I am raising the rating on Medidata Solutions (NSDQ: MDSO), the leading cloud based software platform for biotech research management to Buy from Hold.  I recommended the stock in March 2015 and so far it has delivered a 51% price increase.  But recent price behavior suggests that it’s poised for an upside breakout. 

A Prescription for the Times

Last week I wrote about the Medicare Effect where cost cuts and new forms of bundled payments are likely to decrease the potential profitability of companies across the entire health care sector.  I also noted that at some point, some companies would be in a position to profit from these changes and that the market would eventually adjust to the new world.   One company that’s already benefiting from this new world is Medidata Solutions because its products are just what the doctor called for, a series of processes that make designing, managing and completing research studies and new drug development easier and more economical for cash strapped biotech and pharmaceutical companies.   

As the Medicare price squeeze constricts around the health care system, pharmaceutical companies will be looking to cut drug development costs.  One way is to transfer its back office processes to Medidata in order to improve efficiencies and lower capital expenses.  And as more companies realize this, Medidata’s customer base growth rate will likely increase, as it did in the past quarter (see next section).

Rising Fundamentals

Medidata reported their most recent quarterly results on July 20, beating expectations of 22 cents per share by one cent.  Revenue came in above expectations at $114.6 million, up 17% year-over-year, versus expectations of $112.39 million due to “strong services revenue,” which rose 25% year-over-year. The company reported GAAP profitability of nearly $5 million, up more than 200% year-over-year while operating cash flow came in at nearly $26 million versus nearly $13 million in Q1 of 2015. MDSO also reported its third straight quarter of strong bookings and healthy overall backlog growth, and cited strong broad based execution from a geographic, solution and client perspective.

Medidata confirmed its full-year guidance and reported the addition of 96 new customers, noting that 64 of their 96 new customers came from organic growth. The company also crossed the 700 customer milestone for the first time and now has a total customer base of 711. 

Price Action Depends on Market and Niche

The stock rallied nicely on its earnings report but has been consolidation for the past three weeks and looks set to move above $55.  If it can get above this key level our next target would be the $64 area.  If the stock reaches our target it will have delivered a 78% profit.  There are no guarantees that it will do so, but if there is no external market shock or an unexpected company-specific surprise it is likely that the price may get close to that area where we will be looking to take some profits.  The stock is richly priced at 140 times earnings but is currently shielded by the general, if extraordinary, market dynamic and its own credible growth story as well as its niche of being a key solution provider to an industry that is starting to feel the pinch of tightening purse strings.  It is important to view this company as a moderately speculative pick that should be held in a diversified portfolio and pay attention to the $48 sell stop or any changes in the sell stop over the next few weeks if there are any meaningful changes in the price.

External Risk Alert

I expect both presidential candidates to turn their attention to health care as the election gets closer. When they do, their words and their proposals will likely affect prices throughout the sector. Some company stocks may rise, but many will likely experience price declines.  Generally speaking, pharmaceutical companies are the most likely to take the brunt of the punishment since they are the most visible and well known names.  Companies such as Valeant (VRX) have created a negative atmosphere with their business models and have increased the risk for others to be painted with the same brush.  Medidata is way down the food chain and is in a good position to benefit from any type of financial squeeze around the pharmaceuticals sector.  Still, there is no guarantee that it will escape a major sector wide price decline and I’ll be watching closely.

Disclosure:  I own shares in Medidata Solutions.

Portfolio Summary

Recent Changes:

Medidata Solutions (NSDQ: MDSO) – Buy up to$58. Sell at Stop $48.  Bought on 3/7/16 at $36 – 08/12/16 closing price $54.48.  Dr. Duarte owns shares in MDSO.

Ambarella (NSDQ: AMBA) – Buy until $57.  Bought 6/16/16 at $52.77.  8/12/16 closing price $64.09.  Sell Stop $54.  Dr. Duarte owns shares in AMBA.