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Formula for Growth

By Massimo Santicchia Standard & Poor's Focus Stock of the Week is Tripos Inc. (TRPS), a leading provider of integrated discovery software products, software consulting services, and discovery research services to the pharmaceutical, biotechnology, agrochemical, and other life sciences industries. Tripos carries S&P's highest investment recommendation, 5 STARS, or strong buy.

Tripos' offerings help its clients outsource their research and discovery activities as a means to reduce their product discovery costs and time-to-market. That's particularly important for customers such as pharmaceutical companies who are under pressure from patent expiration and generic drug competition.

The contract research market is expected by S&P to expand to as much as $15 billion in sales by 2004, and Tripos is well-positioned to capitalize on this opportunity. Case in point: The company last month announced a contract with Pfizer totaling over $100 million in potential revenue over the next four years to provide it with its proprietary discovery research, software licenses, and software research products and services.

FAVORABLE TRENDS. S&P's positive outlook for the company stems largely from our belief that long-term industry trends underpin demand for the company's products and unique expertise. In fact, the success of companies in the pharmaceutical and biotechnology industries largely depends upon their ability to identify new chemical compounds with targeted properties that can be brought to market rapidly and on a cost-effective basis.

Currently, the discovery and development of a blockbuster drug takes about 8-12 years, and costs an average of $500 million per drug. By reducing the time-to-market, pharmaceutical companies can generate substantial amounts of additional profits before their product's exclusivity patent expires and generic drug makers move in to take market share.

In addition, in the search for biological activity, many companies have implemented high-throughput screening laboratories for the rapid analysis of large numbers of compounds. High-volume screening has resulted in an unprecedented information explosion of chemical data that need to be processed, managed, analyzed and used for decision making. Repositories for this data must be built and the data must be mined and shared -- much of the time across multi-national, cross-corporate boundaries.

UNIQUE PRODUCTS. Tripos, through its demonstrated ability to integrate chemical data and information technologies, provides the life sciences industry with a solid opportunity to speed the discovery process and reduce costs. The company's foundation is built on its expertise and reputation as a cutting-edge molecular design software provider. Using sophisticated cheminformatics it designs and produces drug-like compounds for screening using proven, reliable and patented methods. Thus, scientists avoid costly laboratory synthesis for chemical compounds not likely to be effective.

But it's not just software: Tripos offers an integrated suite of innovative, knowledge-based discovery products and services that accelerate the discovery process for customers. Its integration of software tools, related software support, customized information management services, designed chemical compound libraries and discovery research services is a unique and unprecedented approach to solving discovery research problems.

BRIGHT OUTLOOK. Our bullishness on the shares is further confirmed by the company's recent announcements of strategic alliances with major pharmaceutical companies -- like Pfizer, AstraZeneca, Bristol Myers-Squibb and Novo Nordisk. Tripos also has deals with smaller players such as Arena and Cyprotex. Although it has been working with Pfizer for more than a decade, the January, 2002, contract is particularly significant because of its size and, even more importantly, because it validates the company's drug discovery technology and knowledge and raises its visibility.

The Pfizer deal is also important because it could also open up the possibility of future, more lucrative collaborations where Tripos would provide an optimized lead -- a compound that Tripos has reviewed and pre-screened and that has a high probability of curing a certain disease when tested in animals and humans -- and not just a number of pure compounds. We believe the company will be able to secure more drug discovery collaborations as the Pfizer's partnership will be used as a model for deals with other companies.

In addition to the deal with Pfizer, Tripos entered 2002 with continuing contracts with major pharmaceutical firms and a strong pipeline in all business areas. We at S&P project revenues of $62.2 million and earnings per share of $0.67 for 2002. In 2003 we see revenues of $80.8 million and EPS of $0.94.

Tripos does not come cheap at 46X our 2002 estimate of $0.67, but S&P believes that the shares represent an excellent growth opportunity for aggressive investors due to its projected annual earnings growth rate of over 30% for the foreseeable future. Moreover, Tripos is already profitable and generates positive free cash flows, a rarity in the life sciences sector. Assuming high but decelerating growth in free cash flow over the next 15 years, S&P's discounted cash flow model points to a price target of $40, which represent a potential price appreciation of about 33% from current levels. Santicchia is an equity analyst for Standard & Poor's

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