To The Moon

Summary

• Medpace Holdings is a US-based clinical research organization that is well-positioned to benefit from increased demand due to geopolitical risks affecting Chinese firms.
• Medpace stands out among its peers due to its growth orientation, competitive margins, and focus on next-generation therapies.
• While Medpace lacks diversification compared to WuXi Biologics, a pair trade strategy can help reduce risk and take advantage of the opportunities in the healthcare market.

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Introduction

Medpace Holdings (NASDAQ:MEDP) is a US-Based clinical research organization, or CRO. With distinct financials and growth orientation that place the firm well above the competition in the non-manufacturing space, it is clear that any demand pushed away from Chinese firms such as WuXi Biologics (OTCPK:WXXWY) or AppTec will go straight to Medpace. As such, I am splitting my CRO exposure to include both a speculative bet on the longevity of WuXi Biologics and a safer bet on Medpace. This scenario also has the distinct benefit of reducing valuation risk in Medpace, as the unknown amount of increased demand will easily fill the company’s current valuation. And, if geopolitical sentiment calms down, the investment in WuXi will rebound as the whole group is the third largest CRO in the world behind IQVIA (IQV) and Thermo Fisher’s (TMO) various subsidiaries.

Why Medpace?

Medpace is the winner amongst a strong group of CROs thanks to their growth orientation and competitive margins, despite lacking the long-term history of peers such as IQV, Charles River Labs (CRL), and ICON (ICLR). As a new company, Medpace’s clientele will be focused on next-generation therapies, adding longevity to their business. This bodes well, as healthcare is a long-term game and low margin, long-term contracts at the larger firms may prevent flexibility in the coming years as biotech research is stifled due to lack of funding. I also am an investor looking for long-term secular opportunity, so a financially healthy competitor at a small, $12 billion market cap is my preference.

The issue is that Medpace does not meet the diversification mark that I expect from my investment, when compared to WuXi Biologics. As I discussed in my article on WuXi, the company takes an incredibly diversified approach to the contract healthcare industry, with exposure to research, manufacturing, commercialization, and more. Meanwhile, Medpace is a stout CRO, although cutting-edge and value adding, with no CDMO revenues. This is why I believe it is worth remaining invested in WuXi despite the geopolitical risks that remain, and use the pair trade to reduce risk.

Manufacturing vs Research

I believe some may wonder why I am focused on Contract Manufacturing Organizations or CMOs. While CRO’s are well established companies with fairly strong fundamentals, EBITDA margins remain below high value CMO’s of equal standing. As an example, IQVIA hovers between 15-20% EBITDA margins, while CRL, ICLR, and Medpace are all close to 20% during good times. This contrasts with CMOs such as Lonza (OTCPK:LZAGY) or Catalent (CTLT) that see EBITDA margins averaging closer to 25% or more (aside from Catalent’s recent issues). As a newer field, CMOs are investing heavily, and some also continue to manufacture low value chemicals such as FUJIFILM Diosynth (OTCPK:FUJIY) (~10%+ EBITDA margins). But, the new age, diversified leaders such as WuXi and Samsung Biologics are able to enter the 30s-40s% range easily thanks to their exposure to new age therapies and high value services.

Diversification is key, and I am not the only one who believes in the inherent synergies between CRO and CMO capabilities. In fact, Thermo Fisher’s services groups, whether manufacturing or research, account for the majority of the company’s revenues, but at a 13% operating margin, less profits than life sciences and diagnostics. While TMO has had CDMO capabilities since acquiring Pantheon in 2017, the recent acquisition of PPD in 2021 adds extensive CRO capabilities in line with the discussed sector leaders. The deal has created new synergies that may be a case study for Medpace to follow moving forward if successful, particularly when it involves moving from the clinical research to manufacturing phase. Based on how WuXi and their subsidiaries have been performing over the years, it is clear the opportunity is immense. The issue is how investors can take advantage now, during the healthcare bear market.

Medpace’s Risky Valuation

Despite solid performance over the past few quarters, the healthcare bear market will soon catch up to Medpace. With one revenue miss already on the books, along with lowered guidance below consensus, I expect the next year to be at risk of weakening fundamentals, particularly falling margins. Despite this, shares continue to trade near all-time highs thanks to MEDP’s clear outperformance amongst peers. At 6.0x trailing sales, Medpace is above its historical valuation, and is unfavorable compared to competitors such as WuXi Biologics, CRL, and IQVIA at 2.6x, ICLR at 3.2x, and even Lonza at 5.1x. I believe that if there is a slight beat of expectations, a valuation below 5.0x will pan out well for investors, but momentum may keep the shares trading sideways for some time.

It is not all bad news though. I believe there is some valuation risk, but I am also a believer that secular opportunity and operational excellence negates most valuation risk. Many of my articles highlight this fact, and Medpace is no exception. And, there are a few unique factors that can negate the risk at the moment. First, any customer shifts from China to the US will likely benefit Medpace, allowing the company to beat expectations. In particular, this would account for pre-clinical contracts that do not have extensive relationships with the Chinese CROs, and want to begin their research lifecycle fresh with Medpace. This will be a short-term and long-term benefit, but due to the geopolitical mess, may create the necessary catalyst for Medpace management to begin an investment in manufacturing. I think it will depend on how many customers they are able to take away from competition, and whether they believe that the CRDMO approach is viable. I certainly believe they should do it.

Conclusion

There is much uncertainty about the fate of Chinese contract companies, but I personally find the risk overblown and globalization will always prevail as it is better financially. But I have no control over the situation, so I believe it is better to negate some risk by pairing my WuXi Biologics investment with Medpace. If WuXi cannot continue working with US customers, I win thanks to my bet in MEDP, but if WuXi continues to operate globally as they do now, then MEDP will still be a solid investment long-term. However, the Medpace bet will face more risk due to the valuation, but I will be adding to my position over months on a recurring basis not making a lump sum purchase. I hope my reasoning makes sense and helps you in your own decision making process. Please feel free to let me know how you are choosing to navigate the current geopolitical situation in the comments below.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.