Veeva: Why We Went Long Our Former Favorite Short
- Vault growth has vastly exceeded our expectations, and thus provided unexpected valuation support.
- We anticipate Sanofi will be moving from IMS/Cegedim to Veeva CRM in 2017.
- Force.com customization concerns as well as Cegedim competitive threat now non-existent.
- The unexpected deployment of CRM at GSK+Sanofi, two top 5 pharmas, over the coming few years ensures very high visibility into Veeva being able to sustain 20%+ top line growth through at least 2018.
- At an EV of 5.3x forecasted 2016 revenue, Veeva valuation in SaaS is no longer the outlier it was when we shorted it at 40x ttm sales two years.
- Veeva's vertical characteristics are much more valuable in the current growth tech investing environment. Balance sheet flexibility, 25%+ EBITDA margins, current relative SaaS valuation, and multi-year visibility into 20% top line growth make it a defensive growth stock with a much more definable valuation floor.
- Veeva shares provide a nice long hedge for our short position in IMS.
We are presently long Veeva (NYSE:VEEV) shares. This is obviously a significant shift for us as the stock had been a notable short for us in the past. As we were quite vocal with our short-thesis, we felt sharing the reasoning behind this shift was appropriate.
When we initially published our short-thesis on Veeva back in November of 2013, the company's valuation had reached levels approaching nearly 25% of salesforce.com (NYSE:CRM) market value and an EV/TTM Revenue multiple of nearly 40x. This bubble was of course pretty hard to ignore when you had French competitor Cegedim with nearly 35% LS CRM market share trading at 0.8x EV/TTM Revenue, and because Veeva was a contractually limited vertically focused value added reseller of the salesforce.com CRM platform. An integral part of our investment process involves recognizing that stock valuations don't exist in a vacuum; what is seemingly overvalued or absurd is most glaringly obvious when compared to similar or potentially superior businesses. This is why we love pair trades and have learned to avoid shorting any stock that doesn't have a decent public market comparable.
When you can ask questions like…
How is a vertically limited value added reseller trading at nearly one quarter of the market cap of the world's largest enterprise cloud company and their own platform provider?
Why is the sell-side pushing Veeva's CRM growth story when they could just buy Cegedim's CRM business for its implied market value equal to 4% of their current market cap and get to 75% market share overnight?
...it doesn't take much to motivate you to take a closer look under the hood of a hyped IPO!
And this is what led us to our Veeva short thesis which primarily focused on a grossly overstated TAM in what we quickly discovered was a very transparent Life Sciences SFA market.
Finding out where the seats were, how the global rep market had been shrinking, what pharma customers were paying and were expecting to pay going forward, the large ASP differential between developed and emerging markets, and understanding the competitive landscape wasn't rocket science. You simply needed to put the time in to bottom-up reverse engineer the addressable market and prove the seemingly obvious. We did that, and two years later we can say there is no doubt we were 100% right on the CRM TAM.
Though we think most market participants adopted our view fairly quickly, we believe the full realization of this did not really hit home until Veeva provided annual CRM guidance on their March 2015 Q4 results conference call. Going into this report was the last time we were notably short Veeva shares, and we didn't really expect to be doing much more with the stock after that one day crash. The name looked to be destined to track sector valuations offering 25% return in either direction depending on which way the broader SaaS wind was blowing at the time. Not exactly our cup of tea, and when combined with the fact that other SaaS names seemed to offer more appealing risk/reward scenarios as well as some evidence of execution issues; we really didn't think twice about moving on. Yet, as if often the case in equity markets, as soon as you get too comfortable with a view, things start to happen that cause you to start reconsidering your position.
So, let's revisit our Veeva short thesis...
Outside of the primary TAM argument in CRM, our Veeva short thesis focused on five key points:
- Outside of Life Sciences CRM, Veeva's nascent operations in Content Management and MDM were completely unproven at IPO. At 60% of management's stated TAM and lacking the backing of an established platform provider like salesforce.com in CRM; the market was foolishly assigning billions of dollars in market value to two business lines generating almost no revenue.
