Food For Thought Regarding Veeva's Future

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About: Veeva Systems Inc. (VEEV)
by: Steve Auger
Summary

Veeva operates a CRM platform for the life sciences industry, built on salesforce.com.

TTM revenue growth of 26% and 41.4% free cash flow margin are exceptional.

Stock price is massively overvalued.

I have concerns that may affect Veeva's future performance.

Veeva Systems Inc. (NYSE:VEEV) is one of those SaaS stocks that most investors wish they had bought a few years ago before its valuation went crazy. Veeva's stock price bottomed at $20 back in 2016 before going on a long bull run, peaking at $176 at the start of July this year for an 8x gain in about 3 ½ years.

Veeva stock chart

(Source: Yahoo Finance)

The stock price has since pulled back about ten percent over the course of the summer. The question that many are asking is whether now is a good time to buy.

It is my opinion that Veeva is a superb business with phenomenal fundamentals, but despite the recent pullback in price, the stock is still massively overvalued. In addition to overvaluation, I have some concerns about the company's future that I would like to share later in this article. Given the lofty stock valuation and these additional concerns, I am giving Veeva a neutral rating.

Stock Valuation

I determine stock valuation on a relative basis by comparing sales multiples and sales growth to the company's peers. I believe that high-growth companies should be more highly valued than slow-growth companies. After all, growth is a prime factor in valuation models such as DCF. Higher future growth results in higher valuation and, therefore, higher EV/sales multiple.

To illustrate this point, I created a scatter plot of enterprise value/forward sales versus estimated YoY sales growth for the 89 stocks in my digital transformation stock universe.

Veeva scatterplot of EV/forward sales estimate versus forward sales growth

(Source: Portfolio123/MS Excel)

The sales multiple in the vertical direction is calculated using the EV and "next year's sales estimate" mean value based on all analysts from the Portfolio123 database. The estimated YoY sales growth is calculated using "current year's sales estimate" and "next year's sales estimate," also provided by Portfolio123.

As can be seen from this scatter plot, Veeva is significantly above the trend line, suggesting that its forward sales multiple is higher than its peers, given its estimated future revenue growth rate. My interpretation is that Veeva is massively overvalued relative to the average stock in my digital transformation universe. In fact, it appears to be THE most overvalued SaaS stock around, at least in my custom universe of stocks.

Company Fundamentals

High-growth companies generally sacrifice profits for growth, and traditional value factors such as P/E ratio are not meaningful. Therefore, I focus on other metrics such as the "Rule of 40%," free cash flow margin, and cash burn to evaluate software companies.

The Rule Of 40%

The Rule of 40% is a metric used by software companies to help them achieve a balance between growth and profitability. The Rule of 40 is interpreted as follows: If a company's growth rate, plus profit, adds up to 40% or more, then the company has balanced growth and profit and is financially healthy.

There are several different ways of calculating the Rule of 40%:

Growth - The standard growth metric is to use the Annual Recurring Revenue (ARR) growth rate. For my Rule of 40% calculation, I use percentage sales growth TTM. There are three reasons for this: (1) ARR is not always available, (2) most SaaS companies grow not only organically but also by acquisition, and (3) many companies are in the middle of a transformation to SaaS and have a significant amount of product sales.

Profit - I have seen many variants for the profit metric. Some analysts use EBITDA margin. Others use operational cash flow margin or free cash flow margin. I use the free cash flow margin, as I believe that is the most meaningful factor from an investor's perspective.

Revenue Growth

Veeva's revenue grew by 26.1% for the most recent 12 months, down from 62% in 2014.

Veeva historical chart of sales growth

(Source: Portfolio123)

Free Cash Flow Margin

Veeva had a free cash flow margin of 41.4% for the most recent 12-month period. The free cash flow margin has been climbing steadily since 2014.

