Solt DB's home state of Pennsylvania has no native monkey population, but that was at risk of changing during late January 2022.

A pickup truck collided with a cargo truck carrying non-human primates (NHP) destined for medical research, and a handful of cynomolgus macaque monkeys escaped. They called the snowy pines of Danville, Pennsylvania home for several hours before being captured with help from locals, firefighters, and a state police helicopter using a thermal imaging camera.

The timing couldn't have been worse. The drug development industry was facing a shortage of NHPs, instrumental for the last step in preclinical research activities, following the global race to develop COVID-19 therapeutics. Pipelines were delayed across nearly all therapeutic modalities as a result of the pandemic. Every additional delay, like overturned cargo trucks in Pennsylvania, added more pain.

Wouldn't it be nice if the industry could simulate animal studies with virtual comparisons? A virtual monkey #virtualmonkeys, perhaps? That's where biosimulation leader Certara comes in.

Certara is developing a technology platform that allows over 2,000 customers, including regulatory agencies such as the U.S. Food and Drug Administration (FDA), to simulate biology virtually. The company's tools have allowed companies to earn FDA approvals for generic pediatric acne medications without conducting clinical trials, suggest appropriate drug labels without additional studies, and yes, even simulate NHP studies on a computer. #virtualmonkeys

Solt DB Invest considers Certara an Anchor position, which means it doesn't require much babysitting and is a great long-term buy-and-hold candidate. However, the business can be difficult to understand and difficult to categorize with blanket investment terms.

Talk Nerdy to Me

Certara is a biosimulation company providing software and services to global drug developers. It counts over 2,000 customers across 62 countries, the average tenure of its top 30 customers spans over a decade, and over 8,000 scientific publications mentioned biosimulation in 2022. The FDA continues to incorporate biosimulation into guidance for the industry to improve animal and patient safety, increase the efficiency of drug development, and accelerate time to market.

Cool, but what the hell is biosimulation?

Drug developers have to gather certain types of data to earn clearance to initiate clinical trials and ultimately earn regulatory approvals.

• Pharmacokinetics (PK) is the study of how a drug moves through the body. How is a molecule absorbed, distributed, metabolized, and excreted?
• Pharmacodynamics (PD) is the study of how drug concentration affects biology and therapeutic effect. What dose is effective and with what side effects – and why?

For a real-world example, Relay Therapeutics needs to know PK and PD metrics for phase 1 clinical trials to understand the selectivity of its drug candidates (a primary value-add for its Dynamo platform), which informs the safety profile and comparisons to competing modalities, such as protein degraders, on comparisons of receptor occupancy. That's a nerdy way of asking, "how effective is the drug, what are the side effects, what's the highest dose we can get away with, and how competitive is this option against all other options?"

Certara has built computational models to simulate PK and PD for 10 organs, multiple therapeutic modalities (ex: AAV gene therapy, monoclonal antibodies, etc.), and various applications. For example, the company's software can help drug developers understand dose ranges for a phase 1 clinical trial, predict kidney or heart side effects, understand differences between adult and pediatric patients, or even how diet affects medications.

Certara provides value to customers in multiple ways – and not just through biosimulation:

• Software comprises roughly one-third of revenue. The aggregate renewal rate is roughly 92%.
• Biosimulation software spans drug discovery (think Schrodinger) and drug development (designing clinical trials and selecting patient populations). The discovery side occurs before humans are involved and relies more heavily on simulation #virtualmonkeys, while the drug development side occurs both virtually and with real human patients.
• Tech-driven services comprise roughly two-thirds of revenue. The net revenue repeat rate is roughly 108%, suggesting customers tend to increase orders over time.
• This segment includes biosimulation services, but also regulatory science (for communicating and interacting with the FDA or other global regulators) and market access (for communicating and interacting with insurance companies and doctors).
• Biosimulation services also comprises helping smaller companies or those without dedicated teams operate Certara's software, simulate experiments, and interpret data.

It's no fluke. Since 2014 over 90% of FDA-approved drugs have leaned on Certara for drug development. That's difficult to argue with.

It's also a bit frustrating for investors. On the one hand, the business is profitable, cash flow positive, and able to self-fund expansion and acquisitions. On the other hand, Certara is only growing revenue about 15% per year and expansion in some countries, such as China, is rife with geopolitical risks.

How should investors approach this investment opportunity?

Is Certara a Growth Stock or Value Stock? Maybe Both

A growth stock is something flashy. A value stock is something boring. Certara is somewhere in between.

Biosimulation is flashy, but a revenue mix biased toward services is boring. Certara is growing revenue at a decent clip, but not a terribly impressive clip. The business is generating operating income (or at least breakeven operations) and cash flow, but it mostly fuels investments in seemingly boring expansion. Better than the alternative, I guess.

Flashy or boring, investors had little to complain about through the first nine months of 2022.

Data Source: SEC filings.

The primary question is how the hell do investors, or the market at large, value the business? As a hybrid growth stock, the business is caught in purgatory.

It wouldn't earn a high valuation as a growth stock, but operating at breakeven levels doesn't help with valuing the business based on earnings either. This hurts Certara's valuation – and there are no reasons to expect this to change anytime soon. (See our modeling in the next section.)

There are encouraging signs the business is focusing on profitability. For example, Certara delivered operating expenses of $167 million in 2020 (on revenue of $243 million) and $161 million in 2021 (on revenue of $286 million). Full-year 2022 operating expenses could come in near $170 million (on revenue near $330 million). That's an attractive trend.

