Description

Simulations Plus trades at 20x revenues and 70x eps, and is probably worth 80% less than its current level.  The company sells software that aids in drug discovery, most notably Gastroplus which models the absorption of new compounds through the bowel.  Basically, these programs allow companies to rule out certain compounds based on statistical rules instead of experimentially.

Sales have grown recently through recent product launches in late 2006, but the market is ultimately much smaller than the market capitalization indicates.  Every large pharmaceutical company is already a subscriber, and the subscription price is too high for smaller companies to pay.  Once consultant (whose clients are smaller biotechs) with whom we spoke said that perhaps 20% of the companies could use the software, or roughly one hundred companies.  These would be much contracts than the current average contract size, which is roughly $100,000, so perhaps this could add 50% to revenues from the current level.  Another consultant said, “I would be absolutely shocked if the revenues doubled from here”.

In our due diligence, there is significant skepticism about how much reliance should be placed on these programs, since the data used for the program assumptions are slightly controversial, and most companies have had mixed results.  There are a shortage of computational chemists, and the current programs are generally used in a centralized computational chemistry lab (the drug discover labs send over compounds and wait for the results), as they are too complicated for non-trained users.  In addition, there are political issues within pharmaceutical companies, as adopting the software involves a power struggle between departments, and many people do not believe in the software.

Gastroplus has a great franchise and little competition, though there is some language in the 10-Q about competition increasing.  There is much more competition in the recently-introduced programs (ADME- absorption, distribution, metabolism, excretion), with many vendors offering good programs, so these will be tougher sales.  As evidence of this, while revenue growth still seems robust on a YOY basis, there has been sequential revenue decline in each of the last 2 quarters.

The company has 9.5 million shares and no debt.  If we assume that they can double revenues from here, that would lead to $17m of revs and .40 of eps, or roughly 40x.  A competitor called Pharsight (PHST) has an enterprise value of $36m and sales of $25m; another called Accelrys an enterprise value of $115m and sales of $80m.  If SLP traded at this 1.5x revenue multiple, the stock would trade at $3 assuming they double their revenues from here.  There has been significant insider selling recently, (in order to pay for the CEO's new private plane).

Catalyst