Schrodinger: Buy The Drug-Discovery Platform And Get The Pipeline Nearly For Free

seekingalpha06-04

Schrödinger is a hybrid biopharma company specializing in physics-based computational chemistry and traditional drug development.The company aims to utilize computational methods to create better drug...

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Nearly For Free\n</h2>\n\n<h4 class=\"meta\">\n\n\n2024-06-04 23:20 GMT+8&nbsp;&nbsp;&nbsp;<a href=https://seekingalpha.com/article/4697356-schrodinger-buy-the-drug-discovery-platform-and-get-the-pipeline-nearly-for-free><strong>seekingalpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>Schrödinger is a hybrid biopharma company specializing in physics-based computational chemistry and traditional drug development.The company aims to utilize computational methods to create better drug...</p>\n\n<a href=\"https://seekingalpha.com/article/4697356-schrodinger-buy-the-drug-discovery-platform-and-get-the-pipeline-nearly-for-free\">Source Link</a>\n\n</div>\n\n\n</article>\n</div>\n</body>\n</html>\n","isBrief":false,"type":0,"news_type":1,"symbol":"LU0072462426.USD","symbol_name":"贝莱德全球配置 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Schrödinger's enterprise value. In a sense, investors are buying the software business and getting the pipeline nearly for free.  Schrodinger's Wave Equation joebelanger Schrödinger, Inc. (NASDAQ:SDGR) is a biotech company specializing in physics based computational chemistry, along with a traditional pipeline of new medicines being tested in clinical trials. The company went public in February 2020, but had existed before that as a private company since 1990. Over this time, Schrödinger built a differentiated physics-based computational platform to enable the discovery of molecules for drug development. Based on the growth of the software business, the market may be undervaluing Schrödinger's collaborations and proprietary pipeline. Upcoming milestones for the company's key pipeline assets in the coming year may provide a catalyst for the market to price in this value. Traditional drug development efforts are complex, lengthy and capital intensive, while still prone to high failure rates. On average, it takes 10 to 15 years and around one billion dollars to advance a drug candidate that still suffers a 90% chance of failure in the clinic. Drugs can fail over 3 stages of clinical trials for a variety of reasons, including: efficacy, toxicity and pharmacokinetics, among others. During each successive stage of clinical development, failure narrows the \"pipeline\" of drugs, until only very few reach commercialization. The dream of a company like Schrödinger is to fully utilize modern computational methods, thus creating better drug candidates and improving strategic decision making. Better drug candidates would present obvious competitive advances for the company, as they will have both improved rates of success and greater sales after commercialization through outcompeting the competition. Furthermore, using computational methods to analyze development may allow for more strategic investment of capital. After all, it is better to fail preclinically or in Phase I than after intensive capital investment onward to Phase III. The dream of a physics based platform would be a transformative improvement in creating drug molecules, as well as better decision making when conducting clinical trials. Drug Discovery Pipeline and Failure Rates (ASBMBToday) Schrödinger has attracted substantial investment from strategic partnerships, including those with luminaries Bill Gates and David E. Shaw. The Gates Foundation presently owns 6.98 million shares, representing 9.6% of the company. In addition, Schrödinger has substantial collaboration with Microsoft (MSFT), including in cloud computing and integration with Microsoft technology. In addition, the high-performance GPU molecular dynamics engine named Desmond was developed by D.E. Shaw Research and is a key component of the company's high-performance software. Schrödinger was founded by Richard Friesner of Columbia University and William Goddard of the California Institute of Technology. Two giants in the field of computational chemistry. There are four primary value drivers for Schrödinger:   Software: The computational physics-based platform for drug discovery that Schrödinger has developed over many years of research.  Equity Portfolio: Schrödinger through collaborations with established Pharma companies and biotech start-ups has taken a number of equity positions in intellectual property that they have aided in designing.  Pipeline: The company has built its own pipeline of drugs that are in the process of being developed.  Balance Sheet: Schrödinger keeps a substantial amount of cash on hand and little long-term debt. As such, the equity value (EV) of the company is a good bit less than the market capitalization.  