbers come from Grand View Research, one of several market research firms that allegedly run content farms in India. The fact that Certara relies on some rather dodgy market research here is a bit disconcerting. We’re also disappointed to learn that Certara stock offers minimal exposure to biosimulation for drug development, with most of the business opportunity focused on compliance and marketing. As investors in disruptive tech, this isn’t where we want to put our money.
Conclusion
While Certara names Schrödinger as a competitor, biosimulation could be complementary rather than competitive to the latter’s computational physics-based platform for drug discovery. It’s unclear to us how strongly these two companies are competing against one another for business, especially given Certara’s focus on other markets. So we’re not too worried as investors in Schrödinger.
In addition, we are already overweight on life science companies in our portfolio. But even if that wasn’t the case, we would not invest in Certara, even though biosimulation appears to be a potentially disruptive technology and the company seems pretty solid overall.
Two reasons why we’re passing. No. 1: We have no idea how much of the company’s revenues are related to its biosimulation platform because of the way revenues are currently communicated. No. 2: The biosimulation market seems relatively small, if we’re even to believe the third-party market numbers. Does Certara offer the downstream upside that Schrodinger does? Who knows, but until we have better transparency into revenues and trust in the market opportunity, we’re passing on Certara stock.
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