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Company: Elanco (ELAN)
Business: Elanco is one of the largest global animal health pharmaceutical companies, developing and marketing products for both pet health and farm animals. It offers pet health disease prevention products, such as parasite and vaccine products that protect pets from insects, fleas and ticks, under the brands Seresto, Advantage, Advantix and Advocate; Indications for pain, osteoarthritis, ear infections, cardiovascular, and dermatological indications in dog and feline under the brands Pet Health Therapeutics Galloprant and Claro; Vaccines, antibiotics, parasites, and other products for use in poultry and aquaculture production, as well as functional nutritional health products including enzymes, probiotics, and prebiotics; and a range of vaccines, antibiotics, implants, parasites, and other products used in ruminant and swine production under the Rumensin and Baytril brands.
stock market price: $15.6B ($33.15 per share)
Percentage Ownership: 1.61%
average cost: n/a
Activist Commentary: Starboard is a very successful active investor and has extensive operational activism experience helping the board and management teams run companies more efficiently and improve margins. He has filed 103 13D. In those 103 filings, they have returned an average of 33.9% versus 13.3% for the S&P 500. Their average 13D hold time is 18 months.
On October 6, 2021, Starboard expressed its belief that Elanco Animal Health Inc. (ELAN) has an opportunity to increase margins through operational improvements.
Elanco was spun out of Eli Lilly September 2018 And was met with great enthusiasm – on its first day of trading, the stock closed +50%. The reason the stock was so well received was that management promoted opportunities to grow revenue and improve margins by about 1,000 basis points over five years at or above the industry’s growth rate. In 2018, Elanco’s EBITDA margin was 21% versus 38% for Zoetis, its closest peer. In addition, Zoetis was a relevant case study for Elanco as it was spun off from a larger company and management was able to execute on its value creation plan, resulting in Zoetis’ share price from the S&P500 to 330 per cent since its IPO. % was performing better.
Elanco management set a target of 31% EBITDA margin by 2023. The company’s management appeared as though its strategy would not be dependent on other large deals and would be focused on executing on its pipeline. However, on August 20, 2019, Elanco announced its acquisition of Bayer’s animal health business for approximately $7.6 billion, which stunned the market and sent the stock down 24%. Elanco explained this acquisition as too good of a passing opportunity as it would massively expand and change the mix of the business. As a result, management accelerated their margin target target timeline by one year and announced that they would reach their 31% EBITDA margin target by 2022 as a result of this acquisition.
Following the acquisition, Elanco and Zoetis had a closer scale and more similar geographic/portfolio mix, but, Elanco’s (including Bayer’s) margins were well below Zoetis, which had an EBITDA margin of 40% as of 2019. Admittedly, Zoetis had some valuable products. With higher pricing power leading to higher gross profit margins than Elanco, that’s why Elanco was targeting only 31%, not 40%. But then, in 2020, management revised its guidance, saying it was now expecting to achieve a 31% EBITDA margin by 2024, a year later than its first launch and two years later than its last launch. in comparison.
To confuse and frustrate shareholders even more, management claims they have realized significant cost savings, but have not resulted in margin expansion. Instead, the gap between Elanco and Zoetis remains: 2,455 basis points in 2020 and an estimated 2,086 basis points for 2021. This resulted in a lack of confidence in the management’s execution, an underperforming stock price and a large margin and several differences with Zoetis Trading. 26x 2022E EBITDA and Elanco trading at 18x. This gap can be closed through improved operating performance, which will inspire greater confidence from shareholders, and lead to a better valuation multiplier. Starboard’s analysis estimates a $47 stock price for Elanco with a 31% EBITDA margin and no multiple correction and a $74 stock price with a 31% EBITDA margin and a multiple equal to Zoetis. Starboard sees a potential $91 stock price, with better margin improvement of up to 37.1%.
It’s important to note that Starboard isn’t the only worker in Elanco. In October 2020, Sachem Head filed a 13D on Elanco. In December 2020, the firm entered into an agreement with Elanco for three board seats for Scott Ferguson, Paul Herendine and William Doyle. Starboard has given the company some time to execute with these new directors and will likely give it more time, but at some point the board and management will have to show they can execute. Starboard isn’t the only shareholder that’s clearly disappointed. At last year’s annual meeting, significant votes were cast against each of the directors for the election – Art Garcia (46.34%), Dennis Scotts-Knight (46.54%), Jeffrey Simmons (37.04%) and William Doyle (21.09%).
Elanco has a great opportunity to create shareholder value through margin improvement, and Starboard has extensive experience in improving the margins of portfolio companies from the board level. Starboard may not nominate a director until January 2022, but it seems like a logical situation for Starboard to have an invitation to be on board, so hopefully it doesn’t come to that.
Ken Squire 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 the portfolio of activist 13D investments. Elanco is owned by the fund.