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GAME CHANGING DRUG DISCOVERY AI PLATFORM

GAME CHANGING DRUG DISCOVERY AI PLATFORM

In 2010, the Bill & Melinda Gates Foundation made a $10 million private equity investment in Schrodinger. Schrodinger is an industry-leading drug discovery & analysis platform. Why would Bill Gates be interested in a small drug development startup? To answer that question we must first examine the primary function of the platform. It’s designed to help research teams identify and analyze the structure of molecules. Pinpointing the right molecular structure is the hardest part of the entire drug development process. The technology enables the user to analyze billions of molecules per week versus thousands of molecules per year. Schrodinger has been the industry leader in this space from the very beginning. It was founded in the ’90s, by two world-renowned award-winning,  chemistry and physics professors.

 

SCHRODINGER 2 YEAR STOCK CHART

2 YR STOCK CHART

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UNDERSTANDING THE PRODUCTS & SERVICES

UNDERSTANDING THE PRODUCTS & SERVICES

Don’t look at this as just another AI drug development platform. That description is far too broad to be able to diagnose Schrodinger’s true competitive advantage. If you don’t understand the industry, you’ll make the mistake of comparing them to the wrong companies. Most of the other drug development software platforms are focused on completely different stages of the drug development process. Google for example is the parent company of a startup called Alpha Fold. Alpha Fold also has an AI drug development software platform, but they are focused on analyzing protein structures. Schrodinger on the other hand is focused on analyzing small molecule structures. This is undoubtedly the hardest part of the drug development process. Schrodinger’s progress in this space has been unrivaled for decades. All of the 20 largest pharma companies in the world are using their technology in some capacity. Hence why the Bill and Melinda Gates Foundation is the second-largest shareholder. Schrodinger platform has large libraries of compounds, allowing users to filter criteria for specific reactants and pathways.  The platform can also be used across stem industries such as semiconductors, electronic displays, aerospace, and energy.

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Software(80%+ of total rev): The hardest aspect of drug discovery is finding the right molecules to combine. Molecules are atoms that are bonded together. When pharmaceutical companies are developing drugs they will research thousands of molecules to find the right combination for their specific use case. Molecular research happens at the preclinical stage and makes up about 60% of the process. Protein structure is a key element of the process. The shape of a protein helps to identify the characteristic of the disease. Molecules can take weeks to analyze with traditional processes. The Schrodinger platform can cut the time down to a few hours. It allows research teams to analyze billions of molecules per week versus thousands of molecules per year. 

Drug discovery(17% of total rev): Schrodinger’s business model has transitioned toward drug development partnerships. In most recent years they’ve started working with pharmaceutical companies of all sizes. This segment of their business has more than doubled over the last 3 years. Although it makes up only 17% of their revenue, the size of their partnerships steadily continues to grow.  Some of the more notable partners include Bayer, AstraZeneca, and Bristol Myers Squibb. 

What investors need to understand is that these partnerships won’t yield any serious material results for many years. Developing a drug takes 10 years on average, so partnerships from even as long as 5 years ago aren’t yet generating any revenue for this company. Most of these deals are structured such that Schrodinger will receive licensing revenue when the drugs make it to market. Not only does this give them an additional revenue source, but also participating in these partnerships allows them to better understand the needs of their customers. User design is often overlooked. You can have the best technology in the world, but if your customers don’t know how to use it then you are going to forfeit market share to your competition. 

SCHRODINGER COMPANY HISTORY

COMPANY HISTORY

Schrodinger was founded in 1990 by two award-winning chemistry professors. Columbia professor Richard Freisner is an expert in computational chemistry, a Berkeley Ph.D. holder, and a highly respected member of the American Academy of arts and sciences. His co-founder William Andrew Goddard is a chemistry and applied physics professor at CAL U. He got his Ph.D. from California institute of technology. From the early days, they’ve been on the cutting edge of using computational power to further drug development.

THE TEAM BEHIND SCHRODINGER'S TECH

Schrodinger’s talent is truly unrivaled. They currently have over 580 employees across multiple continents. Over half of them have Ph.D.’s in either computational chemistry, physics, or computer science. Ramy Farid(CEO)- started off as a product manager for the company. He studied chemistry at cal-tech. Has a Ph.D. in BioChem and Physics from the University of Pennsylvania. His partner Robert Abel is Schrodinger’s CTO &  Chief Computational scientist.  Before moving into the CTO role he was Executive vice president. He has a Ph.D. from Columbia and a strong background in computational chemistry. Robert serves a really important role in making sure the technology stays on the cutting edge. Karen Akinsanya ( Head of R&D)-Karen famously developed a drug that treats prostate cancer, while leading a research team at Firmagon.  Prior to her role at Schrodinger, she worked at Merk for 12 years. Not only does she have a Ph.D. from the imperial college of London, but also she’s undergone several post-graduate programs at Stanford, Tufts University, and the College of London

NOTABLE SCHRODINGER SHAREHOLDERS

NOTABLE SHAREHOLDERS

David Shaw– Schordinger’s single largest shareholder is billionaire hedge fund manager David Shaw. He owns approx 15% of the company.  His firm D.E. shaw is one of the most profitable hedge funds of all time. In fact, they’ve only had one down year since 2008. David is not just any old investor. He has developed one of the most sophisticated Quant funds on Wall Street, by leveraging his background in Computer Science. In fact, he was a computer science professor at Columbia.

What’s most compelling about David Shaw being a notable shareholder is that he is specifically focused on this space and has deep domain expertise. Supposedly his entire life’s work is focused on computational chemistry. He’s arguably one of the most notable investors in the space. He started a completely separate research company callee D.E. Shaw research. Built Anton 3 system a quantum computer designed to do molecular dynamic simulations. Molecules are constantly moving and so therefore you have to be able to study their movement to properly develop drugs. Schrodinger’s tech actually integrates with code written by D.E. Shaw Research. 

