2 Great Businesses On Sale
Disclaimer: Not financial advise.
Every now and then, great businesses go on sale.
MEDP and DPZ are two such businesses. This is not meant to be a deep dive. The full information is available if you simply look a little deeper. This is a quick notes style memo on why I’m buying in.
Disclaimer: Not financial advise. Please be responsible for your own investment decisions.
Medpace Holdings (MEDP) - Picks and Shovels for the Biopharmaceutical Industry
The drug development process is a lengthy, complex journey that typically takes 10-15 years from initial discovery to market approval.
Medpace (MEDP) operates as a full-service Contract Research Organization (CRO) across the clinical drug development process, focusing on Phases I-IV trials after the initial discovery and preclinical stages.
In Phase I (safety testing in healthy volunteers), Medpace manages trial operations and medical monitoring.
During Phase II (preliminary efficacy in 100-500 patients) and Phase III (definitive efficacy in 1,000-5,000 patients), Medpace provides comprehensive services including protocol development, site management, data analysis, and regulatory support.
In Phase IV studies, the company continues involvement through regulatory submission and post-approval.
Medpace differentiates itself through physician-led teams with specialized expertise in complex therapeutic areas (oncology, rare diseases, cardiology), primarily serving small to mid-sized biotech companies that lack extensive in-house clinical development resources.
When you’re spending hundreds of millions developing a drug, you don’t tend to be penny foolish when it comes to CRO solution providers. You get the best because that is what drives the best possible outcome. Competitors don’t tend to focus on cost differentiation, instead using various expertise in different fields to provide differentiated value.
Some additional points:
Dr. Troendle, Chief Executive Officer and Chairman of the Board of Directors of Medpace since 1992 owns 15.8% of the company.
Diluted EPS has compounded at a stunning 55.4%. growing from $0.37 (2016) to $12.63 (2024).
Return on capital has averaged between 28-40% mark the past few years as earnings grew. This makes sense. CROs is a laborious, logistics heavy business but it scales quite easily if you have the infrastructure in place to handle the income contracts. Patient onboarding and searching is the only non-scalable factor but there’s normally so much lead time that its irrelevant and cashflows often his the balance sheet prior to trials ending so this doesn’t seem so weird.
Morningstar assigns MEDP a narrow moat due to late-stage clinical trial exposure, proprietary technology, expertise, and strong client relationships that are supported by intangible assets and high switching costs. This too makes sense. Drug developers dont’ get penny wise pound foolish when it comes to choosing partners for research simply because safety and standards are everything and the FDA is not known to be shy about pulling the trigger on drug recalls, cratering stock prices and manufacturers. The last thing you want is your CRO provider to go “oops?”
More from Morningstar (you can Google/infer most of these, I’ve placed it here for your benefit, do read up more prior to making your own decision, fyi - I consider Morningstar a fantastic service):
Clinical trial outsourcing steadily increased from 37% in 2007 to over 51% in 2022.
Medpace is focused on serving small to midsize biotech companies, which rely heavily on outsourced clinical trial services as they do not have the capacity to conduct in-house clinical trials like large pharmaceutical firms. Small to midsize biotech companies tend to select one trusted CRO to run their clinical trials and often need full outsourcing solutions, so they outsource studies on a full-service model, which is the focus of Medpace’s business.
Customers that outsource to full-service clinical trial providers have even greater switching costs since the entire clinical trial process is managed by the CRO. They would be very reluctant to switch to a different CRO once late-stage clinical trials begin. It is difficult and costly in terms of time and expense to switch, as this would create a several-months-long delay in the clinical development timeline and reduce precious patent-protected time if the drug proves successful and receives regulatory approval. Additionally, companies typically stay with their selected CRO throughout the drug’s lifetime for the continued study and development of additional indications, such as expanding a drug to patients of different age groups or evaluating booster/combination therapies. These switching costs are also supported by familiarity, in which clients prefer the continuity of working with the same trusted CRO since it has expertise concerning the clients' needs, systems, and methods.
What drives growth?
Outsourcing Trend: Pharmaceutical R&D outsourcing to CROs has increased from approximately 36% in 2015 to 49% in 2023, with projections reaching 56% by 2025 (Frost & Sullivan, 2023).
Small/Mid-Size Biotech Focus: Medpace's target customer segment (small/mid-size biotechs) has grown from 71% of the drug development pipeline in 2016 to 80% in 2023 (IQVIA Institute, 2023).
