Model Informed Drug Development Will Face Adoption Friction Yet Ultimately Support A Steady Outlook

Catalysts

About Certara

Certara provides biosimulation software and technology enabled services that support model informed drug development across the pharmaceutical and biotech industry.

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

• Although adoption of model informed drug development is broadening across dosing, efficacy and toxicity work, the recent slowness in Tier 1 services bookings and weaker regulatory services demand could limit how much of this interest converts into higher services revenue and profit growth over the next few years.
• While demand for QSP and biosimulation related to reduced animal testing and FDA guidance on new approach methodologies is building, the current mix of QSP toward services and the low single digit outlook for services growth may constrain margin expansion and earnings growth if software based QSP uptake is slower than hoped.
• Although Simcyp software and Chemaxon are contributing to software revenue and bookings, the shift toward more license based and Chemaxon driven sales reduces the proportion of ratable revenue. This could add volatility to reported revenue and earnings despite healthy trailing 12 month software bookings.
• While new cloud and AI embedded launches such as Phoenix Cloud, Pinnacle 21 Enterprise and CertaraIQ are aimed at expanding usage across discovery, preclinical and clinical phases, pharma customers are still working through internal AI deployment, budgets and data governance. This may delay the timing of broader software adoption and its impact on recurring revenue and EBITDA margins.
• Despite a growing Tier 2 and Tier 3 customer base and increased wallet share over time, ongoing hesitancy and slower decision making among large pharma, combined with the pending outcome of the regulatory services review, introduces uncertainty for services bookings and cash generation that support net income and share repurchases.

Assumptions

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

• The bearish analysts are assuming Certara's revenue will grow by 7.4% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 2.6% today to 4.1% in 3 years time.
• The bearish analysts expect earnings to reach $21.2 million (and earnings per share of $0.13) by about January 2029, up from $10.9 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $53.0 million.
• 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 84.3x on those 2029 earnings, down from 132.4x today. This future PE is greater than the current PE for the US Healthcare Services industry at 53.6x.
• The bearish 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 8.82%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Broadening use of model informed drug development across dosing, efficacy and toxicity, combined with growing adoption among both large pharma and smaller biotech customers, could support higher long term software and services demand than expected, which would feed into stronger revenue and earnings.
• Certara’s focus on QSP and biosimulation, supported by FDA guidance that promotes new approach methodologies and reduced animal testing, may create a structural tailwind for its QSP software and services over many years, which could lift net margins and overall profitability.
• The ramp of new products such as Pinnacle 21 Enterprise, Phoenix Cloud and CertaraIQ, alongside successful integration of Chemaxon with a path to corporate average margins, may increase the software mix and ratable revenue base over time, which could improve EBITDA margins and earnings growth.
• If Tier 1 customer hesitancy in services proves temporary and stabilizes as pharma budgets and pricing visibility improve, while Tier 2 and Tier 3 continue to show good momentum, services bookings and revenue could reaccelerate, supporting higher cash generation and net income.
• Ongoing R&D investment at 10% of revenue, with AI embedded across products and the ability to reuse foundational QSP models, could improve operating leverage over the long run, which may support higher adjusted EPS and expand net margins.

Valuation

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

• The assumed bearish price target for Certara is $9.0, which represents up to two standard deviations below the consensus price target of $12.54. 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 more bearish 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 bearish analyst cohort, you'd need to believe that by 2029, revenues will be $515.0 million, earnings will come to $21.2 million, and it would be trading on a PE ratio of 84.3x, assuming you use a discount rate of 8.8%.
  
• Given the current share price of $9.04, the analyst price target of $9.0 is 0.4% lower. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• 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.