All of these value drivers are discussed in more detail below. Software Schrödinger is the leading provider of computational software solutions for drug discovery and is gaining traction in materials science. In 2023, all of the top 20 pharmaceutical companies licensed the company's software for $71.8 million, or 45% of 2023 software revenue. Growth in the total software business has increased revenues from $32 million in 2013 to $154 million in the 2023 fiscal year, a CAGR of 17.0% over ten years. Schrodinger Software Growth (Schrodinger 2023 10K) All of the major pharmaceutical players pay for this software due to the impressive number of applications relevant to development of new drug candidates. Without going into excessive detail, these applications allow for the predictive understanding of binding of drug molecules to proteins. In 2023, the company spent $182 million on research and development and $136 million on selling general and administrative expenses. The majority of this spending was toward drug candidates that will be discussed later on. However, if Schrödinger was run exclusively as a software company, expenses would be greatly diminished and they are reported as $29.51 million in the most recent 10K, an 81% gross margin. Margins have improved year over year on steady fixed costs, while software prices have increased. The high demonstrated revenue growth and margins of the software business would easily support the enterprise value of the firm if it existed as a stand-alone business. Schrodinger Cost of Revenues for Software and Drug Discovery Segments (Schrodinger 2023 10K) The software business has substantial growth and high margins.   Revenue (2023): $154 million  Growth Rate (CAGR): 17.0% (10 year historical growth rate), forecast 6% - 13% for 2024  Gross Margin: 81%  Operating Margin: Assuming 50% after R&D and SG&A  Weighted Average Cost of Capital: 9%  For a high growth software business projecting the midpoint of 9.5% growth for the next 5 years and declining to 3% thereafter with operating margin of 50% and weighted average cost of capital of 9%, presents a net-present value of $1.01 billion, roughly equal to the company's enterprise value, presently $1.19 billion. In a sense, investors are paying for the software business and getting the pipeline for a small premium to the current market price. To be clear, the revenues from software are being used to pursue the clinical advancement of drug candidates, thus the value proposition of the company must proceed through commercializing novel drugs. The table below further reinforces this point, the software segment enjoyed segment gross profit of $129.6 million, allowing Schrödinger to squeeze out positive net income for the 2023 fiscal year despite heavy investment in its pharmaceutical business totaling $181.8 million in research and development costs. Segment Revenues (Schrodinger 2023 10K) While this research and development spend may appear detrimental as a line item, the billionaire Ken Fisher popularized the price to research ratio as a manner of valuing stocks. By this metric, Schrödinger is extremely attractive relative to larger pharmaceutical companies, as it spends a dramatic share of its market capitalization on research and development compared to more established pharmaceutical companies.   Company Market Capitalization (in millions USD) R&D Expenditure (in millions USD) PRR (Price to Research Ratio)   Schrödinger 1,600 182 8.79   Merck 377,970 30,530 12.38   Pfizer 163,650 10,679 15.32   Lilly 767,390 9,313 82.40   Click to enlarge Schrödinger's strategy of turning software revenues into research and development spending has allowed the company to continue investing in small molecule drugs in a challenging business environment. Equity Portfolio Schrödinger has a substantial equity portfolio, with ownership positions in eight companies outlined in the most recent 10K. In addition, there are many further partnered programs and collaborations by the company. These are a substantial component of the value presented by the equity. Schrodinger Equity Portfolio (Schrodinger 2023 10K) Key value drivers in the above portfolio are:   Ajax Therapeutics: A $95 million Series C financing round led by Goldman Sacks Alternatives was closed in May 2024 to pursue AJ1-11095, the company's novel type II JAK inhibitor. A post-money valuation of $1.5 billion values Schrödinger's stake at $94.5 million.  Apollo Therapeutics: Closed a $260 million Series C financing round in January 2024 with a $1.5 billion post-money valuation, a $118.5 million stake for Schrödinger.  Morphic Therapeutics (MORF): A publicly traded company leveraging Schrödinger's design strategy to advance MORF-057. Schrödinger holds 1.7% of the equity, representing a stake of $25.8 million.  Structure Therapeutics (GPCR): A publicly traded company focused on GLP-1R selective treatment for obesity with its oral Phase II candidate GSBR-1290. Schrödinger holds 2.9% of the equity, representing a stake of $46.2 million. Nimbus Therapeutics, which was acquired by Gilead Sciences for an upfront payment of $400 million and potential to receive $800 million in milestone payments.  