- Veeva's swift success in CRM had largely come at the expense of Siebel Life Sciences in the United States which generally was perceived as a neglected product under Oracle's huge umbrella. Internationally, Cegedim was a much more focused and capable competitor, and so far had lost minimal/negligible market share to Veeva. Consequently, global fragmentation and multi-sourcing of vendors was likely to provide an international seat expansion headwind going forward in any large pharma that had already implemented Veeva CRM in the United States.
- GSK and Sanofi, two of the world's largest pharmaceutical companies accounting for nearly 20% of global reps, were on competing platforms and for unique reasons unlikely to switch to Veeva in the near future, if ever.
- Direct Force.com customization as in the case of ROCHE/Genentech or GSK Consumer was a majorly overlooked threat to Veeva's entire LS CRM business model.
- Relative valuation due to overall SaaS hype and Veeva's unique position as the only "profitable" publically listed SaaS made for a compelling risk/reward scenario for what was clearly at the time still a low market IQ IPO.
Two years later we can humbly say that on the four points Veeva has proven us wrong, and as far as the fifth point goes, the market has gradually taken care of that.
1) Veeva's Progress in Vault and Network has Drastically Surpassed Our Initial Expectations
In our initial report, we were quite skeptical of Veeva's ability to gain much traction outside of CRM. The Vault product line had struggled to gain adoption early on, and we largely attributed that to the fact that EMC (EMC) and other players in the content management space were competing aggressively versus rolling over and dying the way Siebel did in LS CRM. EMC had made some targeted acquisitions to bolster their LS offering, and there also were independent SaaS players like Sharepoint based NextDocs who had demonstrated vertical success. The idea that Veeva was going to come into the regulated content space and start winning very quickly just seemed unlikely. And if that was the competitive picture in content management, the story in MDM and reference database was even worse. Informatica in LS MDM was a formidable competitor, and the Onekey HCP database of Cegedim remained the gold standard on the HCP reference data end. Setting these competitive concerns aside, we also had major TAM concerns as we did not believe either of these markets were nearly as big as Veeva management was claiming.
So, what's changed in two years?
Well, the most glaring change is that Veeva started to have immense success with the Vault product line. To the point that the business is approaching a $100 million annual run rate. They have 70% of the top 50 using some Vault application, are approaching 200 total customers, and have gotten 6 of the top 20 to standardize on their eTMF. This has been impressive as in many cases this involves ripping out the Documentum platform, and replacing all the applications built on top of it as well as all related infrastructure and services. This is something we viewed as highly unlikely early on, so Veeva's progress here has been eye opening.
As is often the case with cash-rich tech IPO companies like this, management always has the opportunity to bolster their growth story by making the right acquisitions. While the KOL deal Veeva did at the beginning of 2015 didn't really interest us much, buying Zinc Ahead this past September caught our eye. By doing this deal, they have taken out Vault PromoMats chief competitor and basically positioned themselves as the dominant market leader in commercial digital content management in life sciences. Veeva can now push Zinc Maps users to migrate over, and has a natural pipeline to work with covering 160+ Zinc pharma customers. This is also not exactly thrilling news for any Veeva CRM competitors who had been working with Zinc Ahead's digital content management platform.
On the MDM side, the progress in Network has been nowhere near that of Vault, but they continue to chip away. Veeva Open Data is being taken more seriously in the customer reference data market, and in some markets like China doing quite well. We think at this point it's hard to argue against the fact that OpenData could prove to be a thorn for the now IMS owned OneKey business. On the Network end, Veeva has added a few customers in the top 50, but nothing notable beyond Eli Lilly in the large pharma space. With this in mind, Informatica seems to be doing a far better job holding onto their market share in this space versus EMC in content management.
Putting this altogether, one has to give management credit for proving that they can compete and thrive outside of CRM in a very short time. At the same time, you also have to appreciate just how poorly priced the shares were at IPO when the non-CRM business was a total unknown. Where would the stock be if they hadn't wildly succeeded with Vault? Because despite the success here, our arguments around the TAMs for Vault and Network still hold muster, and thus are a long-term valuation headwind for anyone long the stock. That being said, we do believe Veeva success here and our outlook for their prospects going forward have significantly reduced the downside risk in the shares. We think at this juncture that outweighs the fact that this success still doesn't generate major valuation needle moving upside potential over the long-term.
