AGB 2021.7 - Veeva Systems (VEEV)
Best in Class Efficiency and Net Retention
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“Life sciences companies will have three major technology partners, one for ERP, one for development systems, and one for commercial, and we're trying to become two of them.” – Co-founder, Matthew Wallach at JPMorgan Conference, January 2018
Veeva Systems is the leading software vendor to life sciences companies. While Peter Gassner, co-founder and current CEO, was working at Salesforce.com he came up with the idea to develop a verticalized cloud solution solely focused on the life sciences industry. Because Salesforce.com didn’t want to specialize in this vertical, Veeva was founded. Veeva’s core CRM product was built on top of Salesforce.com’s platform and this commercial partnership still remains.
Veeva was able to quickly build CRM product specialized for the life sciences vertical by leveraging the platform. In exchange for the technology, Veeva pays a per seat licensing fee to Salesforce.com with minimum commitments, which results in lower gross margins for the commercial cloud business than other SaaS businesses at a similar scale. But even with lower gross margins, Veeva was able to efficiently grow, only needing to spend $3M of the $7M raised from venture capital.
The commercial cloud segment has come along nicely, increasing from $33M in subscription revenues in FY12 to $599M in FY21, or a +38% CAGR over the nine year period. Growth has come from increasing penetration into the universe of 500+ life science companies with commercially available products and adoption of add-on modules that complement the core CRM product. It is estimated that Veeva has over 80% market share of the 450k global pharma sales representatives and the company sees a path to 90% market share.
Veeva commercial cloud still has room to grow as it adds modules on top of the core CRM solution. In FY14, Veeva customers had on average 1.9 products in the commercial cloud segment and that number is above 3.7 in FY21. Typically a module adds another 15%-20% of the core CRM product in revenues and these modules combined can often times contribute more than the core CRM product. CLM (Closed Loop Marketing) is the most popular add-on with over 80% attach rate and Approved Email is the 2nd at 64% attach rate.
What sets Veeva apart from other SaaS companies is the company’s success in developing a 2nd product category. Typically, successful and long-lasting software companies are able to find 2nd and 3rd product lines that can boost growth and/or expand market share. In most cases, acquisitions tend to help shore up the technology for these 2nd or 3rd product lines, but in the case for Veeva, it was internally developed.
The 2nd product category is called Vault, which is software designed to help the development of new commercial drugs and/or devices within life sciences. Vault was launched in 2012, a year prior to the company’s IPO. From the initial stages of research and development to clinical trials to regulatory approval to ensuring safety of the products and to manufacturing, Veeva Vault software provides support for all of these functions.
Vault has expanded the universe of companies that Veeva can sell to. In addition to the 500+ life sciences companies with a commercially available product, Veeva can now sell to the 2,000+ smaller pharma and biotech companies and another 10,0000 medical device companies.
Vault has grown from $133M in subscription revenues in FY17 (first year broken out) to $580M in FY21, or a CAGR of 44% over four years. Similar to commercial cloud, add-on modules have contributed to the growth for Vault but most of the growth has come from new customer wins. The runway for the number of Vault products adopted per customer is much larger than commercial cloud because there are more Vault products to begin with and the average number of Vault products per customer is much lower than that of commercial cloud.
Veeva aims to reach 35% non-GAAP operating margins by 2025, a margin target already surpassed by 2021. As Vault becomes an even larger part of the business, margins should move higher. Offsetting this, the company expects to continue to reinvest back into the business through new internally developed applications and heavy investments into sales and marketing.
Why is it a good business?
Like most other software companies, Veeva benefits from their customers’ switching costs. Once a customer is integrated into the Veeva suite of products, proprietary data is created on the platform. As that dataset grows, it becomes increasingly more cumbersome to switch to another CRM or data management software vendor. There is also the integration and training costs for adopting a new software program, especially one that effectively runs a life science company’s commercial and R&D organizations.
