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Company: Elanco (ELAN)
Business: Elanco is one of the world’s largest animal health pharmaceutical companies, developing and marketing products for the health of companion animals and farm animals. It offers disease prevention products for pets, such as pest control and vaccine products that protect pets against worms, fleas and ticks under the Seresto, Advantage, Advantix and Advocate brands; therapeutic products for pets for pain, osteoarthritis, ear infections, cardiovascular and dermatological diseases in dogs and felines under the brand names Galliprant and Claro; vaccines, antibiotics, parasiticides and other products for poultry and aquaculture production, as well as functional nutritional health products, including enzymes, probiotics and prebiotics; and a range of vaccines, antibiotics, implants, antiparasitics and other products used in the production of ruminants and pigs under the Rumensin and Baytril brands.
Stock market value: $ 15.6 billion ($ 33.15 per share)
Percentage of ownership: 1.61%
Average cost: n / A
Activist comment: Starboard is a very successful activist investor and has extensive experience in operational activism helping boards and management teams run businesses more effectively and improve their margins. They made 103 13D deposits. In those 103 deposits, they averaged a return of 33.9% versus 13.3% for the S & P500. Their average 13D hold time is 18 months.
On October 6, 2021, Starboard expressed its belief that Elanco Animal Health Inc (ELAN) has the opportunity to increase its margins through operational improvements.
Elanco was born out of Eli Lilly in September 2018 and met with great enthusiasm – on its first day of trading, the stock closed at + 50%. The reason the action was so well received is that management publicized the opportunities to increase revenues at or above industry growth rates and improve margins by around $ 1. 000 basis points over five years. In 2018, Elanco’s EBITDA margins were 21% compared to 38% for Zoetis, its closest competitor. In addition, Zoetis was a relevant case study for Elanco as it was also from a larger company and management was able to execute its value creation plan which allowed Zoetis’ share price to outperform. the S & P500 by 330% since its IPO.
Elanco’s management was targeting EBITDA margins of 31% by 2023. The company’s management suggested that its strategy would not depend on other large transactions and that it would focus on executing its strategy. own pipeline. However, on August 20, 2019, Elanco announced the acquisition of Bayer’s Animal Health business for approximately $ 7.6 billion, which surprised the market and caused the stock to fall 24%. Elanco explained that the acquisition was too great an opportunity to pass up as it would significantly increase the scale and change the makeup of the company. As a result, management has accelerated the timeline for its target margin goal by one year and announced that as a result of this acquisition it will meet its target of 31% EBITDA margins by 2022.
After the acquisition, Elanco and Zoetis had a closer scale and more similar geographic / portfolio mixes, but Elanco’s (including Bayer) margins were much lower than Zoetis, which had 40% EBITDA margins in 2019. Certainly Zoetis had valuable products. with high pricing power leading to higher gross profit margins than Elanco, but that is why Elanco was not targeting 40% but only 31%. But then, in 2020, management revised its forecast and said it now hopes to achieve 31% EBITDA margins by 2024, a year later than its first projection and two years later than its last. projection.
To confuse and further frustrate shareholders, management claimed it had achieved significant cost savings, but this did not result in an increase in margin. Instead, the gap between Elanco and Zoetis remains: 2,455 basis points in 2020 and an estimated 2,086 basis points for 2021. This had resulted in a lack of confidence in management’s execution, a course of l The stock underperforming and a large margin and multiple spread with Zoetis trading at 26x EBITDA 2022E and Elanco trading at 18x. This gap can be bridged through better operational execution, which will inspire greater shareholder confidence and lead to an improved valuation multiple. Starboard’s analysis estimates a stock price of $ 47 for Elanco with EBITDA margins of 31% and no multiple improvements and a stock price of $ 74 with EBITDA margins of 31% and a multiple equal to Zoetis. With an even better margin improvement to 37.1%, Starboard sees a potential price of $ 91.
It’s important to note that Starboard isn’t Elanco’s only activist. In October 2020, Sachem Head filed a 13D on Elanco. In December 2020, the company secured three board seats with Elanco for Scott Ferguson, Paul Herendeen and William Doyle. Starboard has given the company some time to run with these new directors and will likely give it more, but at some point the board and management need to show they can execute. Starboard is not the only clearly frustrated shareholder. At last year’s annual meeting, significant votes were cast against every director in election – Art Garcia (46.34%), Denise Scots-Knight (46.54%), Jeffrey Simmons (37.04%) %) and William Doyle (21.09%).
Elanco has a huge opportunity to create shareholder value through improved margins, and Starboard has extensive experience in improving margins for portfolio companies at the board level. Starboard cannot make director appointments until January 2022, but that seems like a logical situation for an invitation to the Starboard board, so hopefully it doesn’t come to that.
Ken Squire is the founder and chairman of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio manager of 13D Activist Fund, a mutual fund that invests in a portfolio of 13D activist investments. . Elanco is held in the fund.