Veeva's Success in the United States Divisions of Large Pharma Quickly Extended Internationally
One of our initial bearish arguments was that Veeva was likely to have a much slower go of things getting large pharmas to standardize globally on their CRM system after they had already won their North American business. This argument was also put forth by Veeva's largest competitor Cegedim, which argued that there would be significant country and regional fragmentation going forward, and that use of multiple vendors would potentially increase in priority. Suffice to say this has not been the case. The trend clearly has been for Veeva CRM customers to standardize globally on their platform, and this doesn't look to be changing anytime soon.
GSK Recently Selected Veeva as their Global Multi-Channel CRM Partner and Our Research Indicates Sanofi is Set to Follow Suit
One of the key areas of focus in our initial short thesis involved mapping out the global pharmaceutical sales rep market, and determining what Veeva's effective penetration was when adjusting for large pharmas that seemed highly unlikely to switch to Veeva CRM in the near future. The three top 5 pharmas that stood out were Sanofi (NYSE:SNY), Roche (OTCQX:RHHBY), and GSK (NYSE:GSK). These three mega pharmas represented roughly one quarter of the of the global LS CRM addressable market as measured by sales reps. In our initial analysis, Roche and Sanofi seemed like highly unlikely candidates to move to Veeva anytime soon. Roche because it had built its own offering on top of salesforce's Force.com platform even though Genentech had been a very early Veeva customer, and Sanofi because it had been a long standing anchor pharma customer of similarly France-based Cegedim. GSK was the oddball early on and proved to be more of a question mark for us. While they were on an Oracle platform, they were one of the few large pharmas to recently transition from Siebel to a highly customized Oracle CRM On Demand environment. This led us to believe the odds of them moving to Veeva anytime soon remained low as competing with Oracle on price with such a large broad customer was not something Veeva was capable of doing. Getting comfortable with the fact that Veeva would not be implementing GSK over the next 3-4 years played a key factor in how we modeled out the CRM businesses declining growth rate as GSK employs the world's largest global pharmaceutical sales force at roughly 10% share, and thus could easily provide notable step function growth if it made an AstraZeneca (NYSE:AZN) like (18-month sprint) global transition to Veeva CRM. This matter resolved itself last spring when Veeva announced that GSK had selected them as Global CRM Multi-Channel partner. Simply put, we were proven wrong here. Though we will say this good news was somewhat tempered by the fact that this appears to be a very gradual roll-out, and thus ultimately didn't really impact our Veeva CRM revenue models for 2015 and 2016.
The Sanofi situation has been a bit more complicated. Sanofi-Aventis USA has been using Cegedim Dendrite CRM since 2001. There is a long-standing relationship here, and one that was further cemented by the close "French Connection" between Sanofi and Cegedim. During our initial research, the general view was that there was no way Cegedim could lose Sanofi, as such a loss would essentially be a backbreaker for the entire Cegedim CRM business. The narrative here changed somewhat when IMS announced they were acquiring Cegedim's CRM business in June of 2014. Veeva started to make some noise that the "French Connection" was now broken, and that they would win Sanofi's business by the end of the year. We remained extremely skeptical despite all the rumbling we heard in the space regarding this matter. There was evidence to support the Veeva case as Sanofi Pasteur MSD (Sanofi's European market vaccines JV with MSD) implemented Veeva CRM in 2014. However, our skepticism persisted as we did not see how IMS could acquire Cegedim's CRM business and close the deal without Sanofi extending their contract, which was set to expire in early 2015. We were proven right here when Cegedim announced a 2-year extension of their master CRM agreement with Sanofi in mid November of 2014. Well, it appears this extension was a temporary reprieve, and that the "French Connection" is in fact broken. Our research indicates Sanofi USA will be dumping Mobile Intelligence and moving to Veeva CRM in 2017.
