Finding a Way Through M&A
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RESEARCHNovember REPORT18, 2019 FindingNovember a Way through18, 2019 M&A Stock Rating HOLD Price Target CAD $123.58 Current Price CAD $140.49 Bear Price Bull Case Target Case $107.75 $123.58 $139.41 Ticker DHR Danaher Corporation Market Cap (MM) $102,707 Finding a Way through Market Cap/LFCF NTM 33.5x M&A EV/EBITDA NTM 22.5x 52 Week Performance After conducting an analysis of the Medical Devices space at large, the Healthcare Team decided that Danaher Corporation’s ability to 120 effectively use inorganic growth as a competitive advantage warrant a further look. This report outlines various elements of Danaher’s business that we wanted to gain conviction on before reaching a 100 decision on the name. Overall, we believe that Danaher’s highly disciplined M&A strategy that incorporates the Danaher Business System (DBS) and philosophy 80 of detail-oriented accountability has demonstrated a proven ability to select, integrate and grow acquisition targets. Coupled with its current business, we believe that Danaher has strong fundamentals. 60 Despite our conviction in Danaher’s fundamentals, our price target of 27-Feb-17 29-Apr-17 29-Jun-17 $123.58 is much lower than their current price of $140.59. Therefore, DHR S&PS&P 100 Index the Healthcare Team has decided on a stock rating of HOLD. Industrials Laura Wu [email protected] Ruby Harris [email protected] William Cao [email protected] The information in this document is for EDUCATIONAL and NON-COMMERCIAL use only and is not intended to Tina Huang constitute specific legal, accounting, financial or tax advice for any individual. In no event will QUIC, its members or directors, or Queen’s University be liable to you or anyone else for any loss or damages whatsoever (including [email protected] direct, indirect, special, incidental, consequential, exemplary or punitive damages) resulting from the use of this document, or reliance on the information or content found within this document. The information may not be reproduced or republished in any part without the prior written consent of QUIC and Queen’s University. QUIC is not in the business of advising or holding themselves out as being in the business of advising. Many factors may affect the applicability of any statement or comment that appear in our documents to an individual's particular circumstances. © Queen’s University 2019 November 18, 2019 Finding a Way through M&A Table of Contents Company History and Overall M&A Strategy 3 Danaher Business System (DBS) Deep Dive 5 Segments Analysis: Overview of Key Segments 6 Environmental & Applied Segment: Hach Company 7 Life Segment: Subsidiaries Overview 9 Diagnostics Subsidiaries 11 GE Biopharma Acquisition: Deep Dive 13 Valuation 16 2 November 18, 2019 Finding a Way through M&A Company History and Overarching M&A Growth Strategy The history of Danaher adds a fair bit of colour to its Danaher could gain a competitive advantage through overall strategy as a company. Danaher Corporation operational excellence, or (2) bolt-on transactions, was originally founded in 1969 as a REIT; 9 years later, wherein complementarity of goods can be leveraged it reorganized itself as a new corporation, called or network effects through expanding market Diversified Mortgage Investors. It then entered into the coverage could be built. This highly principled and vehicle systems market, modeling most of its disciplined M&A strategy has allowed its operating operations after the Toyota Production system. It margins to grow an average of 2.8% faster than eventually expanded into many more markets, most revenue, indicating that with each acquisition it is able notably that of precision motion equipment, electronic to tighten its operations and parent them effectively. test tools, environmental water quality testing, power quality products and consumables manufacturing. After the acquisition is completed, an agile business- Since then, it has been aggressively expanding into the unit integration team takes over from the business medical devices space, gaining a sustainable footing development team responsible for M&A due diligence. amongst incumbents. All of these expansions have The business-unit integration team is responsible for been achieved through acquisitions, mergers or executing all of the ramp-up work to the acquisition takeovers. Since 1984, it has acquired hundreds of target’s normal operations, and ensures that the DBS businesses – more than 50% of Danaher’s total philosophy (and system, when appropriate) were revenue today has been acquired in the past 7 years, implemented successfully. The process of identifying a demonstrating that Danaher is well-versed in the target, conducting rigorous due diligence and execution of inorganic growth. integrating successfully ultimately led to the fundamental transformation of the company from an Highly Effective Serial Acquirer $845MM industrial goods manufacturer to a $12.6B global conglomerate. Danaher’s