I haven’t looked at a Jeff Brown pitch for a while, so I thought I’d try to answer a raft of recent reader questions with a look at his latest “AI drug discovery” tease.
It’s an impressive-sounding pitch, to be sure, all about how AI can make the discovery and testing of new drugs far more effective and efficient… and, of course, there’s “one tiny company” at the heart of it all, which you’ll only learn about if you pony up $2,000 for a subscription to his Exponential Tech Investor.
Or, of course, if you keep reading and seeing what the Thinkolator can reveal for us… at a much more free-ish price. Though the real cost, of course, is that you’ll have to think for yourself a little bit. It’s OK, thinking can be fun!
Here’s how the ad drew us in…
“While Amazon is using AI to modernize the brick-and-mortar shopping experience, a small, little-known company is using AI to modernize the entire biotechnology industry.
“In fact, this convergence of AI and biotech is completely changing the way drug discovery and therapeutic development is done….
“AI can quickly and cheaply screen a database of existing drugs to determine which ones have a reasonable probability of being effective against other disease targets. That takes much of the guesswork out.
“And it saves millions of dollars and valuable years in the process.”
And then as you proceed to the “presentation” we get the “behind the scenes” references to secret locations and unknown companies…
“Behind the scenes, at a facility tucked away in the northeastern corner of the United States…
“This explosive stock market event—this “Convergence” that’s happened just a few times in human history—is happening again…
“It’s happening at a small cap biotech company, 1% the size of Johnson & Johnson.
“And it’s upending the world of modern medicine as we know it.”
Johnson & Johnson (no relation, sadly) is a $450 billion company, so 1% of that size ain’t exactly tiny… but yes, we’ll stipulate that $4.5 billion would be considered a “small cap” these days. Any other clues?
Yep, we get plenty of hints… but first, a little rundown on what this company’s technology is doing. First, the inefficiencies that create the opportunity:
“… human drug researchers don’t really know what they’re doing…
“Only 1 in 5,000 drugs that are discovered in the lab… actually make it to market….
The process involves sorting through thousands of possible molecular combinations… trying to ‘guess’ the right sequence—the sequence that will become an FDA-approved drug.
“It’s like trying to randomly guess a password….
“Modern medicine as we know it—and the many miraculous cures we’ve found so far…
“All of it was built on that “slot machine”—on that 0.02%.
“So imagine this…Are you getting our free Daily Update
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“Imagine bumping that success rate up… to just 1%.
“What would that mean?
“Well, that would mean 50 times more drugs on the market.
“50 times as many answers to pain, suffering, and disease.”
That’s the basic spiel — smarter systems lead to better drug discovery, leading to more and better drugs, which would lead, one assumes, to more profits for those drug developers.
And that system, of course, is being sold by a small company. Here’s more from the pitch:
“This small cap has found a “new way” to discover drugs.
“This ‘new way’ isn’t aiming at 1% better odds… or 2% or even 3%… it’s aimed much, much higher…..
“This small cap is using artificial intelligence to discover drugs—without human input….
“I found this buried down on page 3, line 24 of a protected government document.
“Per this document, this company’s technology can, quote, ‘evaluate billions of molecules per week’ ….
“… if this AI can evaluate just 2 billion molecules per week, that means it’s no less than 10.3 billion percent faster than human beings.
“10.3 billion percent faster than the people who have discovered every cure to date.”
Other clues? Well, that “corner of the Northeastern US is, you may have heard of it, New York City….
“It’s in operation right now, in a lab in New York, at a tiny biotech company.
“Yet you haven’t heard a word about it.
“You haven’t read about it in the mainstream press… The Wall Street Journal hasn’t put it on its front page.”
And there are some big-name investors involved, as always…
“Bill Gates heard about it, of course. He’s purchased over sixteen million shares in this small cap. His fellow billionaires heard about it. David E. Shaw bought over 9 million shares… Ron Baron owns this stock too. So the information was there… somewhere.
“But most people—people like you—have been kept in the dark. Today that changes.”
And there are bunches of other quotes from luminaries and brand names to support Brown’s assertions of the special-ness of this stock…
“The research branch of the infamous hedge fund, Citron Research, called this AI the ‘most disruptive software platform to ever hit the pharmaceutical industry’….
“They also called this company ‘even more compelling than an early-stage Tesla’—they mentioned the word ‘Tesla’ fourteen times throughout the eight-page document….
“A business scholar from the University of Michigan published an analysis in which he wrote, quote, ‘the market is missing the disruptive potential of [this small cap]’….
“Business Wire, a company owned by the oracle of Omaha himself, Warren Buffett, says, ‘[this small cap] is transforming the way therapeutics are discovered.'”