The salesforce.com Force.com Customization Disintermediation Threat To Veeva Never Materialized
In our initial report, we highlighted the threat posed to Veeva by very large pharmaceutical companies potentially choosing to build their own custom CRM on the Force.com platform and thus simply bypassing Veeva. We then followed up this threat by identifying that one of Veeva's first customers, Genentech, had done exactly that. We also pointed out that their parent company Roche had chosen to do the same thing. While we were not concerned about customization leading to immediate Veeva displacements in the near term, we did view it as a threat going forward. We no longer think that is the case. In fact, the current Veeva roll out at GSK Consumer is replacing custom built salesforce.com applications, which would indicate that just the opposite is happening. This of course puts Roche back on the table as a future potential large pharma multi-channel customer for Veeva down the road, and based on some online research and other evidence we have come across, this could be something we see not too far down the road either. That being said, there is not much to say here other than that this is pretty much a complete 180 degree shift from what we had originally assumed would be the case. We initially saw no reason for large pharmas already on custom SFDC SFA applications to move to Veeva as an implementation partner. Not that this was a big issue considering how limited that existing customer base was, but from a threat perspective, it did loom as a potential catalyst down the road should SFDC push harder into the vertical. This is no longer as much of a concern.
As we pointed out in the beginning of this article, we don't invest in growth stocks in a vacuum so relative valuation is always an important measuring stick for us as we like to match our shorts with long pairs. While we get a lot of interest in our initial Veeva report, we rarely have many people ask about how the long pairs ended up fairing. For example, had you bought struggling Cegedim's shares which ultimately sold their CRM business to IMS Health you'd have doubled your money on that side of the pair alone. Furthermore, had you gone long, well established cloud leader and Veeva's boring old CRM platform provider salesforce.com you'd have been up as much as 60% recently. Pretty impressive returns to say the least, and in both cases superior to the 40%-50% returns generated being short Veeva shares. This is of course an often overlooked element in pair trading as investors become preoccupied with the short which requires all the analysis/debunking work, and tend to overlook the long which requires little explaining. Our recent Mobileye (NYSE:MBLY) short thesis is another example of this phenomena as we rarely hear anyone asking us about our Nvidia (NASDAQ:NVDA) long pair, which is up a remarkable 50% in the time Mobileye shares have fallen 50%. Anyway, suffice to say Veeva's relative valuation improvement combined with the aforementioned factors played a key part in getting us to go long the stock.
When Veeva went public, its relative valuation when compared to other blue chip SaaS names was absurd. At the time Veeva was not the only guilty party (you could have done far worse in more egregious tech IPO offenders like Castlight (NYSE:CSLT) or Rocket Fuel (NASDAQ:FUEL)) as cloud and tech jubilation was bubbling over, but as far a real 'plain vanilla' vertical software businesses go, it was in an another dimension. That is no longer the case. The SaaS bubble crash probably reached its zenith with David Einhorn's athenahealth (NASDAQ:ATHN) presentation at the Sohn Foundation Conference in May of 2014, and since then the market has for the most part spent a considerable amount of time weeding out the pretenders. Stocks like Castlight never came back while the likes of ServiceNow (NYSE:NOW) and salesforce.com steadily climb to new heights. One of the main reasons we warmed to Veeva and other SaaS stocks of late is that we feel the group's success is becoming pretty evident, and the infatuation with private market unicorns had allowed these bubbly names to grow somewhat into their valuations as their execution improved. This has allowed for ample opportunities to find longs to pair against shorts in the space. That being said, our longs have generally been driven by our short exposure in the space as we have for the most been happy to be sector neutral, and this is no exception.
IMS Health - The Short Pair In Our Veeva Long
In the early phases of our Veeva short thesis, we viewed the then private IMS Health (IMS) as a potential formidable competitor down the road. That view gained momentum when in June of 2014 IMS announced their purchase of Cegedim's CRM division. This was seemingly competitive landscape shifting news as you now had a much more deep pocketed and diversified Pharma IT provider owning Cegedim's CRM business. Our initial read-through on this deal was that it was bad news for Veeva as IMS had more financial flexibility than Cegedim and could potentially leverage their core information offering to help grab some share in large pharma CRM. We naturally expected IMS to retain Sanofi, the one large pharma anchor CRM client they acquired via the Cegedim acquisition, and to be able to gradually build off of that. We are now confident this is not going to be the case. In fact, our recent research indicates Sanofi could be selecting Veeva as their multi-channel CRM provider, and given the timing of their contract renewal with Cegedim, we expect transition to begin early year. Provided we are correct, the impact of losing Sanofi will more than offset the small inroads IMS has made in CRM, and renders their strategic push into this space pretty much 'dead on arrival'.