overarching operating model, called the Danaher Business System (DBS), is consistently applied EXHIBIT I across all business units. It measures performance in four key areas: quality, delivery, cost and innovation. Danaher Revenue Breakdown, 2002-2015 More than a tactical implementation of a technology, DBS has evolved into a company philosophy that demands rigorous, detail-oriented and measurable Environmental (15%) Environmental (7%) progress at every level. The operating model is built Water Quality (10%) upon the belief that unless well-managed, businesses Motion (21%) Industrial Tech (17%) with high average gross margins become self- destructive and encourage complacent practices. Measurement (15%) Measurement (17%) Applying DBS to newly acquired businesses is able to grow these margins. For example, after Danaher’s Dental (14%) acquisition of Tektronix (a test and measurement Tools (32%) equipment company), its margins increased by 15.8% within a year, and its sales grew by 14.9%. Life Sciences & Other (17%) Diagnostics (35%) Building on this, Danaher only acquires a business if it sees margin expansion potential, as well as if it serves 2002 2015 one of two purposes: (1) platform-establishing transactions (new market entry acquisitions) wherein Source: DHR Company Filings, RBC Capital Markets 3 November 18, 2019 Finding a Way through M&A Company History and Overarching M&A Growth Strategy Capital Allocation: Strong M&A Focus Management has traditionally financed acquisitions via cash on hand, by has also taken on debt to finance As would an astute value investor, Danaher has major acquisitions – whereas the GE Biopharma consistently bought companies trading at a discount acquisition raised their net debt-to-EBITDA to around (Exhibit III). In order to acquire these companies, the 3.9x, they have historically stayed at a steady 3.0x. proceeds from process improvements in previously- Management is communicated that this is a acquired business are used to fund new M&A. These comfortable net debt-to-EBITDA margin. Danaher’s proceeds are mostly unlocked through shared financial position is quite healthy – its 2018 free cash expertise in product engineering, supplier flow (FCF) value of $3.4B represented an increase of management synergies and labour productivity. This 16.5% vs. 2017, a FCF to net income conversion ratio has strengthened its position as one of the most of 127%. This marked the 27th consecutive year in acquisitive players in the “multi-industry” sector, which the FCF exceeded net income. Their dividends allocating almost 80% of balance sheet capacity on are modest, paying out only 0.6% of their net income M&A vs. the peer average of around 40%. when compared to their peers who pay out ~2.0%. EXHIBIT II Danaher’s M&A-Focused Capital Allocation 100% 80% 60% 40% 20% 0% 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: RBC Capital Markets M&A Capex Dividends Buybacks EXHIBIT III Danaher’s Capital Allocation Long term market norm 5.0x Sybron Dental 4.0x 3.0x Hach 2.0x Josiyn 1.0x American Lifeschultz Fluke Tektronix 0.0x Precision Enterprise Value to Gross Value Assets to Gross Enterprise 0% 5% 10% 15% 20% 25% 30% 35% 40% Source: DHR Company Filings Gross Business Return 4 November 18, 2019 Finding a Way through M&A Danaher Business System (DBS) Deep Dive Danaher Business System (DBS) including thorough application of every acquisition done to date by the parent company. Management Danaher’s operations, culture, managerial decisions and prides itself in the ability to swiftly integrate new acquisition performance is defined by the company’s businesses. Consequently, through DBS, management “Danaher Business System.” Operationally, DBS is can make acquisitions of familiar business models with similar to the “Toyota Way”. limited downside risk. DBS is run on the basis of improving cost structure by Through DBS, Hach has reduced its time to market expanding gross margins and lowering G&A as a down on average from 36+ months to 18 months, percentage of sales while reinvesting in top line growth which is beneficial to customers but also helps increase through strong customer relationships. The DBS the cycle time and cadence to producing new products. program is difficult to place a firm value on, but Since 2016, Hach’s product pipeline has increased by fundamentally represents management’s execution on 35% and the launch of products increased by 25%. all subsidiaries with five core values: quality of management, customer engagement, continuous improvement, product innovation, and focus on shareholder value. As such, it is representative of the EXHIBIT IV culture developed at Danaher. The culture appears to Danaher Glassdoor Review be well-received, as it was rated 3.5/5 stars out of ~400 reviews on glassdoor (Exhibit IV). Danaher has sales and service representatives in 60 countries to maintain customer relationships. DBS is designed to allow the sales team to remain accountable with respective call points, and facilitates new integration of businesses.