That’s way more info than the Thinkolator needs, thankfully, so we’ve got an answer for you… if you want to join us on that voyage of self-discovery, you can find the sources of those quotes from Citron’s report (Feb. 2020), for example, but we should also call out the silly name-drop of Warren Buffett there — Business Wire is just a press release distribution platform, and that quote is included in pretty much every single press release this “secret” company puts out. The full quote, which has nothing to do with Warren Buffett, is…
“Schrödinger is transforming the way therapeutics and materials are discovered. Schrödinger has pioneered a physics-based software platform that enables discovery of high-quality, novel molecules for drug development and materials applications more rapidly and at lower cost compared to traditional methods.”
So yes, this is, as some have no doubt already guessed, a tease leading to a recommendation to buy Schrodinger (SDGR).
Which is an interesting company, for sure, and one that I put in my Lock Box portfolio after it dropped a couple months ago (though it has dropped further still since then). What else does Jeff Brown say about them?
“Each of the top 20 pharmaceutical companies in the world have now entered contracts with this small cap to use its technology.”
That’s true, they’ve essentially got every major company in the industry using their platform for drug discovery, to at least some degree. It’s sold on subscription, like any other cloud platform, and they had total software revenue of $92.5 million last year, with annual contract value growing at a 16% CAGR over the past seven years — which is not nosebleed growth for a SaaS company, but it has accelerated in recent years (up 22% last year). They have 16 customers who each generate more than $1 million in annual contract value, up from 10 in 2019, and they had 99% customer retention.
That makes them a pretty interesting cloud software company, though it would be understandable if you didn’t feel like paying 40X sales for a software company that’s growing subscription software revenue at 20% a year. That is a little steep, even in the context of the crazy valuations we’ve seen in SaaS land in the past year.
There is more potential growth on the software side, and Schrodinger makes clear in their presentations and investor calls that they believe the growth potential remains high in that sector because their large users are still not really “power users” and can dramatically increase usage of the system (and therefore revenues) as they begin to accept the benefits it provides… but the big potential beyond that base level of subscriptions might be from the other ways in which they get a piece of drugs that are discovered on their platform… more from Jeff Brown on that…
“There’s a reason why everyone is going to hear about this small cap soon—there’s a reason its name could soon appear on the front page of The Wall Street Journal.
“But it’s not just because of its contracts with Big Pharma.
“It actually has to do with the ‘Second Phase’ of this small cap’s business model.”
Oooh, oooh, what is it? What’s the “second phase?”
Prepare to take a blood oath, here’s more from Brown:
“What I’m about to share next is strictly private.
“I ask that you do not disclose it to anyone, for any reason.
“This stays between you and me….
“This small cap isn’t just renting out its AI to Big Pharma.
“As of today, in virtual secrecy…
“It’s using its AI for itself. To create something remarkable… to create its own ‘miracle’ cure.
“Meaning the gains on the table could be even more massive.
“Because when a small cap company can create its own drug…
“The upside could be bigger than anything we’ve discussed so far.”
OK, so no, it’s not “strictly private” — they haven’t made a huge amount of progress on their plan to develop their own drugs just yet, but they sure talk up the potential with investors every chance they get… this is from their “corporate profile”:
“Schrödinger’s industry-leading computational platform facilitates the research efforts of biopharmaceutical and industrial companies, academic institutions, and government laboratories worldwide. Schrödinger also has wholly-owned and collaborative drug discovery programs in a broad range of therapeutic areas.”
So yes, that’s the basic outline of why any investor would buy the company: The software sales create pretty steady cash flow, and the company has a bunch of collaborations with pharma companies that would lead to royalties on any future approved drugs, as well as a pipeline of it’s own (very early stage) molecules that they’ve discovered and are preparing for possible clinical trials.
The company has been teased before, back in February when Chris Wood touted it (and when the price was about $50 higher)… this is what I said after my first look at the company back then:
“If I were to buy SDGR (I’m not planning to at the moment), it would not be on a near-term bet that something big will happen, it would be on a bet that they might have a dozen good things happen over the next five years, with the growing software sales helping them to avoid burning too much cash while they wait for drug development deals to become commercially meaningful, and I’d try to mostly ignore the share price in the interim — it will probably be a long time before the business catches up with the market valuation, but you can see that it’s clearly possible if the trajectory of their software sales continues and their collaborations yield some fruit and begin to generate meaningful revenue at some point. The main risk today is that, as with so many popular growth stocks, current valuations mean you’re prepaying for quite a bit of success that might or might not happen in the future. Bill Gates waited 10 years before he started selling shares, you might have to wait a bit as well.
