Opinion: Veeva Systems is a Great Money-Making Software Business
Veeva Systems (VEEV) is a cloud-computing company for the Biotechnology sector. They are the undisputed leader in the market, with a 40% market share. VEEV was founded in 2007, and had its IPO in October 2013. They offer very specialized services to the Biotech sector, including compliance management, product development and release of new drugs.
VEEV has performed well financially, offers value-add products and services and seems to have a good growth trajectory. In an uncertain environment, where investors are interested in technology stocks, VEEV seems like a strong buy. It is making money, unlike many other Software-as-a-Service (SaaS) stocks which continue to make losses. VEEV is currently trading at $270 per share. Although I believe it to be overvalued, it is likely investors will still pay a premium for VEEV, so returns are achievable.
Quantitative Analysis
Financial Performance
VEEV had its IPO in 2013 at a price of $20 per share. Since then, VEEV has had explosive growth and is now trading at $270, which is almost a 1200% increase. The growth drivers were primarily the adoption of SaaS services by businesses as it provided very apparent improved effectiveness and efficiency. In recent years, the performance of SaaS companies have been reflected on their valuations, with many trading above 13x EBITDA.
VEEV is a very scalable business, and it is evident from their margins. VEEV has a gross profit margin of around 70%, and an EBITDA margin of 30%. These high margins allow for VEEV to generate strong cash flows, which in turn can be returned to shareholders or kept as retained earnings to improve the business. Both, will create more value. SaaS companies do not require too much working capital expenditure and capital investment, hence their cashflow remain high. The largest portion of VEEV's cost comes under the fixed expenses, in which research and development represents the majority of the cost. For SaaS companies, specially for VEEV as it operates in the Biotech sector, R&D expenditure is imperative to maintain their competitive advantage, otherwise new entrants could easily replicate their services.
In addition, being a very scalable business, VEEV is in a strong position to improve its margins over the next five years. I assumed that VEEV would be able to marginally reduce its COGS/Sales by one or two percent year-on-year, as they will likely see further economies-of-scale benefits as they scale their business. Even if operating expenses were assumed to be relatively similar to previous years, VEEV's businesses will likely generate improving EBITDA margins over the next five years. Analyzing its comparable companies, VEEV has a good EBITD margin, with the exception of Oracle as it is a much larger and more diversified business.
Additionally, VEEV has earned strong returns for its shareholders with an improving year-on-year Earnings-per-Share (EPS). EPS is the amount of profit a shareholder receives, on top of the price they paid for the share. With a growing outlook of EPS, investors are likely to earn higher profits, relative to the price they pay per share over the next few years. In addition, VEEV does not have a significant Long-Term Debt balance, therefore the cash generated from the business can be used to return to shareholders via dividends or buy-backs.
However, VEEV has a very high cash-conversion cycle (CCC). The CCC, in days, has been around 120 for the past two fiscal years. This means that it takes VEEV long to convert its investment into working capital into cash, which may come as a red flag to investors. As this is a SaaS company, there is no inventory, which is a benefit (as it means inventory costs are close to $0), yes, but even without an inventory balance, VEEV's CCC is very high. Investors would want to know why they are receiving late payments, (very high Accounts Receivable balance), and are paying cash to its suppliers quite quick, (a low Accounts Payable balance). In addition, VEEV's financial outlook is very much dependent on their growth. If their growth has reached a plateau, it can yield negative results for investors. VEEV could slow down its growth, similar to IQVIA, which could be looked as an example of a slower growing company in this industry. Additionally, though VEEV does not have a large debt balance, it does have a fairly large Deferred Revenue balance of $460 million, meaning they owe services to customers whom have already paid up-front.
Valuation
For VEEV's valuation, I used the Discounted Cash Flow (DCF) Method and the Comparable Company Analysis (CompCo). For my DCF valuation, I assumed that VEEV would be able to continue its strong growth, with revenue growing at approx. 30% each year. This is a fair assumption in my opinion because the Biotech sector is poised to grow, specially with the emergence of COVID-19. For the other Income Statement variables, I used the percent-of-sales method to project out the numbers for the next five years. I assumed costs (COGS and OpExp) as a percent of Sales to reduce marginally year-on-year because VEEV will likely have economies-of-scale benefits. I used the Accounts Receivable Days, Accounts Payable days and Unbilled Receivables Days to project VEEV's Net Working Capital (NWC) balance, and assumed 1% of sales as Capital Expenditure each year (relatively low because SaaS companies tend to be very capital-light). A WACC of approx. 6% was calculated, giving me a valuation of around $33 billion and a share price of $208.
For my CompCo Analysis, I used Oracle, IQVIA, Salesforce and Upland Software as my comparable companies. IQVIA and Upland Software are the most comparable companies to VEEV as they provide similar services to the same sector. Oracle and Salesforce were used as comparables because they are also SaaS companies, which offer some similar services. Using EBITDA multiples from the comparables, a suitable EBITDA multiple for VEEV was calculated to be 35x (quite high because of VEEV's fast growth). This analysis gave VEEV a valuation of approx. $11 billion and a share price of $70.