Oncology Growth: The oncology clinical trials market is growing at 7.5% CAGR, faster than the overall clinical trials market, with Medpace reporting oncology as its largest therapeutic focus at 39.2% of total revenue in 2023 (Medpace Annual Report, 2023).
Rare Disease Expansion: The number of rare disease clinical trials has increased by 18% CAGR since 2018, with Medpace specifically highlighting rare disease expertise as a core competency (GlobalData, 2023).
Metabolic/Cardiovascular Demand: Metabolic disorder trials have increased 22% between 2019-2023, representing another key therapeutic area for Medpace (ClinicalTrials.gov, 2023).
For a quick and dirty style of judging valuation for a business with positive earnings, cashflow and some stability, I take a look at average vs +1/-1 standard deviation price to earning values.
Average PE of 32x earnings implies a 27% undervaluation.
Shareholder yield is 0.5%.
Earnings growth normalised at the most bearish case seems to 8% (a little less than industry long term growth rates).
Multiple re-rating adds a potential 27%.
Shares have dropped -14% over a 5 year period.
Average capex is 10% of operating cash flow.
Share based compensations seem decent at 4% of operating cash flow.Multiples will drive the greatest value, but long term, EPS growth will also stack up gains for us over time even with valuation going back to 10x for terminal value discussions.
Long MEDP. I will probably rotate some positions around to stump up cash but here’s to hoping it stays undervalued for awhile.
Domino’s Pizza (DPZ)
Growth on the royalty of others
Store Sales: Revenue from company-owned locations selling pizza and sides.
Franchise Royalties: Collects 5.5% of sales from franchised stores.
Supply Chain (61% of consolidated revenues): Sells ingredients, packaging, and equipment to franchisees through company-owned distribution centers.
Revenues: Master franchisees (country level) also pay royalty fees as a percentage of sales (not profits!) and which averaged 3% in 2023.
Technology Fees: Charges franchisees for digital ordering systems and POS software.
Domino's business model leverages franchising for asset-light growth. Put simply, franchisors and private investors (think high earnings individuals or small families) are willing to invest in franchising and opening Domino’s pizza outlets simply because the returns are good - the base unit economics are fantastic.
Payback periods average 3 years (33% return per year), with $1.4 million average store revenues and $162k store level EBITDAs.
Based on an average Domino's store generating $177,000 in EBITDA from $1-1.3 million in annual revenue, the estimated free cash flow would be approximately $150k per year. This is an approximate free cash flow margin of 13-15% on sales and an attractive cash-on-cash return of 44-51% on the initial investment. Pretty crazy returns for anyone who manages to land the franchise agreements (which does not sound easy - all operators must spend some time working and managing a current store before they are allowed to open one themselves in the US at least).
Average PE of 30x earnings implies a 7% undervaluation.
Shareholder yield is 3.48%.
New store growths have average 5%. Same store sales growth averages 2-3%. In 10 years, assuming the current trends hold, net earnings would slightly double.
Capex is decent, consistently about 20% of operating cash flow.
Share based compensations was approx 5% of operating cash flow.
8 years ago, free cash flow was about $5 per share. In 2024, it was about $15. A 3x in 8 years puts cagr at 14.72%. If free cash flow averages 10% cagr a year, shareholder yield averages 3% a year, with multiples returning to normal adding 7%, that’s 20% returns with decent averages.
Long DPZ.
Disclaimer
Nothing on this substack is investment advice.
The information in this article is for information and discussion purposes only. It does not constitute a recommendation to purchase or sell any financial instruments or other products. Investment decisions should not be made with this article and one should take into account the investment objectives or financial situation of any particular person or institution.
Investors should obtain advice based on their own individual circumstances from their own tax, financial, legal, and other advisers about the risks and merits of any transaction before making an investment decision, and only make such decisions on the basis of the investor’s own objectives, experience, and resources.
The information contained in this article is based on generally-available information and, although obtained from sources believed to be reliable, its accuracy and completeness cannot be assured, and such information may be incomplete or condensed.
Investments in financial instruments or other products carry significant risk, including the possible total loss of the principal amount invested. This article and its author do not purport to identify all the risks or material considerations that may be associated with entering into any transaction. This author accepts no liability for any loss (whether direct, indirect, or consequential) that may arise from any use of the information contained in or derived from this writing.
Thanks for putting MEDP on my radar.