“There are only a couple analysts making guesses on SDGR’s future, but right now they expect the company to become profitable next year and for revenues to double between 2020 and 2022. They have continued to raise their price targets over the past few months, but they can’t keep up with the investor enthusiasm for the shares.”
And after the stock fell 40% or so to below $70 in March, I added it to my Lock Box portfolio. Here’s a little bit of what I wrote at the time:
Schrodinger (SDGR) has come up several times in teaser pitches and pundit commentary in recent weeks, and that stock also got clobbered on earnings — so it has now lost about 30% of its value in a week or so, and the share price is back to where it was in December, around $70. The shares are still up 80% since they went public about a year ago, but everything is relative. The reason the shares got clobbered, other than the general panic about richly valued stocks, is that they issued guidance for 2021 revenues that was wildly lower than analysts had been forecasting — I expect that’s partly because of a misunderstanding about how much revenue would be recognized from their big Bristol-Myers Squib deal announced last year, partly conservatism in the face of what is likely to be lumpy revenue, and partly just that we don’t know this company very well yet — they’ve been public for less than a year.
The valuation is still nutty by any historical standard, at 30X next year’s revenue, and that’s probably too much to pay for a cloud software platform that’s still in a fairly niche area of drug discovery… but the reason to consider it is the pharmaceutical partnerships beyond that and the actual drug discovery work, which, if they bear fruit (that’s a big “if”) will lead to milestone payments and royalties. It will be a bumpy ride, and it might fail completely, but it will need time to play out as they develop their drug targets for Bristol-Myers Squib (BMY) and begin to bring their self-developed targets into the clinic, and if the early indications of success turn into something much more compelling it could really snowball with milestone payments and royalties over the next decade….
The primary risk that analysts and investors seem to be worried about is whether or not they’ve “used up” their target market, since they already work with most of the large pharmaceutical companies, but that doesn’t particularly worry me — the platform can be used lightly or heavily, with variable costs, and their customers mostly use it lightly so far… so there’s potential growth as they become familiar with it and begin to use it more, assuming that it continues to work well for them (retention is very strong), and there’s also the just-barely-tapped market outside of pharmaceuticals as they sell their software platform to materials companies who are looking for the best molecular interactions for things like new battery materials.
And how’s the progress? Brown implies that he’s got some special info:
“This small cap is using its AI to create a drug that would, if discovered successfully, completely eradicate one of the deadliest conditions in existence: cancer
“Pancreatic cancer, to be exact.
“This type of cancer has eluded human scientists for decades—and, if nothing is done… it’s set to be the second most common cause of death within the next ten years….
“This cure isn’t just an “idea.”
“This small cap’s AI is already discovering it—as we speak.
“This possible cure is mere steps away from making it into human patients….
“I know this because it came straight from the CEO’s mouth.
“I’m not adding any interpretation to this.
“He stated, in his own words:
“‘We expect to initiate [the first step of the “golden path”] later this year'”
And, of course, he implies that this info was shared in some secret confab for only the uber-elite…
“This small cap’s CEO didn’t say this to a big crowd… he didn’t say it in an interview on TV…
“He said it somewhere only people like me are looking—a location I frankly can’t disclose at this time.
“What I can say is…
“I believe when this hits the wire, all bets will be off.”
OK, so we can pull back the curtain there… this is just a quote from the CEO’s opening remarks in their March quarterly conference call, the actual words were “we also made excellent progress on our discovery pipeline and expect to initiate IND-enabling studies later this year for multiple programs,” according to the Motley Fool’s transcript.
“IND-enabling” is still a pretty early stage, to be clear — that means you’re doing the lab research that would provide enough data for you to apply for IND status (that stands for Investigational New Drug) with the FDA, and if they approve that then you can put that drug into a human being for the first time as you launch Phase 1 clinical trials. Drug discovery is speeded up by the ability to use AI and their massive processing power to select molecules for their precise interactions with other molecules, but that doesn’t mean the process of actually getting regulatory approval and testing the drugs in humans is going to be any faster than usual, so prepare to wait.
Who knows, though, sometimes stocks move significantly on news that a drug is entering the clinic… or on the first news releases about early results from those clinical trials. Neither of those things will be coming from Schrodinger this year, it appears, this is what their Head of Discovery R&D said this week in their first quarter update:
“I will highlight three of our most advanced programs, MALT1, CDC7 and Wee1. Based on the strong data we have generated to-date, we plan to move forward with IND enabling studies for these programs. Subject to completion of the preclinical data packages, we expect to submit up to three IND applications in 2022, with our first submission expected in the first half of next year. “
That Wee1 inhibitor drug they’re developing, which they call SDGR2, could be used to target pancreatic cancer, so that might be the specific drug Brown is hinting at (though they haven’t narrowed it down that specifically yet), and I’m definitely not an expert on the science involved here… so I’ll just issue my typical reminder that it’s going to take a while, and failure in these early stages is common. Maybe it will be less common with a molecule that is vetted for its physical properties and interactions as well as those discovered using Schrodinger’s technology, perhaps there’s lower probability of surprising side effects or higher probability of efficacy, but that’s really still just conjecture at this point.
