This article was originally published 14-May-2021 on LinkedIn.
How did Science 37 get valued at >$1 BILLION?
Two reasons:
- a company is worth what investors are willing to pay for it
- the future is far more important than the past
While it’s easy to get caught up in what a company “should” be worth, “should” doesn’t matter. What matters is who is willing to pay what price:
- LSAQ thinks they're worth $1b, and not just at closing. LSAQ’s key shareholders agreed to not sell their shares for at least 180 days after the deal closes (the “lock-up”).
- LSAQ's other shareholders appear to agree- LSAQ's share price actually jumped on the news, and although it has settled back to $10/share, that still implies LSAQ shareholders don't see an issue with the valuation.
- The PIPE investors agree, although their risk is far less. They don't buy shares until right before closing, and don't have the same lockup as LSAQ's shareholders. Nonetheless, they have skin in the game. If shares trade below $10 after closing for an extended period of time, before the PIPEs can unload their shares, they can lose serious money.
The parties above are sophisticated investors who carefully weigh the risks and opportunities of each investment. If they think Science 37 is worth >$1b, then Science 37 is worth >$1b.
So why would sophisticated investors value a highly unprofitable company at >$1b?
Massive revenue growth of a niche product in a large market opportunity.
Revenue Growth
68% in 2020
120% forecast in 2021 (and 81% of 2021 revenue is already in backlog)
96% estimated next year
This growth rarely exists at scale in this industry.
Niche Product
Decentralized Trials are rapidly gaining adoption and will continue to do so for years to come (see my post from earlier this week).
Large Market Opportunity
Look, the biopharma R&D market is massive, growing, and desperately looking for a way to reduce the costs and timelines for conducting clinical trials. It will still take time to know whether DCT methodology will continue to increase in adoption, but you’re going to have a hard time convincing me it’s a flash in the pan. There is a reason nearly every CRO I track is barreling into the space.
While it’s great the company is growing rapidly with a niche product in a large market...what about those losses?
Note this part will be more speculative because the losses aren't discussed much in the investor materials.
The losses are sizeable and growing:
Source: Science 37 investor presentation
Sc37's CFO described in the webinar that part of the issue is poor gross margins due to historical underpricing. They've raised their rates, and while this will improve gross margins on new backlog, their underpriced historical backlog limits how quickly their new projects can increase the company's overall gross margin. Significant price increases can also affect sales growth, so the company will have a tough balancing act to manage with pricing.
But if investors believe the company can demonstrate growth in gross margins over time, they can envision a scenario where massive sales growth at increasing gross margins produces real profits within a few years (company predicts FY2024 will be its first profitable year).
Current losses also stem from massive growth in sales and marketing expenses ("SG&A") to build their pipeline of opportunities. In fact, since at least 2019 SG&A costs alone exceed total revenues (see chart above). But if investors believe the company's forecasts- that these costs can rapidly slow down in future years while revenue growth can continue its blistering pace- then you have the magic formula:
Substantial revenue growth, at increasing gross margins, against decreasing growth in SG&A costs, yields tremendous future profitability.
But again, what about the losses RIGHT NOW?
If investors believe losses are temporary, and that future profits will be enormous and far exceeding those of other companies in the industry, they will pay a large valuation right now- one even higher than peers with larger current revenues and years of strong profits.
And right now, a lot of investors believe.
Thanks for following these posts!
Disclosure- I have no financial interest in any company mentioned in this post. This post reflects my thoughts and opinions on publicly available information, and is definitely not investment advice!