As the company grows its Vault segment, certain products will have small network effects. For example, Veeva Site Connect (part of Veeva’s Clinical Network products) allows sponsors and clinical research sites to exchange data electronically. If Site Connect were to become the industry standard for electronical data exchange, it would be mission critical to use this software when conducting a clinical trial.
Veeva stands out from the other successful SaaS companies because of the company’s (1) efficiency in acquiring new customers and (2) high net annual retention rate. Veeva’s CAC (customer acquisition cost) has ranged between 0.8 and 1.2 (lower is better) over the past 5+ years, while many other successful SaaS companies have a CAC between 1.5-2.5. Here CAC is defined as the incremental sales and market expense divided by the change in gross profit dollars each year.
The company explains the low CAC relative to peers as the result of reference selling and specialization in the life sciences vertical. Veeva customers are generally happy to convert from general purpose (and older) license based software from Siebel or Oracle to Veeva’s life science focused cloud software. Also in many cases, customers are converting from software built inhouse or just the use of spreadsheets.
The industry dynamic in life sciences is also concentrated with a few large players (the top 50 companies account for 70% of total revenues). This would imply that if high product quality is achieved, it would be much more efficient to sell vs. general purpose software. Mathematically this means that the sales and marketing expenses for Veeva as a percentage of revenues at 16%-20% is much lower than that of other SaaS companies. This ratio is 44%-46% for Salesforce.com, 32%-36% for Workday and 44%-46% for Service Now.
The high retention rate can be explained by the add-on products that Veeva offers in addition to core CRM or Vault clinical suite. This is accentuated by the fact that Vault is growing faster than commercial cloud, which tends to have more add-on opportunities as a customer goes through the R&D to clinical trial to commercialization life cycle. The company’s retention rate has ranged between 122%-127% for the past 5 years, implying that customers buy more each year while few cancel their subscriptions. It’s estimated that gross churn is roughly 4%, also best in class among SaaS companies.
Returns on capital?
Over the past 10 years, Veeva has spent 59% of its capital on R&D, 5% on capex and 35% on acquisitions. R&D is generally the biggest use of capital as the company continues to release new product categories (Vault and QualityOne) and add-on modules such as Veeva Clinical Network, MyVeeva and Veeva Stats (newest releases in 2021). Capex is not that relevant, and it couldn’t be more evident from the company’s latest form 10-K. Capex and capitalized software were grouped together under a line item named long-term assets in the cash flow statement.
Acquisitions are uncommon for the company and typically, the acquired companies are smaller, tuck-in acquisitions that Veeva feels would be complementary to its core product offerings. Two of the more recent and larger acquisitions were Crossix and Physician One. Crossix is a data platform that provides anonymous patient data, which will be critical to build out Veeva’s data cloud and Physician One is a speaker event organizer for healthcare professionals.
It can be argued that the returns on R&D dollars for the Vault segment were even higher than commercial cloud, even though the company spent extra resources to build the Vault platform independent of Salesforce.com. This is because the growth rate of Vault has outpaced the commercial cloud ever since its third year in existence. Reference selling has definitely helped Vault adoption and the larger set of potential customers also contributed to growth.
There is also a natural replacement cycle with each clinical trial for which Veeva can sell Vault products. This implies that Veeva has more shots of goal to sell software that helps these companies conduct their clinical trials in everything from data collection to management to submission and reconciliation. If a drug or medical device gets through the approval process, there’s also safety, manufacturing, and regulation software that the company can also sell to their clinical trial customers.
We estimate that Veeva has generated between 35%-65% returns on its capital invested for the past 5 years. Because the company was able to sustain its high total revenue growth rate between 25%-35% due to the success of Vault, the returns on R&D spend were very high for this period.
Veeva has always maintained a very conservative balance sheet, with no debt and a healthy cash balance. This is due to the efficiency of the business and so far, Veeva has been able to grow without a large M&A transaction. In the future, as the company expands into other verticals or product categories, large M&A may be a possibility, which could mean that Veeva takes on some debt.
