Medidata Solutions a Strong Buy in Cloud Computing

Medidata Solutions (NASDAQ:MDSO) is a player in several game-changing themes we’re following, including cloud computing, IT innovation and medical breakthroughs. They bring it all together to provide cloud-based software that helps pharmaceutical, biotech and medical device companies perform voluminous and expensive research more efficiently, effectively and cheaply.

In other words, MDSO helps them get the most out of their research dollars, one reason the stock is so attractive in this time of fiscal and budgetary pressures.

Medidata is one of the leaders in this burgeoning industry, with 22 of the 25 largest global pharmaceutical companies as its customers. These are recognizable names like Pfizer (NYSE:PFE), Wyeth, Roche (PINK:RHHBY), the Mayo Clinic, Eli Lilly (NYSE:LLY), GlaxoSmithKline (NYSE:GSK)and Bristol-Myers Squibb (NYSE:BMY). (One of our stocks, Cognizant (NASDAQ:CTSH), an IT company, is also a customer.)

MDSO’s star product is called Rave, a software platform that integrates electronic data capture with a clinical data management system, completely replacing outdated paper-based methods of capturing and managing data.

The four key words the company uses in describing Rave’s capabilities are build, capture, study and report. Here’s how they fit together: Rave can “build” clinical studies; “capture” the data from all global clinical sites; “manage” the data by providing researchers with the ability to study and query the data in real time; and “report” clinical data in real-time with visualization tools.

Rave is cloud-based, so one advantage is that it can be run on pretty much any computer or mobile device like an Apple (NASDAQ:AAPL) iPad. As you would expect, Rave is technically sophisticated, so it can allow allowing customers to manage increasingly complex clinical trials. And yet, it is designed to be easy and intuitive to use so customers can get up to speed quickly. Rave is also scalable, so it can be used in clinical trials of all sizes, and it can be programmed to be used in a local language for international clinical studies, a key feature for Medidata’s many international customers.

MDSO makes it money selling its applications, with 90% of application sales coming from Rave, as well as providing professional services. Customers generally purchase applications for multiple studies, usually a pre-determined number, but Medidata also offers single-study contracts to entice new customers to try their products. Professional services revenues come when customers pay for Medidata’s expertise in clinical research and implementing the applications. These services can help customers with things like meeting data requirements and designing the work flow to match the needs of trials in various stages of clinical research.

Strong Momentum Ahead

MDSO has grown rapidly in recent years, with revenues nearly tripling from 2007–2011, increasing to $184.5 million from $63 million. Sustained growth like that is evidence of the market’s strong acceptance for the company’s products and services, even in a weaker economy. I expect strong growth to continue for several reasons.

First, Medidata’s customer base continues to expand, increasing from 148 at the end of 2009 to 275 at the end of 2011. It’s important to note that customers are very satisfied with the MDSO’s products, with more than 90% remaining customers. MDSO is targeting more customers in middle-market sized firms and from foreign companies. The company is already very strong in foreign markets, generating 41% of their sales in 2011 from outside the U.S.

Second, in addition to bringing in new customers, Medidata looks to grow the amount of business it does with existing customers. For example, the company has taken a lot of market share from Oracle Life Sciences recently, no small feat considering that Oracle (NASDAQ:ORCL) also has a significant presence in major pharmaceutical companies. Continuing to displace Oracle at existing customers is an excellent opportunity for Medidata, and they feel there simpler and easier-to-maintain products give them a competitive advantage.

This year got off to a strong start, with revenues in the first quarter increasing 24% to $50.4 million. That was much higher than the 10% growth the company achieved in 2011, and it also exceeded the company’s projections for revenues of $48.5 million to$49.5 million.

The pick-up in growth was due to the market share gains we just talked about. In addition, 17 more customers were added in the quarter, bringing the total to 287, up 24% from the previous year. Operating income increased 40% from the prior year to $10.3 million, which is all the more impressive considering the company is heavily invested in research and development. R&D is the lifeblood of innovation, so I like to see the commitment.

For all of 2012, revenues are expected to jump to $213 million to$217 million, which would be 16.5% growth at the $215 million midpoint. Net income for the year is estimated at $27 million to $30 million, which would work out to $1.12 a share at the $28.5 million midpoint, which is what analysts are also expecting. That will be down from the $1.60 earned in 2011, but the reason is that 2012 will be the first year the company paid a full tax rate on earnings.

I view the revenue and earnings estimates for 2012 as quite achievable, and in light of the very strong first quarter, the company could well exceed one or both. I wouldn’t be surprised to see current estimates for $1.12 a share increase in coming quarters. Also, as we approach the end of the year, investors will start to look ahead to fiscal 2013 results, and I feel $1.40 to $1.45 are reasonable, which would be growth of about 25%.

Medidata is an excellent fit for our strategy of investing in companies with very well-defined growth prospects and minimal risk from macro factors. Management believes customers are at the early stages of a multiyear adoption cycle, current momentum remains strong, and I expect the company to continue to grow rapidly in the future.

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