Medpace Holdings, Inc.

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

A global clinical research organization (CRO) that focuses on providing clinical research services to the pharmaceutical, biotechnology, and medical device industries.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview Medpace is a full-service, global clinical contract research organization (CRO). A CRO is a company that provides clinical trial services to the pharmaceutical, biotechnology, and medical device industries. Its operations are primarily located in North America, Europe, and Asia.

Medpace’s revenue generation stems from multiple clinical development services. Medpace offers a comprehensive suite of clinical development services across Phase I-IV development, including medical and regulatory affairs, bio-analytical laboratory services, and central laboratory services. They have also expanded in to imaging services and bio-statistical analysis. Their medical device business focuses on medical device development, providing regulatory, safety, and monitoring services to clients.

Trends in the Industry

The CRO industry has seen steady growth. This is driven by the increasing complexity of clinical trials, the rising costs of pharmaceutical and biotech companies’ R&D efforts, and the focus on outsourcing to reduce drug development times. These trends are likely to continue, so a tailwind for CROs.
The COVID-19 pandemic impacted the CRO market. The pandemic led to a shift to remote monitoring practices in clinical trials, requiring innovation and adaptability from CROs. Medpace has also experienced disruptions and delays in clinical trials, although they have made a full recovery from these effects.
Emerging markets have seen increasing clinical trial activity. CROs, including Medpace are expanding in these regions. This will give them larger access to patients.
The market shows a trend toward full service, that is, CROs that provide the full suite of services to a client, as this reduces burden for biopharma companies. CROs that can do this well will have an advantage.
The sector as a whole has a history of intense competition and price pressure.
There is a push towards personalized medicine and targeted therapies. This will change how clinical trials work.

Margins and Competitive Landscape Medpace’s profitability and margins are somewhat better than their peers (e.g. IQVIA, Syneos, PPD), as their operating margins are at 16-19% in the past few years, with operating margin growth, however, this margin decreased recently in 2022 and is at 10.7% for the 9-month period of 2023 (more on financial performance in the next section). This decrease in margins has been driven by multiple factors, one of them being that their net client services revenue has decreased, combined with a slight decrease in revenues from upfront and backlog-related revenue recognition, and higher operating expenses. They have also been less aggressive with acquisitions, a sign that they are trying to get operating margins and earnings better. Their competitors are larger but seem to have difficulty delivering the same ROIC as Medpace. The sector is very concentrated among a handful of large players. Their clients usually do not have pricing power, because their profits are so high.

What makes them different:

Their core business focuses on small-to-mid sized biopharma companies, which generally have high needs for outsourcing.
They are a highly profitable niche operator, with an innovative business model that helps them better execute trials and manage margins than competitors.
They’re also a relatively smaller and more nimble firm than other CROs.
They have been consistently performing better than their peers.

Moat: 3/5 Medpace has a narrow economic moat stemming from its specialization in small-to-mid-sized biopharma companies, its operational expertise, and its brand name (although not a very recognizable brand to consumers). Although the industry as a whole has fairly low barriers to entry, the quality of execution and high returns of Medpace make them hard to imitate. The focus on small-to-mid-sized biopharma companies has given Medpace a niche market. They are also a leader in core services like medical & regulatory affairs and data analytics which are crucial to its clients. However, we think that their moat is more narrow than wide, because their competitive advantages are not enough to command higher prices than their competitors, as they are a price taker in general. The risk of competition in the sector is high, as new companies can try to steal share from them through acquisitions, or by offering discounts for certain services. Also, because regulations are somewhat more predictable in this sector, a new company with good execution may also eat away at some of their returns. We rate it at 3/5.

Risks to the Moat and Business Resilience There are several risks that could impact Medpace’s moat and business, including:

