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Company: Fortrea Holdings (FTRE)
Business: Fortrea Holdings is a global contract research organization (CRO) providing clinical development and patient access solutions to the life sciences industry. CROs work with pharmaceutical companies at all stages of the drug development process, from drug discovery and preclinical development to post-approval work in Phases I to IV. The company was originally part of Covance from 1997 to 2015, where it had central laboratory capabilities for preclinical and clinical development of phases I to IV. Covance was acquired by Labcorp in 2015 and Labcorp (LH) spun off Fortrea in July 2023.
Market value: $2.6 billion ($29.77 per share)
Activist: Starboard value
Percentage ownership: 8.75%
Average cost: $28.42
Comment from activists: Starboard has submitted 113 previous 13D filings and has an average return of 26.61% versus 11.88% for the S&P 500 In the same period. Of those 113 filings, 13 were in the healthcare sector, where Starboard returned an average of 38.64% versus 13.23% for the S&P 500 over the same period.
What happens?
On October 17, Starboard reported an 8.75% stake in Fortrea Holdings.
Behind the scenes
Fortrea was spun off from Labcorp on July 3 as a Phase I-IV clinical development company. The company is one of the seven largest contract research organizations and controls 80% of the market. Over the years, pharmaceutical companies have spent more and more money on research and development. Since a significant portion of this has been outsourced, the CRO industry has grown accordingly. So there are strong long-term tailwinds driving the growth of the CRO industry, but to be a successful contract research organization it helps to have global reach. Fortrea operates in more than 90 countries and focuses on more than 20 therapeutic areas. This has enabled over 5,000 studies to be carried out in the last five years. Yet despite its global reach and size, the company’s adjusted profit margin before interest, taxes, depreciation and amortization is just 9% in 2023 (with a forecast margin of 13% for 2024), well below the peer median of 18%. This is not unusual for a company that has recently been spun off from a larger company, as it may face a bloated cost structure upon the spin-off and may have been somewhat operationally neglected as a smaller part of a large company.
The company can now be run more efficiently as management focuses exclusively on the CRO business. The critical factor in achieving this is having the right CEO for the job, and Fortrea has him. In January, Tom Pike joined Labcorp as president and CEO of its Drug Development Clinical Development business and retained his CEO post at Fortrea following the completion of the spin-off. Pike has a track record of improving CRO profitability. When he was CEO of Fortrea competitor IQVIA (formerly known as Quntiles), he increased margins by 425 basis points between 2012 and 2016, leading the stock to significantly outperform the market by 48% during that period. He has already committed to increasing margins at Fortrea from 9% to 13%, but this still falls short of the performance of his competitors. Starboard believes the company can achieve a pure margin of 18%. The firm has extensive experience helping portfolio companies operate more efficiently and improve their margins, whether as an active shareholder or as a member of the board.
With Pike as CEO and margin guidance heading in the right direction, we expect Starboard to be an engaged shareholder here and only seek a seat on the board if things don’t go as planned. In this case, there is no reason why this would not be consensual. Both Starboard and Pike share the same views on margin improvement and appear to be rowing in the same direction. Using comp margins and comp multiples, Starboard believes this is a $47 to $72 stock.
Finally, attractive strategic opportunities can also arise to create shareholder value. Private equity firms and strategic companies have been frequent buyers of CRO assets and recent transactions have occurred at higher multiples, with an average of 14x EBITDA. Furthermore, it is currently an industry that is consolidating. Elliott Management recently teamed up with Patient Square Capital and Veritas Capital to acquire Fortrea competitor Syneos Health Inc (SYNH) for $7.1 billion. This acquisition is expected to close in the second half of 2023. Elliott also just hired management at Catalent, a pharmaceutical outsourced manufacturer, to conduct a strategic review. Once margins improve and the business is running efficiently, there may be significant private equity and strategic interest here too.
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. Fortrea Holdings is a shareholder in the fund.