With the frothiness of the artificial intelligence (AI) craze in full swing, Schrödinger (SDGR -2.61%) is a biotech that investors should know about now. While many questions remain about the viability of its business model and its ability to grow in the long term in the face of mounting competition, for the moment it's one of the leaders in the field of information technology-driven drug development.
But is right now the best time to make an investment given the market's fervor when it comes to everything remotely associated with AI? Let's investigate in closer detail.
Aiding in drug discovery and development
Schrödinger is a leader in the field of technology-assisted drug discovery and development. It uses a combination of molecular modeling, machine learning, and computational chemistry, along with plenty of raw data on structure-function relationships across a swath of different biological molecules, to find promising leads for drug development.
The company is also using its platform to advance therapy programs of its own. While management doesn't market the business as relying on AI, it's likely that AI will eventually become a core pillar of its platform, too. The company's pitch is that this approach can produce candidates that are cheaper, more effective, and take less time to develop than with traditional drug discovery. Therefore, the idea of the business model is that customers will be willing to pay to use that platform, whether by licensing its software directly or by initiating joint development pacts.
It already has standing collaborations with global biopharma heavyweights like Bristol Myers Squibb, Eli Lilly, and Sanofi, not to mention a few biotechs like Structure Therapeutics. Those collaborations and partnerships ideally will grant it access to a significant sum of milestone payments as well as potential royalties from any medicines that end up being marketed as a result of the joint work.
Given that Schrödinger won't make any revenue from sales of its internally developed medicines for a number of years, as its most mature programs are still only in phase 1 clinical trials, the milestones and royalties could help to hold it over and keep the lights on.
It's early in the game, and it isn't the only player
There are a couple of reasons to hesitate or perhaps even avoid buying this stock at the moment. The first reason is that its top line isn't steadily growing. In the second quarter of this year, its revenue dipped by more than 8%, arriving at just over $35 million. In short, there aren't yet any signs of a gold rush sending customers and collaborators flocking toward the company's drug discovery platform.
Another trouble is that Schrödinger already faces a lot of competition, and it's still the early innings. Fellow biotech competitors like Recursion Pharmaceuticals and 23andMe are developing similar platforms to accelerate the drug development process. Even powerful players that haven't traditionally competed in healthcare, like Nvidia, are starting to dabble, too. While there is no evidence of a fierce competitive battle yet, eventually it's guaranteed -- and that'll pressure Schrödinger's margin.
On the note of its margin, investors should appreciate that this company's operations aren't consistently profitable, and there is no telling when or if that'll change. It's more accurate to say that it's burning money; in the second quarter, it reported a cash outflow of $21 million. Nonetheless, it has $194 million in cash, equivalents, and short-term investments, so it can still sustain roughly that rate of cash burn for quite some time.
Does it make sense to buy it?
In the long term, one or more companies like Schrödinger are likely to grow tremendously, assuming their core claims about the utility of these platforms are proven true. The simple fact of the matter is that most of the low-hanging fruit for drug development has already been picked in the period of rapid biomedical progress between roughly 1980 and today.
Research and development (R&D) expenditures by drugmakers will thus continue to rise as they attempt to create more complex drugs for harder-to-address illnesses and symptoms, and for smaller and harder-to-access patient populations. Such a setup implies that any tools capable of reducing the pain points of that process will be seen as valuable.
So far, Schrödinger's growing roster of high-powered collaborators implies that the door to success remains wide open. But for investors who want a sure thing, this stock isn't it. It'll be a long time before the business has a stable niche. On the other hand, if you're patient and willing to accept the moderate risk of its falling short, then the potential upside could be worthwhile.
Be sure to check out this company's third-quarter earnings report when it's published on Nov. 1 to get a better feeling for how its margin and its top line are developing.