Regulatory changes, can impact the type of drug development services and their pricing. This is important to consider given the FDA’s increased scrutiny on clinical trials.
Increased competition from other CROs. Competition, both direct and indirect, can affect margins and revenue growth. Competitors can try to poach employees by paying higher prices, or offer lower prices to clients, taking market share from Medpace.
Changes to pharmaceutical and biotech companies’ R&D spending. If these companies start reducing their R&D, CRO’s will suffer.
Loss of key customers. Medpace relies on a few key customers. The loss of one or more customers can greatly decrease their revenue. The top ten customers account for roughly 50% of their revenues.
Failure to adapt. Medpace must continue to innovate and stay abreast of technological changes in the sector, failure to do this could leave the company exposed to new entrants.
The cyclicality of their end markets, small biotech, can be very volatile and can affect Medpace’s demand if their end clients start to experience financial troubles.
Acquisition risks. Although Medpace management seems to be more conservative with acquisition strategy now, they do make acquisitions. These acquisitions have to be successfully integrated to create value, else, they can negatively impact financial performance.
Data security concerns. Any failure in this regard can seriously affect operations, client’s trust, and reputation.
Loss of personnel. Medpace relies heavily on their employees for their operational expertise, and loosing a portion of its highly qualified employees may hinder growth.

Despite these risks, the company has proven itself resilient in the past. They have shown the ability to innovate and adapt to new business environments. They have also generated significant returns and cash over the years. Their client base is also very diverse, so they are less likely to suffer significantly from an individual client’s performance. Also, their client industries should continue to grow at a rapid pace for many years to come, driving demand for their services.

Financials

Revenue: Medpace revenues have generally been on the rise, since 2018, they grew at an average of 21.5% year over year. However, revenue growth has slowed down recently, with a yoy growth of 8.5% for the nine months of 2023 vs the same period of 2022.
Margins: Operating margins are about 16-19% before 2022, where it dropped to 11.4%, for 2023 YTD it is around 10.7%. This a trend that should be closely followed by management to determine the reasons. The net profit margin is usually around 10%.
Returns on invested capital (ROIC): ROIC is at high levels in recent history, having hovered around 15-20% during 2015-2020, but dropped to around 10-13% in 2022 and later. ROIC should also be closely followed as a key indicator of the profitability of the company.
Cash flow: the company typically generates a lot of cash. The yearly free cash flow (FCF) is around 100 million, while in 2022 it dropped to -54 million, because they had a large increase in net working capital. FCF has bounced back to 255 million for 2023 YTD.
Debt levels: while they do have some debt (around 1.8 billion), as their cash balance has always been above a billion, this does not pose any solvency risks for the company. They have a long-term debt-to-equity ratio of 0.85-1.10.
Share repurchases: company has bought back around 380 million in stock in the past few years, as the company has seen its share price be undervalued. They still have around 500 million authorized for further repurchases.
Share dilution: share count has remained the same in the last 5 years or so, meaning no share dilution from them.
Guidance: company expects revenue of 1.66 to 1.7 billion, EBITDA of 339 to 370 million, and EPS of 6.84 to 7.42 for 2023.

Understandability: 3/5 The business model of a CRO is relatively straightforward-they conduct clinical trials for biopharma companies. Understanding the importance of data analytics, or medical regulatory affairs, might be a little difficult. The financial model is relatively complex because of the way they recognize revenue from contracts, which isn’t a point of sale method. They also have several financial metrics that are important to the analysis, such as NOPLAT, ROIC, WACC, FCF, which can be daunting to someone that isn’t experienced with finance. In total, we give an understandability of 3/5.

Balance Sheet Health: 4/5 Medpace has a very strong balance sheet with a lot of cash and very manageable amount of debt. Their liquidity position is also solid, and can comfortably meet any obligations that might come due. However, like mentioned previously, the company’s ROIC and operating margins have taken a hit, but the company will likely return to past performance. Given this, we give it a health of 4/5.

Recent Issues Their financial results in 2022 have taken a hit, and have been underperforming analyst expectations since. Their operating margins have dropped due to multiple reasons, such as decreased revenue, and increased staffing and facilities. Also, the management has been more aggressive in acquisitions. This is a cause for concern, but we think it will be fixed in the coming quarters. The stock has also been very volatile recently, a fact that long term focused investors should ignore, according to their beliefs. Overall, they think they can fix their operational inefficiencies, continue to gain market share from smaller, or inferior performing CROs, and grow revenue. Management said that they are shifting from rapid revenue growth to profitability, which is the right step, according to us.

They are very confident they can return to previous levels of performance in coming quarters. They are actively working to streamline their business, and make it more efficient, but they think that the key drivers for their business continue to be their great operational expertise and focus on mid-sized biopharma companies. They are also improving transparency by sharing more detailed info about the projects that they undertake, and focusing more on long term relationships with clients.