Veeva historical chart of free cash flow margin

(Source: Portfolio123)

Rule Of 40% Applied To Veeva

Veeva's revenue growth was 26.1%, while free cash flow margin was 34.9%. Therefore:

Revenue Growth + FCF margin = 26.1% + 41.4% = 67.5%

The Rule of 40% calculation comes out much higher than 40%, I conclude that the company is very financially healthy.

Food for Thought

I have established that Veeva's stock price is significantly overvalued relative to other SaaS stocks. I have also shown the wonderful combination of revenue growth and free cash flow margin, making Veeva a very desirable stock to own, which also explains the lofty valuation.

Earlier, I promised to share my concerns with this stock. And, here they are:

1. Revenue growth for the core product is decelerating

Veeva's commercial cloud products which include the CRM application has, in the words of Veeva management, already "achieved substantial penetration within the sales teams of pharmaceutical and biotechnology companies." Management's guidance for commercial cloud subscription revenue growth for the fiscal year 2020 is "between 13% and 14%."

Now that Veeva's commercial cloud products are leveling off, the Veeva Vault is expected to pick up the slack if the company wants to see revenue growth similar to the past. i.e. greater than 25%.

2. The Veeva CRM product is limited to pharmaceuticals and biotechs

By a legal agreement with salesforce.com, the Veeva CRM is limited to pharmaceuticals and biotechs. Therefore, we won't see any future CRM applications developed that are outside the life sciences industry. According to Veeva's Q2 2020 quarterly report:

Our agreement with salesforce.com provides that we can use the Salesforce1 Platform as combined with our proprietary Veeva CRM application to sell sales automation solutions only to drug makers in the pharmaceutical and biotechnology industries for human and animal treatments, which does not include the medical devices industry or products for non-drug departments of pharmaceutical and biotechnology companies.

Don't expect to see Veeva building out any other CRM applications because it isn't going to happen! Only the Vault products will be tailored for outside industries, industries such as cosmetics and consumer packaged foods.

3. Third-party competitors won't release customer data

Normally, healthcare data is licensed by customers to be uploaded to the Veeva platform. However, some third parties, specifically IQVIA (NYSE:IQV), are also competitors and won't agree to release the data. This warning is provided in Veeva's quarterly report:

Many of our customers license healthcare professional and healthcare organization data and data regarding the sales of prescription drugs from third parties such as IQVIA. In order for our customers to upload such data to the Veeva CRM, Veeva Network Customer Master, and Veeva Nitro solutions, such third-party data providers typically must consent to such uploads and often require that we enter into agreements regarding our obligations with respect to such data, which include confidentiality obligations and intellectual property rights with respect to such third-party data. We have experienced delays and difficulties in our negotiations with such third-party data providers in the past, and we expect to experience difficulties in the future.

For instance, IQVIA currently will not consent to its healthcare professional or healthcare organization data being uploaded to Veeva Network Customer Master and this has negatively affected sales and customer adoption of Veeva Network Customer Master. To date, IQVIA has also restricted the uploading of IQVIA data to Veeva Nitro. Similarly, sales and customer adoption of Veeva OpenData has been negatively impacted by certain restrictions on the use of IQVIA data during customer transitions from IQVIA data to Veeva OpenData.

In fact, legal action has been ongoing between Veeva and IQVIA since 2017. IQVIA alleges that:

we (Veeva) have used unauthorized access to proprietary IQVIA data to improve our software and data products, and that our software is designed to steal IQVIA trade secrets. IQVIA further alleges that we have intentionally gained unauthorized access to IQVIA proprietary information to gain an unfair advantage in marketing our products and that we have made false statements concerning IQVIA's conduct and our data security capabilities.

Veeva then filed a counterclaim:

The counterclaims allege that IQVIA has engaged in various tactics to prevent customers from using our applications and has deliberately raised costs and difficulty for customers attempting to switch from IQVIA to our data products.

4. The Salesforce.com Health Cloud

Despite an agreement between Veeva and salesforce.com along with its customers that only Veeva would own the life sciences CRM market, salesforce.com has created a Health Cloud with CRM functionality and IQVIA is apparently a partner in this venture. And of course, IQVIA is withholding health data from Veeva.

