If you’re not already familiar, let me introduce you to Schrödinger (NASDAQ:SDGR), a biotech company that was once a trailblazer in using machine learning, physics, and chemistry to accelerate the drug discovery process. However, it seems the tides have turned, and I’m here to explain why I believe this company might be headed for troubled waters.

Background: The Rise of Schrödinger
Schrödinger, known for its unique blend of scientific prowess and cutting-edge technology, entered the scene with a remarkable value proposition. By combining complex physics-based algorithms like free energy perturbation (FEP) with the power of machine learning, the company aimed to identify potential drug candidates more efficiently. But there’s more to the story than just that.

The Business Fundamentals Decline
Since going public, Schrödinger’s financial performance has been anything but consistent. Metrics like revenue, profit margins, and customer acquisition costs have taken a noticeable hit. The cause? The increasing popularity of open source software, which has managed to outperform Schrödinger’s proprietary platform.

The Value Proposition Erosion
As the software offering from Schrödinger loses its competitive edge, it’s becoming increasingly evident that the company’s value proposition is weakening. This not only affects the software segment but also the potential for future drug discovery partnerships. It’s like a domino effect, where declining software quality leads to diminished partnerships and, consequently, lower drug discovery revenue.

Why I’m Betting Against Schrödinger
Now, let’s dive into the heart of the matter. I’m taking a stance against Schrödinger’s potential for recovery, and I’ll tell you why.

1. Current Business Landscape
Analyzing the company’s portfolio and financials reveals a bleak picture. While there’s a substantial valuation of assets, Schrödinger’s earnings have hit a downturn. Q2 earnings reported the company’s first-ever year-over-year decline, indicating that something is amiss. The decline in software revenue is particularly concerning, as it directly reflects the health of Schrödinger’s core value proposition.

2. Software Obsolescence
A deeper dive into Schrödinger’s algorithmic approach highlights some shortcomings. The FEP algorithm, although a pioneer, is sluggish and resource-intensive. The company’s solution to this was to integrate graph convolutional neural networks (GCNN) for faster predictions. However, this approach falls short compared to recent breakthroughs in machine learning for drug discovery. Other researchers are already outperforming Schrödinger’s methods, spelling obsolescence for their once-revolutionary approach.

3. Competitor Gains
Recent advancements in machine learning for drug discovery have rendered Schrödinger’s methods obsolete. For instance, a paper by Qiao et al. showcases geometric deep learning’s potential in predicting quantum mechanical properties with higher accuracy and speed. These new approaches overshadow Schrödinger’s outdated techniques, leaving them behind in the race for innovation.

The Valuation and Conclusion
Given the company’s dwindling fundamentals and the emergence of more potent competitors, I believe Schrödinger’s downfall is inevitable. Valuation models predict a significant downside for the company, even considering conservative growth estimates. I recommend shorting Schrödinger, with the potential for a substantial 37% profit from the current price.

Final Thoughts
In the world of biotech, where innovation is the driving force, Schrödinger’s decline serves as a cautionary tale. While they once stood at the forefront of technology-driven drug discovery, their failure to adapt has left them lagging behind. The importance of staying at the cutting edge cannot be understated, and Schrödinger’s story stands as a reminder that even pioneers can falter when they don’t keep up with the pace of innovation.

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