Biosimulation Expansion And AI Products Will Drive Long Term Margin Upside

Catalysts

About Certara

Certara provides biosimulation software and technology enabled services that help biopharma customers accelerate and de risk drug development.

What are the underlying business or industry changes driving this perspective?

• Rapid expansion of model informed drug development across discovery, preclinical and clinical phases, supported by FDA guidance on new approach methodologies and reduced animal use, should structurally increase demand for biosimulation software and QSP services. This could lift long term revenue growth and shift the mix toward higher margin offerings.
• Chemaxon integration and the build out of a unified discovery to development platform, combined with strong Simcyp growth and 104% software net retention, position Certara to capture larger enterprise wide footprints and wallet share. This supports the potential for sustained double digit software revenue growth and operating leverage.
• New cloud and AI enabled products such as Phoenix Cloud, Pinnacle 21 Enterprise and CertaraIQ create standardized, reusable models and workflows that scale globally. This should help drive recurring license uptake, expand subscription share and enhance gross margins and earnings power over time.
• Accelerating QSP demand in biologics, large molecules and complex modalities, together with foundational disease models that can be sold repeatedly, creates a high value, differentiated revenue stream that may outgrow the rest of the portfolio and support higher blended net margins.
• An improving mix toward software, disciplined cost management and productivity gains in services, plus lower interest expense from the term loan repricing and active share repurchases, collectively provide a multi year path for adjusted EBITDA margin expansion and potentially faster growth in adjusted EPS than in headline revenue.

Assumptions

This narrative explores a more optimistic perspective on Certara compared to the consensus, based on a Fair Value that aligns with the bullish cohort of analysts. How have these above catalysts been quantified?

• The bullish analysts are assuming Certara's revenue will grow by 8.8% annually over the next 3 years.
• The bullish analysts assume that profit margins will increase from 2.6% today to 11.0% in 3 years time.
• The bullish analysts expect earnings to reach $58.6 million (and earnings per share of $0.36) by about December 2028, up from $10.9 million today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as $4.7 million.
• In order for the above numbers to justify the price target of the more bullish analyst cohort, the company would need to trade at a PE ratio of 54.1x on those 2028 earnings, down from 125.6x today. This future PE is lower than the current PE for the US Healthcare Services industry at 56.2x.
• The bullish analysts expect the number of shares outstanding to decline by 1.08% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.79%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Persistent hesitancy and delayed decision-making among Tier 1 pharma customers in services, already driving only 1% bookings growth and a 9% decline in services bookings, could signal a structurally slower spending environment that caps long-term services revenue growth and constrains total company revenue.
• Organic growth remains modest at 3% to 4% over recent years and software organic revenue grew only 6% despite acquisitions and product launches, suggesting the core business may not naturally support the high single digit to double digit growth implied by a bullish view, which would limit long term earnings expansion.
• The regulatory services business has experienced inconsistent performance and double digit bookings declines while still being relied on for cash generation, so any divestiture or restructuring outcome from the ongoing strategic review could reduce cash flow support and weigh on net margins and earnings if not offset quickly by higher margin software growth.
• Chemaxon currently contributes a meaningful portion of software growth and is largely license based, so if its growth normalizes or customers shift away from upfront licenses, the mix driven gross margin tailwind could reverse and pressure overall gross margins and profitability.
• Heavy investment in R&D, up 24% year over year and now 10% of revenue, alongside aggressive AI and cloud product development may not translate into proportionate adoption if customers prioritize their own internal AI initiatives or slow spending cycles, which would compress the return on investment and limit future net margin and earnings improvement.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bullish price target for Certara is $16.0, which represents up to two standard deviations above the consensus price target of $12.96. This valuation is based on what can be assumed as the expectations of Certara's future earnings growth, profit margins and other risk factors from analysts on the bullish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $16.0, and the most bearish reporting a price target of just $9.0.
  
• In order for you to agree with the more bullish analyst cohort, you'd need to believe that by 2028, revenues will be $535.4 million, earnings will come to $58.6 million, and it would be trading on a PE ratio of 54.1x, assuming you use a discount rate of 8.8%.
  
• Given the current share price of $8.58, the analyst price target of $16.0 is 46.4% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.