The Bill and Melinda Gates Foundation– Much like other foundations they have a separately managed endowment. They currently own 11% of the company. The foundation started investing back in 2010, after being presented with Schrodingers vision for collaborative R&D partnerships. 

SCHRODINGER'S MAIN COMPETITORS

MAIN COMPETITORS

It’s really difficult to compare Schrodinger to anybody. When you talk to experts in this field, you’ll come to the realization that they are industry-standard software providers. To quote a biotech industry expert” Schrodinger would be the equivalent of Microsoft word or Excel”. Alpha Fold: could be considered somewhat of a competitor. They developed an attention-based neural network to identify and analyze the structure of proteins. Alpha Fold is an artificial intelligence (AI) program developed by Google’s DeepMind which performs predictions of protein structure. Protein makes up 80% of the human body and completely runs the human immune system. One of the most important scientific problems right now is mapping out protein structures. Protein structures are what we refer to as large molecules. Schrodinger focuses on the analysis of much smaller molecules. Biovia: This is a larger company from a revenue standpoint, but they have a much wider suite of product offerings than Schrodinger. The platform features are not nearly as advanced and robust as Schrodinger. It develops and sells a vast range of modeling and simulation software.  The powerful BIOVIA product portfolio is focused on integrating the diversity of science, experimental processes, and information requirements across research, development, QA/QC, and manufacturing.

SCHRODINGER'S MAIN COSTUMER'S

SCHRODINGER'S COSTUMER'S

This software firm has been disrupting the drug development industry for decades. It’s been used by all of the top pharma companies for 15+ years. Here are some of the firms utilizing their platform: Pfizer, AstraZeneca, J & J, Novartis, Abbvie, Bristol Myers Squibb, AstraZeneca, Amgen, Biogen, Bayer, Gilead, Teva, & Merk. One notable KPI in the software space is customer retention. Schrodinger’s retention rate is over 90%. No other firm has been able to make as much progress in the molecular structure software space. The top 20 pharma companies make up 30% of the companies revenue.

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EVALUATING THE COMPANIES FINANCIALS

COMPANY FINANCIALS

The company is valued at 4 Billion. Down 50% from their Feb 2021 high of $8Billion. Over the past 4 years, they’ve increased top-line revenue by nearly 100%. 2017 they had 55 million in sales versus $108 Million in 2020. The average rev growth rate is 24%. Schrodinger’s valuation doesn’t seem unreasonable if you are basing your argument on top-line revenue. What makes it seem expensive is the lack of profitability. The gross margin is 56% which is not bad at all. Where they are really losing money is Research and Development. Last year alone they spent $63 million on R&D. Part of the reason that R&D expense is such a large portion of their revenue is that they are partnered with various pharma/biotech companies to help them develop proprietary drug technology. This is a small portion of their business but has been growing substantially over the last few years. Drug development takes a long time but can result in an asymmetric payout. 

SCHRODINGER KEY FINANCIAL RATIOS

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OVERALL ANALYST MAIN THESIS

ANALYST THESIS

Schrodinger has disrupted the industry it serves, in such a significant way. Long term they are positioned to dramatically reduce the barriers to entry in the pharmaceutical business. Reducing time in the pre-clinical trial phase is a key element to increasing the amount of life-saving drugs that go to market.  What’s interesting to me about this company is the fact that they are able to take advantage of the growth across the entire space. The Biotech and pharma space is always a growth industry as a whole, but it’s extremely difficult to figure out the companies that are gonna come out ahead. 14% of all the drugs that reach clinical trials will succeed. It takes years and years just to get to the clinical trial phase. A lot of money gets burned in the process. Outside of the big pharma companies, most of them depend on the success of a handful of drugs. Therefore they are more often than not unprofitable. 

Despite the fact that Schrodinger’s stock price has dropped in half from last year’s high, the valuation still seems a bit rich.That said we must remind ourselves that the market is filled with overvalued companies at the moment. What you have to focus on is relative valuation. When you think about it in those terms, it’s much easier to justify paying 40 times last year’s sales. By no means is that cheap, but think about the multiples that people pay for biotech companies with zero FDA-approved drugs. The upside can be massive, but so can the downside. With Schrodinger, you have a company that already has substantial revenue. Not only do they have revenue but the average growth rate is 24%.

ALPHA UNIVERSITY'S PLAYBOOK

OUR PLAYBOOK

The real question is how to proceed, knowing that SDGR is trading at a steep premium. Situations like this require some creativity. My plan is to utilize the wheel strategy. The wheel strategy is when you sell far out of the money puts to collect income prior to buying the stock. Put options give the buyer the right to sell the stock at a specific predetermined price that’s outlined in the contract. The put buyer is paying the seller a premium so they can have the optionality to sell the stock if it drops significantly. If you sell puts at the right price you have very little risk of getting assigned. Ideally, we will be able to sell puts several times before being forced to buy the stock.

 The alternative strategy is to buy some shares now and limit the exposure until prices become more attractive. I personally like the idea of buying some shares now, but mostly using the wheel to get larger exposure. This will allow me to collect income despite the valuation. If you sell $50 or $55 options a month or two out more than one time you’ll be able to ideally offset around 10% of the cost of the stock possibly a lot more. Once I’ve gotten full allocation I’ll more than likely start to sell calls to further offset the cost of the trade. The only issue with that is a lack of liquidity. This name is too small to have serious liquidity in the options market. I don’t mind that so much only because this position doesn’t meet my typical criteria. 

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