The Case for Schrödinger (NASDAQ: SGDR)

Brit Ryle

Posted April 3, 2023

It’s writing term papers for college students and complex computer code for programmers. It’s drafting legal documents, driving autonomous cars and developing pharmaceuticals…

For better or worse, the Artificial Intelligence (AI) revolution is here.

This year (2023), AI products, software and services are expected to generate $500 billion in revenue from businesses and governments looking for better and faster ways to make use of the massive amounts of data our digitized world generates. 

With Microsoft’s release of its latest version of Bing, we’re just now getting a taste of AI-powered search engine. Other industries have been using AI for years…

Like the pharmaceutical industry.

Back in 2016, Pfizer (NYSE: PFE) hooked up with IBM (NYSE: IBM) to use IBM Watson to speed up its drug development process. And in 2018, Pfizer joined MIT’s Machine Learning for Pharmaceutical Discovery and Synthesis Consortium.

Today, AI is an integral part of every pharmaceutical companies’ drug development process. 

  • Pharmaceutical companies currently use AI to forecast sales and manage supply chains; and to identify new uses for clinical stage molecules for treating genetic diseases; and to identify potential drug candidates  
  • AI algorithms are used to predict the presence of disease, risk of disease progression, and response to treatment and to develop more accurate models to predict which compounds could be promising in the later stages of drug discovery and development.  
  • With cancer research, AI is used in clinical trials to better understand the expected outcomes of various cancer treatments.  
  • AI is being used to predict dementia and neurodegenerative diseases using voice samples; to process images of cardiovascular, lung perfusion and pulmonary vessels to treat hypertension  
  • AI is helping to identify and validate combinations of drug targets for metabolic disorders like diabetes.

That’s just a taste of how the pharmaceutical industry is using AI to streamline their operations and speed the discovery and development of new drugs and treatments. 

It’s important to understand that there are many companies out there delivering the AI goods to Big Pharma. And there is no all-in-one solution that can provide for the wide range of needs from each pharmaceutical company. Each of the 20 biggest pharmaceutical companies buy software and services from several different AI companies. And sometimes they even partner with these companies.

If you start digging into the the space, you’ll find that a Big Pharma company like Pfizer or Merck, for instance, uses AI applications from companies like AtomWise, Iktos, CytoReason, BioXcel, along with the company I’m here to tell you about today: Schrodinger (NASDAQ: SDGR)

The Case for Schrodinger (NASDAQ: SDGR)

Current price: $26

52-Week Range: $15.86 – $36.33

Market Cap: $1.5 billion

2023 Revenue (est): $238 million  

2024 Revenue (est): $320 million

Forward P/E: N/A

Price-to-sales: 10

12 Month Price Target: $41

I do not invest in biotech stocks. I’m not a doctor. I’ve never played one on TV. Therefore I do not have the expertise to evaluate whether a particular biotech is on the right path with its development of a particular compound into an effective treatment…

And the risks of an uninformed biotech investment are severe. A botched clinical trial or failure to gain FDA approval can send a biotech stock plunging. I’d rather not take a hit like that in my own investment portfolio, and I’m certainly going to advocate that kind of risk to my readers.

But with that said, I am not at all opposed to a “picks and shovels” type of investment opportunities in the biotech/pharma space. Schrodinger is one such company.

Schrodinger is a “computational chemistry” company. It codes physics and chemistry into a software platform so that pharmaceutical companies can model molecules that could become new drugs. The platform can explore billions of molecules over the course of a couple days. 

The “chemistry” part refers to the actual modeling of a molecule. Schrodinger’s software platform allows for the discovery, modeling and testing of molecules that could treat disease. And the physics aspect is, in part, about the delivery of said molecule, as in, getting it through the stomach wall, or through a cell wall, or even through the blood-brain barrier. 

All 20 of the largest pharmaceutical companies in the world use Schrodinger’s software platform. And Schrodinger also has 1,750 biotech companies as customers. “Ubiquitous” might be too strong a word to describe Schrodinger’s technology, but it is widely used. 

In addition to licensing its drug development platform, it also runs its own drug development program and seeks to partner with biotech/pharma companies for the development of its novel compounds. 

One such partnership with Nimbus Therapeutics just resulted in a $100 million payout to Schrodinger after Takeda Pharmaceuticals bought the TYK2 inhibitor which will aid in the treatment of psoriasis. Another $32 million is coming in the next month or two.

Schrodinger currently has 15 development partnerships working and 18 in-house development programs that could eventually turn into partnerships.

Still, software licensing is Schrodinger’s bread and butter. And the sales strategy is to sign 2-3 year contracts with its customers, and then upsell customers on broader access to the platform during the life of those contracts.  

In 2021, Schrodinger had 2 customers paying $5 million annually. In 2022, the number of $5+ customers doubled to 4. The gross margins for Schrodinger software is above 80%. And it is the upsell that is expected to drive software revenue growth of 13% – 17% over the coming year. 

Now, Schrodinger is not profitable yet. In Fiscal 2022, total operating expenses increased to $248 million compared to $177 million in 2021. 2022 revenue was up 31% from 2021, to $181 million. The company spent $120 million in cash, and finished the fiscal year with $456 million in cash. Add in the $132 million that Schrodinger is getting from Nimbus and the company has enough cash to get to profitability. 

Institutional Darling

Schrodinger went public on February 6, 2020 at $26 a share. Its all time highs above $100 were hit early in 2021.

Anytime a growth stock stops hitting its growth targets, the stock will get crushed. And that’s exactly what happened in March of 2021 when the company forecast revenue growth of 25%. 

But now, with the stock trading below $30, it’s a whole different ball game. The stock is reasonably priced for current growth expectations. And I’m not the only one who thinks so: 80% of its stock is owned by institutions, and they are adding.

Woodline Partners recently bought 462,345 shares, raising its stake in shares of Schrödinger by 425%.  in the second quarter. JPMorgan added 133,277 shares to bring its total holdings of Schrodinger stock to 435,064 shares. Stephens Investment Management bought 54,683 shares to bring its total ownership to 776,532 shares. And Lazard is another significant owner with 645,861 shares of the company’s stock.

Most analysts rate Schondinger highly. Yeah, Goldman is kind of lame, with a “neutral” rating and a $23 price target. But Citi calls the stock a “buy” and has a $51 price target. BMO rates it “outperform” with a $78 target. And Piper Sandler says “overweight” the stock and has an $87 target for the stock.

I rate Schodinger a “strong buy” under $29 and I’m putting a relatively conservative $41 price target for the stock over the next 12 months.

That’s it for me today, take care and I’ll talk to you on Wednesday…

Briton Ryle
Chief Investment Strategist
Pro Trader Today