And that also means the news flow might be a little less immediate than Jeff Brown implies (which is common, newsletters need to generate a sense of urgency to make sales), since Schrodinger won’t even be asking for permission to test their first drug on humans for probably a year or so… clinical trials are still quite a ways off. You’ve got time to think it over before their self-developed drugs get onto that “golden path” (which seems to mean just, “beginning clinical trials”).
If you want some further confirmation, that quote about “billions of molecules per week” appears several times in Schrodinger’s SEC filings, (or, if you want to make them seem more mysterious, “protected government documents”), like this in their IPO registration filing (S-1):
“Speed. Our platform is able to evaluate molecules in hours rather than the weeks that it typically takes to synthesize and assay molecules in the laboratory.
“Scale. Our platform can explicitly evaluate billions of molecules per week, whereas traditionally operated discovery projects only synthesize approximately one thousand molecules per year, thereby increasing the probability that we find a novel molecule with the desired property profile.
“Quality. In a peer-reviewed study, our platform was tested against traditional methods for selecting tight-binding molecules and resulted in an eight-fold increase in the number of molecules with the desired affinity.”
We should be clear about what’s being claimed versus what Jeff Brown is touting, however — Schrodinger believes, with evidence, that their platform can help cut the time for drug development in half and make it more efficient and effective. That’s a really big deal, but when teaser pitches start throwing around phrases like “10.3 billion percent faster,” well, we might get an unfortunate tendency to overreact. There are lots of different AI-powered drug-discovery and molecule testing strategies in use now and being developed in labs, Schrodinger’s is not the only one… though it is one platform that has been adopted for at least some use by almost all the major pharma companies, and the company sees a huge potential to ramp up usage as those companies see the results of their initial work and begin to use Schrodinger’s platform more aggressively.
And Schrodinger’s biggest partner is also name-dropped in Brown’s ad, in case you’re curious about the “free” stock he gave away in his presentation:
“I told you earlier I’d give you the ticker of a company on the ground floor of this major moment in biotech and AI — this ‘Convergence’ — for free….
“As a thank you for sticking with me right up to the end, here it is: Bristol-Myers Squibb. Stock ticker “B-M-Y.”
“This company is sitting right at the epicenter of this small cap’s “Convergence”.
“Bristol-Myers Squibb is actually partnering with this small cap.
“They’re looking to take a cut of the profits if one of this small cap’s drugs goes to market, so they’ve agreed to handle the “dirty work,” like marketing and distribution, in return for a piece of this small cap’s sales.
“It’s an incredible deal for Bristol-Myers Squibb.
“But, of course, as great as this deal is… Bristol-Myers Squibb is, as you know, a large cap company. A market cap of $140 billion.
“As I’ve shown you, it might see a modest bump from this news, maybe it won’t—that’s the nature of large cap companies like it.”
That collaboration between Schrodinger and Bristol Myers was announced back in November, and it is a big deal — with the potential for billions of dollars in milestone payments and some good royalties if drugs are successfully developed and commercialized… though investors reacted lustily to the news and drove the shares up dramatically after that, and then sold them off when it became a little clearer that this collaboration was not going to instantly double revenues.
SDGR did not change their forward guidance for 2021 this quarter (which perhaps is another reason for recent weakness in the shares), so they’re anticipating $133 million in revenue this year — and have made it clear that milestone payments will not be as consistent or imminent as was originally anticipated by some analysts back in November, so they’re not likely to be profitable this year or next. That’s really the shock to the system that caused the share price to falter this year — analysts overstated the immediate impact of the BMY deal and sent the 2021 revenue estimates to $175 million or so, with expected profitability right away (47 cents/share in earnings forecast), and SDGR threw cold water on that in March and sprinkled slightly more on top this week. Now profitability is pushed out to 2023, most likely, though the business is very hard to predict and analysts have probably over-corrected on the pessimistic side, and SDGR is valued at about 30X 2021 sales and about 19X forecasted 2022 sales.
I continue to think Schrodinger is an appealing speculation for the long term, because of both the possibility of meaningful growth in subscription revenue and the many partnerships and development programs that could bear profitable fruit in the future. Revenue is still growing nicely from both milestone payments and their fairly steady SaaS revenues, but investors are also a bit more leery of paying big multiples these days, and the obvious catalysts