Schrödinger: Bill Gates’ support is not enough (NASDAQ:SDGR)
The software framework created by Schrödinger (NASDAQ:GDPR) has revolutionized the process of discovering new treatments and materials. The company licenses its computing platform to universities, pharmaceutical and biotechnology companies and government agencies around the world to help develop new materials and therapies. The company’s computing platform accelerates the discovery of high-quality pharmaceutical and material molecules. Machine learning improves the speed and accuracy with which these chemicals can be identified, speeding up the process of identifying new drugs and reducing costs. The resulting platform is highly scalable and has strong network effects due to these competitive advantages. For SDGR, the company lacks operational leverage to facilitate any profitability. The hopes of profitability that were once management’s calling in 2021 are now a long way off, with the company struggling to turn a blockbuster product into shareholder value.
The company says its computational process allows researchers to uncover new opportunities at lower cost and with a higher success rate than with conventional methods. Schrödinger’s computer algorithms have been perfected to the point that they can now map the essential characteristics of molecules exactly.
The usual approach to drug development is inefficient and time-consuming. The standard drug approval process takes an average of five to seven years, and more than two-thirds of drug research studies fail.
The standard technique is to screen existing chemicals for “hit molecules” or those with detectable action. Once discovered, these blockbuster molecules would be subjected to intensive testing to maximize their activity, with the goal that one of these tests would produce a new drug. Due to the manual nature of this process, it is not only time-consuming and error-prone, but also expensive. When something is overpriced, it usually brings with it a number of challenges.
Thanks to machine learning and physics-based platforms, pharmaceutical companies can discover more effective molecules in much less time than in the past. Programmers can use Schrödinger’s platform to anticipate fundamental molecular properties and their effects. With this automated system, locating the right molecule for success in a development project is much faster, cheaper and more reliable.
Schrödinger is able to accomplish more in less time and on a larger scale than conventional discovery methods. Undoubtedly, it provides great benefit to the customers. When using Schrödinger, users have access to a much larger library of compounds than when using standard methods. Schrödinger can provide developers with an optimal molecule for their targeted profile much faster than standard discovery methods.
This is because fewer pharmaceuticals will be involved. When the price of a product increases, buyers tend to buy less of it. No accommodation should be given for drug testing. It stands to reason that as the cost of drug discovery increases, fewer new treatments will be introduced. Instead of experimenting with brand new substances, researchers will simply look for the most promising opportunities. As a result, fewer molecules will be available for screening, which will hamper the identification of innovative therapies.
Given the company’s computing and machine learning roots, it’s no surprise that Schrödinger is able to expand the platform quickly. The implementation of machine learning has directly led to reduced search and evaluation times for molecules in Schrödinger. This is essential because the marginal cost of obtaining new customers is minimal.
It’s no surprise that the top 20 pharmaceutical companies are all Schrödinger customers, given the aforementioned benefits of their products. Another advantage of Schrödinger over its competitors is the longevity and credibility of the platform. Investors can see how powerful their competitive advantages are since securing business from major manufacturers.
Along with much of the credibility that the company’s customers infer about the software, significant investments from renowned philanthropists such as Bill Gates further illustrate the reach and demand of the product to further improve the medical field.
Financial statement of the company
Clearly, the company’s product has the potential to transform a trillion dollar industry. The product is widely used and accepted conceptually, but as investors we need to look beyond it. The fundamental story describes a company that has continued to penetrate the industry, while the profitability scorecard describes a company that cannot scale its operations. Turning R&D into free cash flow that can effectively be returned to shareholders appears to be in the distant future as profitability continues to decline. The company continued to demonstrate its inability to reduce operating costs in inflationary environments, with R&D and “other AMS” costs increasing 100% during the same period when sales increased 65%. The lack of operating leverage played a significant role in the share price decline in 2021 and 2022.
Given the decline in profits, the company’s return on equity continued to deteriorate. Pre-tax margins deteriorated to levels significantly different from the -11% margins seen in March 2021. This deterioration, coupled with the 17% increase in the leverage ratio, broadened the return from capital discounting . Importantly, shareholders will continue to realize no value until management is able to facilitate growth or until operations can be expanded.
The unusual case of Schrödinger relative to many of his peers, some of whom have been publicly traded for the same length of time as Schrödinger, indicates the possibility of a significant downward yield distribution. A visual examination of companies’ profitability indicators reveals that their operating profits are among the worst performers in their respective peer group. This, along with the highest valuation in the group, indicates a disconnect between fundamentals and market price that cannot continue to persist.
Schrödinger has developed software that will continue to support the expansion of the medical R&D sector for many years to come. The world’s largest pharmaceutical companies use the software, which is backed by an all-star team. This is when the notion of scalability and management’s ability to turn this product into a tremendous cash-generating business is key. The sad reality is that the company’s management continued to struggle significantly to make significant changes in the fundamental drivers of the income statement. Therefore, I do not consider it a viable investment.