Biopharma Budget And Pricing Will Curb Margins But Yield Promise

Key Takeaways

• Near-term revenue and profit growth are challenged by biopharma client budget constraints, delays, and industry consolidation despite strong long-term digitalization trends.
  
• Rising competition from open-source AI and global cost pressures threaten pricing power and margin expansion, even as new product features drive competitiveness.
  
• Weak biopharma demand, pharma client consolidation, software churn, project delays, and costly M&A missteps are driving recurring revenue risks and margin compression pressures.

Catalysts

Develops drug discovery and development software for modeling and simulation, and prediction of molecular properties utilizing artificial intelligence and machine learning based technology worldwide.

• Although regulatory developments and macro health trends are structurally increasing demand for in silico drug development and predictive software, Simulations Plus is currently facing budget constraints and funding pressures across biopharma clients, leading to a slower pace of contract awards and deferred projects, which is likely to suppress near-term revenue growth until end-market stability returns.
  
• While expanded use of advanced modeling, AI, and automation in drug development holds long-term promise for increasing software adoption and productivity gains, the company must contend with growing pricing pressure from drug price controls and healthcare cost containment globally, which could cap the growth in licensing revenues and moderate future earnings expansion.
  
• The introduction of new AI-driven features across Simulations Plus' portfolio-including the cloud-based GastroPlus update and broader cross-product AI integration-should enhance competitiveness over time, but there is a significant risk that continued rapid advances in open-source AI and analytics tools could undercut the company's pricing power, putting downward pressure on software gross margins.
  
• Despite reinforcing its product ecosystem and expanding its total addressable market through acquisitions such as Pro-ficiency and strategic investments like Nurocor, Simulations Plus remains exposed to biopharma industry consolidation and client site closures, which have already driven down renewal rates and threaten to reduce recurring software revenue if these trends continue.
  
• While multi-year digitalization tailwinds suggest higher long-term adoption of Simulations Plus' solutions, persistent delays in service project initiation, client cancellations due to failed drug programs, and ongoing cost discipline at major customers may weigh on near-term profitability and make net margin recovery slower than anticipated, even as operational efficiency improvements kick in.

Simulations Plus Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Simulations Plus compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Simulations Plus's revenue will grow by 3.8% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from -78.6% today to 20.0% in 3 years time.
• The bearish analysts expect earnings to reach $18.0 million (and earnings per share of $0.87) by about July 2028, up from $-63.2 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 27.6x on those 2028 earnings, up from -4.2x today. This future PE is lower than the current PE for the US Healthcare Services industry at 59.7x.
• Analysts expect the number of shares outstanding to grow by 0.3% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.42%, as per the Simply Wall St company report.

Simulations Plus Future Earnings Per Share Growth

Risks

• Persistent headwinds in the biopharma sector-including patent expirations for large pharma, Inflation Reduction Act pricing pressures, reduced NIH and FDA budgets, and capital constraints for biotech-are causing extended caution and slower spending by key clients, directly lowering near-term revenue growth and potentially stalling longer-term earnings expansion.
  
• Recent consolidation and site closures among pharmaceutical and biotech clients have led to a significant decrease in software renewal rates, especially for key products like GastroPlus and MonolixSuite; this trend introduces greater risk of further client attrition and shrinking recurring revenues.
  
• Simulations Plus is experiencing increased pricing pressure and longer sales cycles for services, while project delays and cancellations-including substantial loss from a major client's canceled drug programs-are dampening services revenue and making earnings more volatile.
  
• The company recently recognized a $77.2 million noncash impairment charge related to acquisitions, reflecting near-term decreases in asset value and raising questions about the effectiveness of its M&A and organic growth strategies, which could impact future net margins if integrations or acquired business lines underperform.
  
• Despite enthusiasm for innovation and AI integration, R&D and operating expenses may need to increase further to remain technologically competitive, especially as AI-driven and open-source tools proliferate; this could lead to ongoing margin compression and higher cost structures if revenues don't accelerate accordingly.

Valuation

• The assumed bearish price target for Simulations Plus is $20.0, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Simulations Plus's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $31.0, and the most bearish reporting a price target of just $20.0.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $89.9 million, earnings will come to $18.0 million, and it would be trading on a PE ratio of 27.6x, assuming you use a discount rate of 7.4%.
• Given the current share price of $13.27, the bearish analyst price target of $20.0 is 33.7% 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.