To be clear our initial decision to short IMS shares was not predicated on them losing all or a significant portion of the seats at Sanofi. Veeva's continued execution already made us extremely skeptical that IMS would be able to convince large pharma clients that had recently moved to Veeva to switch at any point over the next five years. That alone was enough for us to be confident that this acquisition would not end up being the landscape shifter we initially thought it could be. However, we did think IMS would have more time to sell this story to the market. We now have abandoned that view, and believe IMS is one Veeva PR away from having to face critical questions regarding their Cegedim CRM acquisition.
We have done extensive research on IMS and had intended on sharing a detailed short thesis this past November, but the stock really sold off faster than we expected leading us to believe more than a few people already share the same view. We still find the short attractive, and thus briefly sharing the crux of this thesis in conjunction with our shifting view on Veeva is warranted.
IMS Short Summary
- Taken Private Early 2010 in $5.2bl LBO, IPO 2014 $12bl EV.
- Between dividend recap and sponsor fees, sponsors recouped $2.1bl cash covering bulk of their initial equity investment by IPO 2011 IMS - $2.3 bl revenue, adj-EBITDA margin 29.7%, Core prescription data information business 65% revenue/tech services business 35% revenue
- 2014 IMS - $2.6 bl revenue, adj-EBITDA margin 33.2%, Info Biz 57% revenue/services 43%.
- 2011-2014 Info Rev - 0.4% CAGR, Tech Services 10.6%, $650 million on 28 acquisitions largely in tech services, $300 million internal development projects and capex, additional $424 million to acquire Cegedim CRM/Strategic Data division.
- Management message to Wall Street
a) Restructured pharma data leader with info biz gross margin expansion offsetting flat but stable core information offering top line
b) Growth story coming from tech services division where acquisitions have created analytics/applications SaaS player in Life Sciences and consequently expanded TAM $5bl to $75bl
c) Stock offers nice mix of capital return thanks to stable info biz fcf as well as multiple expansion on push into analytics/SaaS in life sciences
- Bulk of restructuring value already extracted by PE sponsors pre-IPO with dividend recap and gross levg at 5x.
- Tech services organic growth not very impressive as we estimate $210 million in acquired incremental revenue ($130 million SDI/$70ml+rest) or roughly closer to 3% CAGR 2011-2014.
- Cegedim acquisition likely to prove strategic pitfall as secular decline in CRM business offsets cost synergies.
- IMS' valuation is surprisingly highly levered to a small piece of the pie that is the recurring revenue tech services application/analytics offerings vs. the info biz or tech services consulting/bpo bulk of the pie. We are essentially too late for IMS to transform into Veeva/Medidata for pharma and should trade at 8x-10x ttm adj-EBITDA vs. 16x when we shorted and 12x now.
We'd also point out that IMS senior management commentary on the acquired CRM business doesn't instill much confidence.