Veeva has a good understanding of where each of their products are on the adoption curve which allows the company to properly allocate its sales efforts and R&D investments in the necessary product segments. The more mature product lines include the core CRM software (80+% penetration of all pharma sales reps), CLM at 80% attach rate to CRM and Approved Email which is close to 65% attach rate. Some of the products that have more room to grow include CTMS (clinical trial management system), QualityOne, Safety, MyVeeva, etc.
At the company’s FY14 analyst day, the addressable market was estimated to be $2B in commercial cloud, $1B in Veeva Network and $2B in Vault, totaling $5B. In six years, at Veeva’s FY20 analyst day, the TAM was increased to $12B with commercial cloud increasing to $3B and Vault increasing to $5B. QualityOne is $1B (though this will likely be revised higher in the future) and Data Cloud (Nitro, Andi, Crossix, etc.) is $2B.
Most likely the largest growth opportunity will be in clinical trial management software. The company estimates that $120B-$130B are spent on clinical trials each year and that Veeva has the opportunity to extract $2B-$4B in revenues over time.
With a reinvestment rate between 40%-70% and a return on capital between 35%-65%, we estimate that Veeva’s intrinsic value increased 22%-26% annually for the past 5 years. Looking back, with Vault being one the best second product launches for a software company, it makes sense that the intrinsic value has increased at such a high rate for that time period.
What else is important?
Partnership with Salesforce.com
The partnership with Salesforce.com is interesting because it enabled Veeva to efficient build its first commercial product. As mentioned before, the gross margin dollars may be lower due to the license fee, but the R&D dollars at least initially were much lower. Veeva needed to customize the CRM offering to cater to the life sciences industry’s specific needs, but not having to build a CRM product from the ground up was a big advantage. So far, this partnership remains until 2025.
There are some drawbacks to partnership. One is that the Veeva CRM product can only be sold to life sciences companies. While Veeva is branching out to selling software to non-life sciences companies in the chemical, CPG and cosmetic industries (QualityOne), selling a CRM system to these companies would violate the agreement with Salesforce.com.
While Veeva doesn’t have a single competitor for all of its product offerings, the company views IQVIA as its biggest competitor. IQVIA is the result of a merger between a clinical data company (IMS Health) and a contract research organization (Quintiles) and the combined entity has many unique datasets that are critical to the commercialization process. Veeva sees IQVIA in almost every large deal and many customers use Veeva software as well as subscribe to the services that IQVIA provides.
IQVIA has a dominant position in certain performance data that is used to analyze the sales of commercialized life science products. And IQVIA is making it difficult for its customers to port this data and other datasets into Veeva software. There is a lawsuit + counter lawsuit regarding certain anti-competitive behavior. Because it’s difficult to estimate what the timing or outcome of these lawsuits will be, it’s likely best to just mark it as an item of interest for now.
Here is a nice overview of the lawsuit vs. IQVIA.
Public benefit corporation
Veeva, with shareholder approval, converted to a public benefit corporation this year. This means that while profits are important, the company is legally responsible for balancing the needs of customers, employees, partners and shareholders.
This likely doesn’t change anything operationally for the company in the near-term, and with ESG strategies continuing benefit from net equity flows, being a public benefit corporation may actually benefit the stock. It can be argued that Veeva has been run as it if were a public benefit corporation since it was founded, so we shouldn’t expect anything to change behaviorally at the company. Management has stated that the only difference is that the legal charter for the company is now aligned to the way the company has been run all along.
QualityOne is the company’s largest upside potential right now in terms of near-term attainable revenues. Veeva thought that expanding its quality software product lines to service chemical, CPG and cosmetic industries would be a natural evolution. What the company didn’t know until selling to these new industries was that Veeva’s software solutions would be such a great fit.
The opportunity set for QualityOne is 600+ manufacturers with over $500M in revenue and 1,600+ with over $100M in revenue in the U.S. The company already has 60 customers and is generating $30M in revenues from QualityOne. Many analysts expect QualityOne to grow even faster than Vault and Commercial Cloud.
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Good writeup, thanks!
Excellent analysis, insightful, many thanks!!