"Medidata is uniquely positioned at the intersection of life sciences and technology." - Tarek Sherif, CEO Medidata Solutions
The best of both worlds. That's the enviable position Medidata Solutions (MDSO) finds itself in as we enter the Fall of a blistering year in the stock market. Two sectors that have outperformed are Cloud Computing and Biotech. Medidata's flagship product Medidata Rave sits solidly in the center of these two arenas. It offers cloud based solutions in the clinical trial process for biotechnology companies, medical device manufacturers, and big pharma.
The company had its IPO in June 2009 at $14/share. It barely budged from its initial share offering for two years as investors slowly waded back into the stock market. Once earnings and revenues increased at a healthy pace, investors took notice, and elevated the share price from $16 to $100 in 24 months.
(Chart Source: Yahoo Finance)
At par value, the equity sports a trailing twelve month P/E Ratio of 121. Although earnings growth for 2013 is a healthy 33%, the consensus estimate on Wall Street drops to 17.5% for 2014 (which may be conservative). My contention is that Medidata Solutions is ahead of itself, and may be due for a significant haircut if the next quarter doesn't live up to lofty expectations, or guidance disappoints. After all, Wall Street is looking for next year's numbers now.
To make my point, the remainder of this article will be liberally paraphrasing and quoting from the company's annual report, most recent conference call, and its presentation at the Morgan Stanley Technology, Media & Telecom Conference.
The Company Near Term
The Pharmaceutical Industry spends $90 billion a year developing new drugs, and Medidata Solutions is the largest task provider of solutions to the life sciences companies. According to the CEO, in its core market, it has over 50% market share, and has achieved "critical mass" in terms of the kind of data it's collecting. The company's chief competitors are Oracle (ORCL), Perceptive Informatics, and Tableau Software (DATA).
The annual report states primary product Medidata Rave is built on industry standards, enabling interoperability with legacy and third-party applications throughout the development process. CEO Sherif gives his spin:
We focus on replacing paper-based, Excel-based, and legacy-based processes in drug development in actual clinical trials with a very innovative disruptive technology solution that helps them to both save money, and to drive down times in drug development.
The company's software has end-to-end support for Unicode characters, required to deliver multi-lingual studies, which enabled its globally positioned sales force to land a who's who of pharmaceutical juggernauts. Johnson & Johnson (JNJ), Roche and AstraZeneca (AZN) are clients of note. Medidata can also boast a laundry list of biotechnology all-stars on its roster. The company's five largest customers accounted for 29%, 31% and 43% of Medidata revenues in 2012, 2011 and 2010, respectively. However, in 2012 and 2011, no single customer accounted for 10% or more of total sales.
Medidata is taking market share from some of the incumbents, or the legacy solutions. Last year, it added 100 new customers. It has 363 customers currently. There are over 2,000 companies globally that develop drugs. So there's a wide open field for it to continue to add new names.
It has a subscription model in terms of customers having the right to use Medidata technology for a period of time. It drives volume in terms of the adoption of the technology solutions, it recognizes revenue on a ratable basis over the contracts short-time, and its strategy is to drive adoption of the company's technology through its infrastructure, which is highly scalable on a gross margin basis.
The applications are very sticky. Last year, its retention was in the high-90% range, and that's not even counting the up sell opportunity it has with those customers. Last quarter, the retention rate rose to 99%.
Although this gestalt of information is impressive, it still doesn't warrant a trailing P/E Ratio of 120. However, as experienced investors understand, you are paying for future earnings growth. Medidata Solutions executives believe they are at the right place at the right time to take advantage of the paradigm shift in drug discovery.
The Company Long Term
Although trends in pharmacology such as Personalized Medicine, which includes genomics and targeted therapeutics, will likely be catalysts going forward, it is the expansion of Medidata's core competency that will drive share price higher. Recently, the company broadened its platform dramatically, and now focuses across the entire drug development spectrum. So from conception of a clinical trial through to completion of that trial. Last quarter, non-Rave revenues increased 144% year-over-year.
We are able to increase market share across multiple functions within a single customer. As we identify new customer needs, our cloud model makes it much faster and more efficient to develop and deploy new functionality and solutions, continuously broadening and improving our platform and therefore, expanding our revenue opportunities.
Medidata is helping to define the vertical cloud business model, and its power is evident in its financial results. Not only did it exceed its previously stated outlook for revenue and EBITDA, and saw cash flow from operations increase to record levels, but it also continued to lead its SaaS peers in profitability measures. Second quarter highlights included:
- Application services grew 36% year-over-year.
- 45% of existing clients purchased more than one product, up from 41% in the first quarter.
- Total revenues for the second quarter of 2013 were $68.1 million, an increase of $14.6 million, or 27%, compared with $53.5 million in 2012.
- Application services backlog for the remainder of the year as of June 30, 2013, increased to $110 million, up 38% over the comparable period a year ago.
- Total cash, cash equivalents and marketable securities were $140.4 million at the end of the second quarter, an increase of $26.5 million, or 23%, as compared with $113.9 million at the end of the second quarter 2012.
- Cash flow from operations was a record $26.2 million in the second quarter, up 361% year-over-year.
No question it was an outstanding quarter, and I realize sell side Wall Street analysts are giving Medidata premium pricing, but I still remain convinced the stock is overvalued.
Medidata Solutions' short float is only 5.5%, so the smart money is betting the stock has room to run. It keeps ascending to new highs on a daily basis, so short sellers beware. That said, its price/sales is 11, price/book is 16 and cash/share is only $1.45. That seems expensive to me. Young growth companies plow a lot of their revenues back into SG&A [Selling, General and Administrative Expenses] and R&D, and therefore, don't make a dime. That's not the case with Medidata. It's an extremely profitable and well run company, even with an R&D budget that's 19% of revenues.
Many investors subscribe to the Efficient Market Hypothesis where prices reflect all publicly available information, and that prices instantly change to reflect new public information. I take a different approach and believe that investors aren't always rational. Although the rank and file at Medidata are doing a great job where the company is concerned, in my opinion, the stock isn't worth $100, not at this juncture. I wouldn't short it. Personally, I don't short individual stocks, and that's especially true in a bull market.
Bottom line is I'd like to own this equity, but not at the lofty valuation. My purchase price for Medidata Solutions is somewhere between $65-$75. Its 200 day moving average is $64, and I prefer to buy my holdings for bargain basement prices. Your investment style may be different, and this stock has a full head of steam. If you don't mind the macro issues that hover over the stock market, this a great choice for short-term momentum players.