A weighted average of both valuation methods gave VEEB a final valuation of approx. $29 billion (DCF was weighted very highly because VEEV's comparables are not very similar) and a share price of $195. VEEV is overvalued, according to my analysis, by 38%. However, it is arguable that investors will still rally to its stock. There has been a huge flock towards technology stocks, specially SaaS, during these times of uncertainty as these companies have a strong growth outlook. However, many of the high-growth tech stocks are not making money, thus will not be able to return money to shareholders at the rate, or in the time, which some investors expect. VEEV is making money. Its is unlike these other high-growth tech stocks because it has strong, positive margins, a good cash flow, scalable business and is an disputed market leader. Though it does fall under the overvalued high-growth tech stock category, it is still making money which may be something investors want to look at in times of uncertainty caused by COVID-19.
Qualitative Analysis
Firstly, VEEV's business model is a very attractive to investors. VEEV's main revenue model is a subscription model, where in companies earn money through weekly/monthly/yearly payments, offering investors a steady, predictable cash flow. In addition, it makes VEEV's offering a "sticky" business, meaning customers are less likely to switch providers of their service, and stick to the contracts with VEEV, as it involves changing the entire software system for the customer. VEEV earns up to 80% of revenue from the subscription model.
Secondly, VEEV's business is very scalable. VEEV, requires very little capital expenditure to grow its business. It can obtain new customers by spending on their marketing and advertising, which is essentially, the main expense in growing their business. In addition, the Biotech and Life Sciences industry is growing very fast, accelerated further by COVID-19. The Biotech industry is expected to reach a market size of $750 billion, with a CAGR of 7%, by 2025. This means that VEEV has a huge market for its services, as many new startups will emerge in this sector and with the megatrend of digitalization, and the nature of Biotech businesses, VEEV's software should be in high demand over the next few years.
Furthermore, VEEV reported around 860 customers, with leading companies such as Merck & Co. and Novartis International. Their largest 10 customers represent around 35% of their revenue, which is not a very high customer concentration. Many SaaS companies tend to have their customer concentration of their top 5 customers at more than 50%, which is a huge red flag to investors. VEEV's more spread out customers can give investors confidence, because losing one major customer should not be fatal to the business. VEEV is the market leader in this SaaS Biotech space, with at least 40% market share, suggesting that it will be able to attract new customers faster and better than smaller companies, or new entrants. Their strong market position creates a high barrier-to-entry.
However, VEEV does have risks associated with its business. Firstly, one of their competitors is Salesforce, which is a much larger (more than 4x) and more trusted company. VEEV has been able to mitigate the risk from Salesforce by reaching an agreement with them, wherein VEEV uses some of the cloud solutions of Salesforce, by paying them a CRM fee and get a non-compete agreement. This contract is valid till 2025, which gives VEEV five years to find an alternative solution to using Salesforce's services, as they would prefer to have their CRM cloud solutions in house. At the moment, many of their products, such as the Veeva Vault, is very much dependent on the contract with Salesforce, which could be a concern for investors.
But, Salesforce has not only contracted with VEEV. Salesforce partnerships also include IQVIA, which is one of VEEV's top competitors in the SaaS for Biotech market. IQVIA has almost 10x the sales of VEEV, but not the same growth momentum. Though some of VEEV's products are very unique and highly-demanded, such as the Veeva Vault, IQVIA does have the resources to offer a competing product. This industry is likely to see a lot of rivalrous competition, with IQVIA and VEEV already in legal battles. As the Biotech sector is a very attractive one, and seeing VEEV's strong growth and high margins, it can attract the big players such as Amazon and Oracle. If these behemoth companies enter this market, it could be a huge setback to VEEV's business. For VEEV's shareholders, one way to mitigate their risk of new entrants like Amazon would be to offer a merger, as this would give shareholders a strong returns. Investors need to keep a close eye on the industry and look out for competitor activity.
Conclusion
Veeva Systems is a great business. It handles all the IT services for Biotech companies, which is a huge value-adding service. Its got a great, recurring revenue business model, a strong market position and an attractive growth outlook. Unlike many other high-growth tech stocks, VEEV is actually making very high, positive, margins and generating enough cash flows to sustain and grow their business and return some value to shareholders. Their unique, patented, products, are well above the competition, which can give investors confidence in VEEV's growth plan.
However, the stock is still overvalued by almost 40%. In addition, competition in this industry is fierce with some large players in the market, relative to VEEV, and even larger players looking into the market. VEEV will have to react well to behemoth corporations entering the market if they wish to survive.
Though the stock is overvalued, primarily because most high-growth tech stocks are overvalued by investors right now, I believe investors will still pay a premium for VEEV. It is making money, and its a great business with a value-adding service. There is some room for returns in VEEV's stock, therefore, in my opinion, it is a buy.
My analysis was done studying the SEC filings of Veeva Systems, reports on general market trends and financial news. If you’d like to see my excel workbook, or have any further questions, please feel free to reach out to me, especially if you have any positive or constructive feedback.
Written by, ?
Abhishek Khetan
BU 2020 Graduate