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Company: Henry Schein (HSIC)
Business: Heinrich Schein is a healthcare solutions company. The company operates in two segments: healthcare distribution and technology and value-added services. The Healthcare Sales segment sells a range of offerings, including consumer products, small equipment, laboratory products, large equipment and equipment repair services. The Technology and Value-Added Services segment provides software, technology and other services for healthcare practitioners. It provides dental practice management solutions for dentists and doctors. In addition, solutions are developed for the orthopedic treatment of the lower extremities (foot and ankle) and upper extremities (mainly hand and wrist).
Market value: $9.36 billion ($75.08 per share)
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Henry Schein in 2024
Activist: Ananym Capital Management
Property: n/a
Average cost: n/a
Comment from activists: Ananym Capital Management is a New York-based activist investment firm founded on September 3rd. It is led 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). Ananym looks for high quality but undervalued companies, regardless of industry. The company would prefer to work amicably with its portfolio companies, but is willing to resort to a proxy dispute as a last resort. The company holds about 10 positions in its portfolio and currently manages $250 million.
What happens
On November 18, Reuters reported that Ananym is pushing Henry to renew its board, cut costs, tackle succession planning and consider selling its medical distribution business.
Behind the scenes
Henry Schein is a leading global distributor of healthcare products and services, primarily to practicing dentists and physicians. The Company operates in two segments that provide different products and services to the same customer base: (i) Healthcare Distribution and (ii) Technology and Value-Added Services. Healthcare distribution includes 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 divided into dental (61.1% of total net sales) and medical (32.4%). While the Company's primary go-to-market strategy lies in its distribution capabilities, it also sells its own branded portfolio of products and manufactures certain specialty dental products. In terms of size, the company is the world market leader in dental sales and the second largest in medical sales to practicing physicians. Henry Schein's Other Technology and Value-Added Services segment (6.5% of net sales) includes sales of practice management software and other value-added products. With a market cap of about $9 billion, the company generates free cash flow of about $1 billion annually.
Despite Henry Schein's leading market position, attractive market structure, differentiated value proposition and strong earnings power, no value has been delivered to shareholders over the last five years based on total return to shareholders (0% as of November 15th) compared to 59% for the S&P 500 Health Index and 105% for proxy peers. The main cause of this underperformance is relatively clear: cost control. Since 2019, the company has grown its revenue at a compound annual growth rate of 5% and gross profit at a compound annual growth rate of 6%. But the company spent all that extra revenue and then some on operating expenses, resulting in annual operating expense growth of 8% and a decline in adjusted earnings before interest, taxes, depreciation, and amortization from 10% to 8%. In other words, in 2019, the company had revenue of $10 billion, gross profit of $3.1 billion, and EBITDA of $916 million. Today, the company has revenue of $12.5 billion, gross profit of $3.9 billion, and EBITDA of $815 million. One reason is that the company spent more than $4 billion (nearly 45% of its current market cap) on bad acquisitions that produced a return on invested capital well below the company's cost of capital. Additionally, management failed to integrate these acquisitions, resulting in excessive selling, general and administrative expenses. First, Henry Schein must implement a comprehensive cost restructuring plan that exceeds the $100 million the company announced. There is potentially $300 million in actionable savings that could increase earnings per share by 35% or more.
Next, the company needs to improve capital allocation. It needs to stop using cash flow to make acquisitions or pay down its debt, which has a 6% cost, and instead start buying back shares at those prices. The company trades at a price-to-earnings ratio of 13 times over the next 12 months – close to a 15-year low. Henry Schein has stable cash flow and a strong balance sheet. Combined with cash flow, the company could 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, in contrast to the meager share buybacks of 300 It has announced up to 400 million US dollars (< 5% of market capitalization) for 2025. This would further increase earnings per share by potentially 50%. In addition to these moves, the company's medical business presents a strategic opportunity. While Henry Schein has successfully established itself as the No. 2 player in the physician practice niche, the business environment is far more competitive and will favor larger distributors. This asset could be worth $2.5 billion or more if sold, which would have a positive impact on the stock price and could be used to further repurchase the company's discounted shares.
Many companies have serious problems and need an activist to persevere. This is a company that doesn't need an activist to survive, but it would greatly benefit from an activist who could help improve its operations and balance sheet. Henry Schein is a great company that got sleepy and was allowed to rest when it could have been flying high. The market allowed this to happen in part because the company was compared to its sleepy competitors, Patterson and Benco. Benco is a private company and Schein's three-year return of -12% dwarfed Patterson's -41%, but Schein should align with the largest U.S. healthcare distribution companies such as Cardinal Health (+135%), Cencora (+93%) and McKesson (+ 173%) Perhaps not in terms of size or end markets, but more in terms of ambition and commitment to shareholders. This would require an updated board With Henry Schein in office and the board lacking top-notch sales skills, a new board can come in and create a succession plan for Stanley Bergman, who has been CEO for 35 years. But under According to the current board, the company has recorded a worrying fluctuation in management since 2021.
Ananym doesn't have an activist history yet, but knowing Charlie Penner and Alex Silver, we would expect them to strive to work amicably with management to create value for shareholders. We do not assume that the company will insist on a board seat for an Ananym boss. However, we expect that Ananym will propose several well-qualified executives from the industry who can help bring about the necessary changes to create significant shareholder value at the board level. But don't confuse the investor's friendly demeanor and friendly engagement with weakness. The Company acts as a fiduciary for its own investors and will do whatever is necessary to create value in its portfolio companies. The director nomination window does not open until January 21, 2025 and we expect the parties to have an agreement in place by then.
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.