The equity value of the portfolio is substantial, and it should be noted that the acquisition by Takeda of Nimbus Lakshmi Inc. (a wholly owned subsidiary of Nimbus) resulted in cash distributions totaling $147.2 million for Schrödinger in fiscal 2023. As such, the company has a proven track record of turning these collaborations into cash-flow. Partnered Programs and Collaborations Schrödinger has established various partnerships and collaborations with pharmaceutical companies. Some of these, as noted above, establish equity positions, while others make the company eligible for milestones and royalties depending on progress of the programs. Partnered Programs and Collaborations (Schrodinger Investor Relations) In total, these programs include 5 Phase I and 3 Phase II programs, a substantial number that would rival most established pharmaceutical companies. This is a demonstration of the competitive advantage of Schrödinger's platform, which is the reason why so many collaborations are present and why they are so advanced. Proprietary Pipeline Schrödinger has a diverse pipeline of drug candidates, for the purposes of valuation only those advanced into clinical development will be considered. SGR-1505 is a MALT1 inhibitor currently under investigation for the treatment of B-cell lymphomas and SGR-2921 is a CDC7 inhibitor under investigation for AML or myelodysplastic syndrome. Both are currently in Phase I. Schrodinger Proprietary Pipeline ( Schrodinger 2023 10K) SGR-1505 shows antitumor activity in a MALT1 enzymatic assay, a biochemical measurement of the strength of this inhibitor to bind the MALT1 protein (left-hand side). The inhibitor in a protein only experiment binds MALT1 at an IC50 of 1.25nM, meaning that a 1.25nM concentration of SGR-1505 results in 50% occupancy of the protein. In addition, the company has developed impressive biology, showing the inhibition of MALT1 is active in BTKi resistant cell lines. The well-known drug Ibrutinib inhibits a different protein called Bruton's tyrosine kinase (BTK), unfortunately many patients become resistant to BTK inhibitors. The cell viability results on the right-hand side are powerful demonstration in vitro that SGR-1505 shows promise in such patients. In vitro is Latin for \"in glass,\" meaning testing that is done outside a living organism. SGR-1505 In Vitro Performance (Schrodinger 2023 10K) SGR-1505 also shows promising results in vivo in ABC-DLBCL patient-derived xenograft (PDX) models. These data suggest that targeting MALT1 with SGR-1505 may expand therapeutic options for selected patients with B-cell lymphomas. In addition, combination of SGR-1505 with BTK inhibitors may be a strategy to overcome drug-induced resistance, a noted drawback of these drugs. In vivo testing is performed in a whole organism, demonstrating the performance of SGR-1505 to inhibit the growth of tumors in a mouse. SGR-1505 In Vivo Performance (Schrodinger 2023 10K) Importantly, SGR-1505 shows competitive advantage that the company has developed through its physics based platform. SGR-1505 improves upon the biological properties of JNJ-6633, as evinced by its dramatically improved potency in a MALT1 biochemical assay and improved performance in various cell-based assays. This is a notable testament to the competitive advantage of Schrödinger. Through their physics based platform, they have outperformed Johnson & Johnson (JNJ), a mega-cap Pharma company with greatly increased financial resources. SGR-1505 Performance Vs. JNJ-6633 (Schrodinger 2023 10K) Finally, for SGR-1505 the company has made use of target engagement biomarkers to inform its Phase I study. In this case, 73 healthy volunteers have been dosed with no drug-related serious adverse events or dose limiting toxicities observed. The biomarker IL-2 was measured to demonstrate target engagement at tolerable doses. This data shows that safe inhibition of MALT1 to knockdown IL-2 levels is possible, leading to the conclusion that continued exploration in the clinic should be advised, although the final Phase I results read out later this year. SGR-1505 Phase I: IL-2 Levels (Schrodinger 2023 10K) SGR-2921, the company's CDC7 inhibitor, entered clinical trials in July 2023. Space constraints limit fully analyzing every program being explored by Schrödinger, but the graphic below demonstrates again the company's competitive advantage being able to design a substantially improved drug candidate compared to established pharmaceutical companies with far greater financial resources. SGR-2921 Performance (Schrodinger 2023 10K) Successful Phase I candidates represent highly valuable assets, often fetching prices as high a $1 billion depending on the market size. SGR-1505 in particular could be a substantial asset if co-dosing with Ibrutinib demonstrates an improvement in survival by limiting resistance. Ibrutinib had sales in 2023 of $3.5 billion. Balance Sheet Schrödinger presently has a market capitalization of $1.60 billion, however, the company's enterprise value is lower at $1.19 billion (market cap + debt - cash). The company keeps a substantial amount of cash and marketable securities on hand ($155.3 million in cash and cash equivalents and $307.7 million in marketable securities). The balance sheet contains little long-term debt, thus the enterprise value of the company constitutes the market capitalization adjusted by Schrödinger's cash rich balance sheet. Consolidated Balance Sheet (Schrodinger 2023 10K) Schrödinger is an intriguing investment because it has the reliable cash-flow of a software business and the risk-taking nature of a small biopharma. Some investors may prefer to stay out of the risky biopharma business