Activist Anonymous calls for cost-cutting at Henry Schein. What to expect

Ownership: n/a

Average cost: n/a

Worker Commentary: Anonym Capital Management is a New York-based activist investment firm launched on September 3. It is run by Charlie Penner (former partner at Jana Partners and head of shareholder activism at Engine No. 1) and Alex Silver (former partner and investment committee). Member at P2 Capital Partners). Anonymous looks for high-quality but low-cost companies, regardless of industry. The firm would prefer to work amicably with its portfolio companies, but is prepared to resort to proxy fights as a last resort. It has approximately 10 positions in its portfolio and currently manages $250 million.

Henry Schein is a leading global distributor of healthcare products and services primarily for in-office dental and medical practitioners. The Company operates through two segments that offer different products and services to the same customer base: (i) Healthcare Distribution and (ii) Technology and Value Added Services. The healthcare division covers Henry Schein’s distribution of dental and medical products, such as laboratory products, pharmaceuticals, vaccines, surgical products, specialty dental products and diagnostic tests. This segment, which accounts for 93.5% of net sales, is subdivided between dental (61.1% of total net sales) and medical (32.4%). While the company’s primary go-to-market strategy is in its distribution capabilities, it also sells its own corporate brand portfolio of products and manufactures specialty dental products. In terms of scale, the company is the global leader in dental distribution and second in medical distribution to office-based physicians. Henry Schein’s second segment, Technology and Value-Added Services (6.5% of net sales) covers the sale of practice management software and other value-added products. With a market cap of about $9 billion, the company generates about $1 billion in free cash flow annually.

Despite Henry Schein’s leading market position, attractive market structure, differentiated value proposition and strong earnings power, on a total shareholder return basis over the past five years (0%, as of November 15), vs. No value delivered. % for the S&P 500 Healthcare Index and 105% for proxy peers. The main source of this poor performance is relatively obvious: cost controls. Since 2019, the company has grown gross profit at 5% compound annual growth rate and 6% CAGR. But it spent all that extra revenue and then some on operating expenses, resulting in an 8% increase in annual operating expenses and adjusted earnings before interest, taxes, depreciation, and amortization margins from 10% to 8%. has fallen To put it differently, in 2019 the company had $10 billion in revenue, $3.1 billion in gross profit and $916 million in EBITDA. Today, it has $12.5 billion in revenue, $3.9 billion in gross profit and $815 million in EBITDA. One reason is that the company has spent $4 billion (about 45% of its current market cap) on underperforming acquisitions that have provided a return on invested capital far below the company’s cost of capital. Additionally, management has been unable to integrate these acquisitions leading to increased selling, general and administrative expenses. The first thing that needs to be done is for Henry Schein to implement the comprehensive restructuring plan announced by the company to cost more than $100 million. There is a potential of $300 million in actionable savings that could increase earnings per share by 35% or more.

Next, the company needs to do a better job with capital allocation. It should stop using cash flow for acquisitions or repay its debt at 6% and start using it to buy back stock at those prices. The company trades at 13 times trailing 12-month earnings – near a 15-year low. Henry Schein has stable cash flow and a strong balance sheet. With cash flow, it can increase net leverage from 2.6 times to 3.0 times to acquire more than 10% of its float today and 40% of its float by 2026, as a modest $300 million to $400 million stake. Compared to repurchasing. (<5% market cap) it has announced for 2025. This will further increase the EPS. Possibly 50%. In addition to these initiatives, the company's medical business presents a strategic opportunity. While Henry Schein has successfully developed the office-based physician space as the No. 2 player, the business environment is far more competitive and will favor larger distributors. The asset could be worth $2.5 billion or more in the sale, which would increase share prices and could be used to repurchase more of the company's discounted shares.

Many companies have serious problems and need a worker to bear them. It’s a company that doesn’t need an activist to survive, but it would benefit greatly from an activist who could help improve its operations and balance sheet. Henry Schein is a great company that has fallen asleep and been allowed to coast when it could have been elevated. One of the reasons the market has allowed it is that it has been compared to its sleeper peers, Patterson and Banquo. Benco is a private company and Schein’s three-year return of -12% blows away Patterson’s -41%, but Schein has positioned itself as one of the largest US health care distributors such as Cardinal Health (+135%). ), should be benchmarked against Cencora (+). 93%, and McKesson (+173%). Perhaps not in terms of scale or end markets, but more in the desire and dedication of shareholders. This will require a refreshed board. Many directors at Henry Schein have been in their seats for more than a decade and the board lacks excellent distribution skills. A new board could come in and create a succession plan for Stanley Bergman, who has been CEO for 35 years. This is easier when the company can retain top management. But under the current board, the company has experienced a corresponding level of executive turnover since 2021.

Anonymous doesn’t have an employee history yet, but knowing Charlie Penner and Alex Silver as we do, we’d expect them to work amicably with management to create value for shareholders. Will try. We do not expect the firm to insist on a board seat for an anime principal. However, we expect that Ananym will recommend several good industry executives who can help drive the necessary changes to create significant shareholder value from the board level. But don’t mistake investor-friendly behavior and friendly engagement for weakness. The firm is loyal to its investors and will do whatever it takes to create value in its portfolio companies. The director nomination window will not open until January 21, 2025, and we expect the parties to work on an agreement before then.

Ken Square is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments. is