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Company: Elanco Animal Health (ELAN)
Business: Elanco is an animal health company that provides products and services to prevent and treat diseases in livestock and pets. Its portfolio serves animals across all of its core species and offers products in two categories: Pet Health, which focuses on parasiticides, vaccines and therapeutics; and Farm Animal, which consists of products designed to prevent, control and treat health problems primarily focused on cattle.
Market value: $7.34 billion ($14.90 per share)
Activist: Ancora Advisors
Percentage ownership: ~3.0%
Average cost: n/a
Comment from activists: Ancora is not an activist investor. It is primarily a family wealth advisory and fund management firm with $8.7 billion in assets under management and an alternative asset management division managing approximately $1.3 billion. It was founded in 2003 and hired James Chadwick in 2014 to carry out activist activities in niche areas such as banks, savings banks and closed-end funds. Ancora's website lists “small cap activists” as part of its products and strategies, and its strategy has evolved in recent years. From 2010 to 2020, the majority of Ancora's activity consisted of 13D filings on micro-enterprises, and in recent years they have taken a larger number of shares of less than 5% in larger companies. The Alternatives team has a track record of leveraging private and, when necessary, public collaboration with portfolio companies to drive governance improvements and long-term value creation.
What happens
On Dec. 14, Bloomberg reported, citing people familiar, that Ancora had taken a position at Elanco and was pushing for a replacement of the company's CEO, changes in the company's board makeup and improved margins.
Behind the scenes
Elanco is one of the largest global animal health pharmaceutical companies, developing and marketing products for both pet health and livestock. The company operates in a long-term growth industry that has experienced a massive wave of consolidation and has been recession-resistant in the past. The company is one of four players – including Zoetis, Merck Animal Health and Boehringer Ingelheim – that together have a market share of 80%. Elanco spun off from Eli Lilly in 2018 and was met with great excitement: On its first day of trading, the stock closed 50% higher than its IPO price. The reason the stock was so well received was because management announced opportunities to grow revenue at or above industry growth rates and improve margins by about 1,000 basis points over five years. In 2018, Elanco's profit margin before interest, taxes, depreciation and amortization was 21%, compared to 38% for Zoetis, its closest competitor. Although Zoetis' product mix allows for higher margins, this gap is still far too large and Elanco management is targeting an EBITDA margin of 31% by 2023.
Then, on August 20, 2019, Elanco announced an agreement to acquire Bayer's animal health business. Elanco said this acquisition was too good an opportunity to pass up as it would significantly increase scale and change its business mix. As a result, management accelerated its margin target timeline by one year and announced that it would achieve its 31% EBITDA margin target by 2022 as a result of this acquisition. But then in 2020, management revised its guidance and stated that it now hoped to achieve an EBITDA margin of 31% by 2024, a year later than its first forecast and two years later than its last forecast . To further confuse and frustrate shareholders, management claimed that it had achieved significant cost savings, but this did not translate into margin expansion.
In October 2020, Sachem Head Capital Management filed a 13D against Elanco, in which he also raised concerns about the company's EBITDA margins and progress in improving them. On December 13, 2020, Sachem Head and Elanco entered into a cooperation agreement that gave the activist three board seats for William Doyle, Scott Ferguson and Paul Herendeen. Scott Ferguson has since stepped down from the board, but Doyle and Herendeen currently serve as directors.
Now Ancora has taken a stake of about 3% and plans to push for margin improvements, a board renewal and a CEO replacement. Ancora sees this as a failure of corporate governance and accountability. In addition to failing to improve margins over the past five years, management overpaid Bayer and was late in converting its debt from variable to fixed, leading to significantly higher interest expenses. Additionally, the board does not appear to hold management accountable. For example, at the 2023 annual meeting, 62% and 71% of voting shareholders, respectively, opposed the election of two directors. Despite the results, the board made no changes. The director who received 71% of the vote against him is the company's chairman, R. David Hoover.
The board's chickens may be coming home to roost. Ancora will have the option to replace four directors, including the company's CEO Jeff Simmons, at the next annual meeting. Ancora is pushing for a board renewal and CEO replacement, but the company could potentially do it in one fell swoop. If Simmons is not re-elected as a director, it will be difficult for even this board to retain him as CEO. Ancora is expected to appoint three industry directors and one Ancora executive, signaling its intention to be a long-term shareholder. Of the four incumbent directors up for re-election at the next annual meeting, all received over 20% “against” votes in their last election in 2021 (two of them over 46% and Simmons over 37%) and were not even contested. At that time, Elanco was trading at $35.76 per share. It is now around $14 per share. Shareholders should wait for Ancora with flowers and chocolate. We believe Ancora should easily win three seats in a proxy fight, and the chance of winning the fourth seat could be even greater. Understandably, Institutional Shareholder Services doesn't recommend voting against a sitting CEO, but it also doesn't like a board that has ignored the will of its shareholders. Even if Simmons is able to retain his board seat in a proxy fight, the large number of shares voted against him when it comes to a vote will send a strong message to the board and likely be a writing on the wall for him.
We rarely see a company so well prepared for a board renewal and management change. A refreshed board and management team that can deliver gross margins in the mid-50s to 60s and EBITDA margins in the high 20s (even below the 31% promised by management) would significantly increase shareholder value.
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, an investment fund that invests in a portfolio of 13D activist investments.