Not only that but the Health Cloud appears to directly compete to Veeva's Vault for clinical data management and regulations compliance. According to Tal Rosenberg, senior vice president, Global Technology Solutions at IQVIA:

We are excited to build a suite of applications that will enable an uninterrupted flow of study information and results, while connecting clinical, regulatory, and compliance content to the Orchestrated Customer Engagement solution on a common Salesforce platform...

5. The top ten customers account for 39% of revenue

There is a lack of revenue diversification which is a problem waiting to happen. This is highlighted in the quarterly report:

In our fiscal years ended January 31, 2017, 2018, and 2019, our top 10 customers accounted for 45%, 42%, and 39% of our total revenues, respectively. .... The loss of any of our key customers, or a failure of one or more of them to renew or expand user subscriptions, could have a significant impact on the growth rate of our revenues, our reputation, and our ability to obtain new customers. In the event of an acquisition of one of our customers or a business combination between two of our customers, we have in the past and may in the future suffer reductions in user subscriptions or non-renewal of their subscription orders.

We are also likely to face increasing purchasing scrutiny at the renewal of these large customer subscription orders, which may result in reductions in user subscriptions or increased pricing pressure. The business impact of any of these negative events is particularly pronounced with respect to our largest customers.

6. Management lacks confidence in new applications

Based on statements by Veeva management, it appears that newer applications such as Nitro and Andi may not be gaining traction or otherwise doing well:

I would say we're feeling a little bit of headwind from some of the anti-competitive behavior from IQVIA. So, some of the same behavior that they've demonstrated with network, they're also demonstrating with Nitro. So, we have to balance some of the success that we're seeing with these early adopters with some of the headwind that we're seeing as well.

I would say with Andi, we're focused on getting the product to the right level of maturity and also getting some of those early customers kind of signed up and live. This is still early market -- early days really for both Nitro and for Andi. So, from a contribution standpoint, it's going to take some time before their material and meaningful impact from a contribution perspective.

7. Veeva Vault does not have an economic moat

While Veeva's CRM product has a wide economic moat, at least according to Morningstar, Veeva Vault doesn't. Vault is expected to carry the torch into the future as revenue for the CRM level off. Guidance for FY 2020 is for "Vault subscription revenue growth of approximately 40%."

(Source: Veeva)

However, I would like to suggest that the Veeva Vault is a glorified document management platform with revision control. I mentioned earlier that Veeva Vault appears to be competing with IQVIA and the salesforce.com Health Cloud. There are also other companies that can compete as well, including OpenText (OTEX), Medidata Solutions (NASDAQ:MDSO), and Oracle (ORCL).

8. Legal action by Medidata

Veeva appears to be no stranger to trouble. In 2017, Medidata Solutions filed a legal complaint:

The complaint alleged that we induced and conspired with the Individual Employees to breach their employment agreements, including non-compete and confidentiality provisions, and to misappropriate Medidata's confidential and trade secret information.

Veeva's motions to dismiss have been denied, and no court date for the trial has been set.

Summary

Veeva operates a vertical CRM for the life sciences industry, a market that is maturing and for which revenue growth is leveling off. Veeva's second product, Veeva Vault is now expected to pick up the pace. While Vault recurring revenue has grown 40% YoY, it is my opinion that there is no moat for this product, and Veeva is vulnerable not only to its main competition IQVIA and other players such as Medidata, OpenText, and Oracle. It is not clear where salesforce.com stands, but it sure has muddied the waters! Veeva also has legal troubles that could eat into margins, both with IQVIA and with Medidata.

I love the company fundamentals. High revenue growth and strong free cash flow are a very enviable position to be in. Despite the great company fundamentals, I view the stock price to be substantially overvalued, and therefore, I am giving Veeva a neutral rating. The concerns I have outlined don't help the case for investment.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.