Here's the thing: As an Anchor position, Certara might be frustrating, but it requires little babysitting. The valuation in 2023 isn't as stretched as it was in early 2021, so it's not a bad position to hold onto and add to during attractive months.

There's room for considerable upside:

• Certara is focused on growing software revenue as a share of its revenue mix. This would help quell questions about revenue, profitability, and valuation, especially considering software revenue is accompanied by higher margins and makes a greater contribution to the valuation.
• As previously discussed, the regulatory submission for an AAV gene therapy candidate comprises tens of thousands of pages mostly related to chemistry, manufacturing, and controls (CMS) data. Certara's GlobalSubmit software platform is licensed by both drug developers and global regulatory agencies to decipher applications with natural language processing (it would take humans wayyyyy too long to read that many pages). Positive trends in the maturity of the global industry pipeline in cell and gene therapy is a nice tailwind.
• The FDA is considering requiring biosimulation for regulatory submissions. That might not seem like much of a catalyst when 90% of approvals are from Certara customers, but it could drive customer growth among smaller companies (you know, the ones failing). However, these companies would be more likely to utilize lower-margin services instead of software, but add to revenue growth nonetheless.
• Certara's current portfolio and revenue is more heavily focused on small-molecule drug development, which suggests there's considerable growth potential in biologics drug development (antibodies, cell therapy, gene therapy, etc.). Smaller competitor Applied BioMath has an excellent offering in antibody development, for example.

Certara is no slouch in biologics, either. And it's easier to bring new products and software to market when you have over 2,000 customers.

• (January 2021) Researchers at Oxford University used Certara's flagship Simcyp software to correctly predict that first and second doses of mRNA COVID-19 vaccines would be optimally spaced at 12-week intervals, not the three or four weeks recommended by BioNTech and Moderna. This was first proposed virtually, then confirmed in human studies. It won a global innovation award.
• (June 2022) Certara released new software for immunogenicity (i.e. Selecta Biosciences), immuno-oncology (i.e. Coherus BioSciences), and vaccine simulators (i.e. Dyadic International... teaser alert). The datasets were based on quantitative systems pharmacology (QSP) and informed by academic and industry leaders.
• (July 2022) Certara announced a collaboration with Memorial Sloan Kettering Cancer Center to develop biosimulation software and services for CAR-T cell therapies. The collaboration builds on the QSP datasets mentioned above, and aims to virtually predict optimal dosing of cell therapies to design clinical trials with higher probabilities of success.

Biosimulation of biologics is better suited for digitization than small molecule drug development due to the complexity of biology, but there's a long way to go before the business generates over half of revenue from high-margin software revenue. To be blunt, all of the pieces are in place, but more patience is required.

Forecast & Modeling Insights

Certara can have an allocation of up to 10% in most portfolios. As previously communicated, I personally reduced my stake to 5% to re-allocate in AVITA Medical, which provides a better near-term growth opportunity.

That's not to say I've lost faith in Certara. It's just… more of a slow burn opportunity. It'll reliably grow revenue at a roughly 15% annual clip for the foreseeable future. It could significantly and rapidly improve profitability if it ever slows investments in overhead. But during the ongoing biotech correction there are simply better opportunities. It's okay to admit that.

For now, Certara is overvalued according to our models. It's difficult to justify the current valuation based on the growth rate or profitability metrics even through 2024. However, there are signs the business could focus on profitability in 2023, which would slightly alter our models.

Solt DB Invest forecasts (will be fine-tuned after full-year 2022 results are released in the coming weeks):

• Full-year 2023 revenue of roughly $379.5 million, a gross margin near 60%, and an operating margin near 13.9%. Our midpoint is a valuation near $2.28 billion (vs. $3.048 billion as of market close January 26, 2023).
• To be transparent, our modeling for 2024 isn't as clear and will change after full-year 2022 operations are confirmed and full-year 2023 revenue guidance is provided. But… Full-year 2024 revenue of roughly $435.4 million, a gross margin near 60%, and an operating margin near 19.9%. Our midpoint is a valuation near $3.055 billion (vs. $3.048 billion as of market close January 26, 2023).

Additional acquisitions, an increased focus on software, and deprioritization of operations in certain international markets such as China could alter our model. The beauty is none of that would change Certara's Anchor stock label or no-babysitting characteristic.

Margin of Safety & Allocation

(No change.)

Certara is considered an Anchor position. The current margin of safety range for the company is below:

• Current Price (market close January 26): $19.09 per share
• Likely Undervalued:          <$10.44 per share
• Midpoint:                           $14.62 per share
• Likely Overvalued:            >$18.80 per share
• Allocation Range:              Up to 10%

Certara reported 159.673 million shares outstanding as of November 1, 2022. The margin of safety range above assumes 163.665 million shares outstanding, or dilution of 2.5%.

Further Reading

Certara has yet to schedule a full-year 2022 business update, but investors can expect an update in early to mid-February.

• January 2021 scientific paper from Oxford University and Certara simulating optimal dosing regimen for COVID-19 vaccines.
• MONKEYS ESCAPE IN PENNSYLVANIA TAKE COVER
• June 2022 press release discussing QSP software release
• July 2022 press release announcing collaboration with Memorial Sloan Kettering Cancer Center.