From IMS' 2015 Q3 Conference Call
"I think if you look at overall seats, again, this is before these wins. These wins will add incrementally to our current position, but I think the market share seats that we have is to look at the total of 425,000 seats that's what we have, we think that Cegedim has 137,000 seats, that's about a 30%, 32% market share. But that includes seats on in on-site, on-premise, non-SaaS CRM. And if you take that out, obviously our market share is on purely SaaS-based CRM, then we are much small. I think the leading competitor on the SaaS is Viva, which has 120,000 seats as we understand and that's about 30% share overall, and of course bigger share of the purely SaaS business. I think we still have Oracle and CBOE that have about 65,000 seats that's about a 15% share and then a variety of others, another 100,000 about a core of the market is a lot of mom and pops and different local solutions." - IMS,CEO
We think? Really, a year and half after announcing the acquisition, and after two quarters of consolidated Cegedim reporting IMS senior management doesn't know precisely how many seats they have.? And Veeva has 120,000 seats? To be clear they passed 100,000 in May of 2013, and are somewhere north of 230,000 now. There really is no excuse for being this far off and sounding this clueless about the core business of the largest acquisition you have ever made. In fact, the idea that Cegedim's seat count hasn't changed at all in the 2.5 years we have followed this space is now starting to look rather suspect. Our seat mapping work tells us that Cegedim's rep count has to be somewhere between 10%-15% less than this static 137k number, and that SaaS based seats are between 60-75k. That means losing Sanofi's 20-25k Mobile Intelligence seats works out to a significant 30-40% hit to the SaaS seat base. If we were long IMS shares, we would immediately insist that management clear things up on their CRM business and start providing quarterly seat counts numbers that can be tracked. There are questions that should be answered here. For example, how quickly is on-premise running off? Where are those seats concentrated? Are you having any luck converting these seats to your SaaS offerings? What percentage of your seat count is with top 20 pharmas that have been globally standardizing on Veeva? Some answers here would be nice!
Even if you are not short IMS, we still believe Veeva is worth a look as a stand-alone long or potential SaaS short pair hedge at current levels. The current macro environment lends itself to defensive growth stories in tech. Pure story stocks and broad based futuristic investing theme names with potentially huge TAM's are now being punished. In such a tape, growth investors need to focus on being able to quantify the downside versus chasing unlimited upside. When we initially shorted Veeva, it was a vertical SaaS with a very finite and overstated TAM trading at multiples of sales multiples of some of the leading dominant horizontal SaaS names. It essentially had very finite upside yet was priced at a huge premium to all the seemingly unlimited upside names in software because it was 'profitable'. That made it an outlier. Its characteristics of solid profitability, vertical specific focus, significant market penetration, and high future revenue visibility worked against it. It was for example much easier to value than let's say a FireEye (NASDAQ:FEYE) which was incinerating cash chasing a seemingly limitless upside story in Cybersecurity. And as it was so much easier to value, the short case simply required eliminating the upside versus conclusively proving out the downside. This environment is the complete opposite as the seemingly impossible to value unlimited upside growth stories have seen the rug pulled out from under them. Ironically, this works in stocks like Veeva's favor. Their 10% net cash on hand position, 25%-30% EBITDA margins, and very high visibility as far as 20%+ top line revenue growth goes makes quantifying the downside a lot easier. This is a unique combination in such a volatile growth stock environment, especially the visibility on the top-line growth. Adding large scale CRM deployments at GSK and Sanofi in 2017/2018 pretty much assures Veeva revenue growth rate slow down questions get pushed out another two years, and that the stock will continue to have a lot of fans in the short-term focused financial metrics obsessed world of investing. Not exactly what one gets excited about in a bullish tape, but knowing the growth stock you own isn't going to be delivering some shocking growth rate warning over the next 12 let alone 24 months goes a long way if you are long fishing in a bearish environment. What happens after 2018? Well, at this juncture you have to believe that Veeva is more likely than not going to hit its $1bl revenue target by 2020, and that by that point free cash generation should have them at over $1.1 bl cash on balance sheet. Basically, it doesn't require much to at least get comfortable with the fact that the current valuation will be grown into over the next five years. It is around that point that the major question marks arise as they have for vertical software success stories countless times in the past. Does Veeva find itself in a position to milk another 5-10 years out of what at this point possibly a $300-$400ml a year cash cow? Do they leverage up and do some crazy buy back right before their business starts to go the way of Siebel? Does SFDC swoop in and consolidate them before then during a market trough or does this turn into a PE play like IMS? Do they merge with Medidata (NASDAQ:MDSO) at some point creating a dominant LS vertical software company? Essentially the story comes full circle and you are dealing with everything we have all seen before in vertical technology services land. Could there be upside in terms of some new product gaining traction and accelerating growth again, sure, we don't rule that out, but that's less important than being confident that they simply can execute on their boring plan going forward which is all they need to do to allow us to hedge our related shorts with it or to go outright long at current valuations.
Disclosure: I am/we are long VEEV.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am/we are short IMS