entirely, but it is contended that the company's more reliable cash flows from software effectively subsidizes the risk of drug discovery. Schrödinger is not currently profitable due to large investments in its proprietary pipeline. However, its 2023 results give some reasons for optimism. In fiscal 2023, the company reached full-year profitability on a non-GAAP basis, with net income of $40.7 million. What is impressive about the company is its ability to invest heavily in the pipeline, but offset most of these development costs. Schrodinger 2023 Results (Schrodinger 2023 Full-Year Financial Results Press Release) As a result of narrowing losses, Schrödinger has been able to issue little equity since 2020, with shares outstanding at 70.0 million then vs. 72.7 million presently. Over this time, the company's cash and short-term assets began at $642.7 million in 2020 vs. $431.1 million as of the last quarterly report. Over approximately 3.5 years (Dec 2020 to present), the company has spent $211.6 million, or on average approximately $60 million per year. Therefore, at the historical burn-rate, Schrödinger has cash for approximately seven years, nearing the time when its candidates should reach commercialization. In the short-term, it is expected that Schrödinger will continue to invest heavily as its Phase I programs progress to Phase II. However, this will be offset by continued growth in the software segment, projected to be between 6% and 13% for 2024. In the medium to long term, Schrödinger's financial outlook could improve significantly. Successful Phase I, II and III trials would greatly enhance the company's valuation and attract further investment, paving the path to final profitability for the company. Risks  The major risk to investors in Schrödinger is that the company remains young and has not yet reached commercialization of its own drugs. This is not surprising given the timelines presented at the beginning of this article. However, it will still be a number of years before the Phase I assets in the company's pipeline have an opportunity to bear fruit. From the beginning of Phase II to commercialization, there are likely 5–7 years remaining. Some collaborations with other pharmaceutical companies are more advanced. However, there is also a substantial risk that these programs are not directly under the control of the company. For example, in the past year, Schrödinger was given back rights to its SOS1 program from Bristol-Myers Squibb (NYSE:BMY). In this case, business reasons for BMS were the likely culprit, as BMS had acquired Mirati Therapeutics (NASDAQ:MRTX) for about $4.8 billion. Mirati had independently developed a candidate for SOS1, and Schrödinger became collateral damage and a major component of the company's subpar stock performance in the past year. Investors in Schrödinger must be content that the company is developing far more candidates than are likely to work out in practice. As such, failures are to be expected as part of the pathway to success. Successful biotechs, such as Vertex Pharmaceuticals (VRTX) have been built on success of a single franchise, in this case cystic fibrosis. Should the propriety pipeline succeed, investors will be greatly rewarded. Conclusion It has been a challenging year for Schrödinger, and the company's stock price reflects this. A number of headwinds from uncertainty in application of the Inflation Reduction Act, to withdrawn collaborations by BMS and software revenue growth coming in lower than expected have pushed the stock to 52-week lows. Schrodinger 52-Week Performance (Seeking Alpha) However, a major catalyst for the company is upcoming, given that both SGR-1505 and SGR-2921 are expected to complete Phase I trials late this year or early next year. If these programs proceed favorably, the market should begin to price in more value for the pipeline. Since Schrödinger's software business has a DCF value roughly equal to the entire company, the market appears to give little value to the company's equity portfolio, collaborations and proprietary pipeline. The primary value driver for the company over time is whether it proves able to commercialize new drugs. Buyers of the stock should also be wary that this value will only reveal itself after years of clinical development. The averages shown in the first figure of this article show the averages: following Phase I on average 6.5 years of additional investment are required and only one program in six will reach commercialization. As such, the potential catalyst of SGR-1505 and SGR-2921 transitioning to Phase II assets should be a substantial catalyst for Schrödinger. On average, a successful Phase II asset is worth $405 million, with two opportunities for success in the coming year. Given the value of the company as a software provider, it is argued that this presents an asymmetric risk/reward as the market is unduly pessimistic even though early indications show good target engagement and low toxicity for SGR-1505.  Over the longer term (5+ years) if Schrödinger is able to commercialize new drugs, the return potential is greater. Single commercialized assets in the pharmaceutical space have multi-billion dollar price tags. 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