We may be on the cusp of an artificial intelligence (AI) revolution. With the growth of ChatGPT and other lifelike chatbots, the technology giants are making a huge push to build consumer-facing AI tools. This has propelled growth technology stocks in 2023, some to record highs. Companies in the cloud computing and semiconductor markets should benefit from the proliferation of these AI services, and investors are getting increasingly bullish about what it means for their stock prices.
But the AI revolution is not just for consumer-facing software. There is a mountain of money getting spent on AI-focused solutions in the life sciences, healthcare, and drug discovery space. But what companies are powering this research? Enter Schrödinger (SDGR 2.70%). The physics- and machine learning-based computation platform is helping power the next leg of the biotechnology revolution. Should you buy shares?
A computational platform for life sciences (and more)
Schrödinger -- named for the famous quantum physicist -- was started in 1990 by Richard Friesner and Bill Goddard. The two aren't running the business today (Friesner remains on the board), but the current team has a similar mission to the founders decades ago: Help companies run simulations with lifelike physics models.
Today, the company focuses on molecular structures, using predictive modeling and physics simulations to help other companies rapidly predict how molecules will interact. The platform can help teams working in a wide range of fields such as materials science or engineering research, but its core focus right now is drug discovery. Unlike traditional drug discovery methods, Schrödinger can identify and analyze billions of molecules within weeks. Its pitch to customers is that it can increase the speed of drug discovery while also reducing costs. That's a win-win over the traditional discovery methods.
This pitch seems to be working. Schrödinger boasts 1,750 software customers around the world paying for its platform licenses. It also makes money by partnering with other companies to work on drug and materials science discoveries, with 13 active projects as of last quarter. When its partners come to market with products, Schrödinger can earn a fee or revenue share. For example, Bristol-Myers Squibb has signed a deal with Schrödinger that could pay it as much as $2.75 billion if the partnership is successful.
Lastly, Schrödinger has gone for even further vertical integration and is now working on its own drug pipeline. It has 19 wholly owned or partnered programs, none of which have come to market yet.
Growth potential for AI-powered research
All this research is expensive (Schrödinger brags that it has more than 150 Ph.D. scientists on staff), but the company wants to invest ahead of the coming AI boom in biotechnology. The global biotech market was estimated to be $1.22 trillion in 2022 and is expected to grow to an astounding $3.2 trillion in annual spending by 2030. These companies are spending hundreds of billions on research and development every year, providing Schrödinger with a gigantic market opportunity. It could also benefit from its own drug discovery efforts.
As a public company, Schrödinger has put up some solid revenue growth. Since 2020, its trailing revenue is up a cumulative 176%, with revenue growth expected to be at least 15% in 2023. As a young company trying to reinvest in its platform, investors should expect many years of double-digit revenue growth from Schrödinger.
Data source: YCharts
Focus on the path to profitability
Schrödinger has a lot of irons in the fire, which is expensive for a company generating just under $200 million in annual sales. That is why investors should not just focus on revenue growth, but also profitability. Through the first six months of 2023, Schrödinger spent $83 million on research and development, which is more than the $59.5 million in gross profit it generated over the same time period. This led to a free cash burn of just above $50 million for the first half of 2023.
Given its ambitions, the company is likely still many years away from positive profit margins, which should keep investors cautious. On a positive note, it has over $500 million in cash on the balance sheet, which will provide a multi-year runway before Schrödinger needs to generate a profit.
At a market cap of $1.7 billion, Schrödinger trades at an expensive-looking price-to-sales ratio (P/S) above 8. This is more than double the market average. What does this mean? Investors not only need to expect Schrödinger to quickly increase revenue, but eventually generate above-market profit margins at scale. It's not impossible -- and there is a ton of potential with this AI-powered biotech platform -- but investors need to temper expectations here. The stock still looks very expensive at these levels.
