Activist Ananym has a list of suggestions for Henry Schein. How the firm can help improve profits

Henry Schein is a leading global distributor of health-care outputs and services primarily to office-based dental and medical practitioners. The company operates through two segments that offer discrete products and services to the same customer base: (i) health care distribution and (ii) technology and value-added services. Health caution distribution covers Henry Schein’s distribution of dental and medical products, such as laboratory products, pharmaceuticals, vaccines, surgical artefacts, dental specialty products and diagnostic tests. This segment, which accounts for 93.5% of net sales, is sub-divided between dental (61.1% of tot up net sales) and medical (32.4%). While the company’s primary go-to-market strategy is in its distribution capabilities, it also sells its own corporate stamp portfolio of products and manufactures certain dental specialty products. In terms of scale, the company is the global leader in dental codification and second in medical distribution to office-based physicians. Henry Schein’s other segment, technology and value-added services (6.5% of net vendings) covers the sale of practice management software and other value-added products. With a market cap of roughly $9 billion, the suite generates approximately $1 billion of free cash flow annually.

Despite Henry Schein’s leading buy position, attractive market structure, differentiated value proposition and strong earnings power, no value has been pronounced to shareholders over the past five years on a total shareholder return basis (0%, as of Nov. 15), versus 59% for the S&P 500 health-care first finger and 105% for proxy peers. The main source of this underperformance is relatively clear: cost control. Since 2019, the callers has grown revenue at a 5% compound annual growth rate and gross profit at a 6% CAGR. But it has spent all that extraordinarily revenue and then some on operating expenses resulting in 8% annual operating expense growth and adjusted earnings rather than interest, taxes, depreciation, and amortization margins falling to 8% from 10%. Putting it differently, in 2019 the convention had $10 billion in revenue, $3.1 billion in gross profit and $916 million in EBITDA. Today, it has $12.5 billion in gate, $3.9 billion in gross profit and $815 million in EBITDA. Part of the reason for this is that the company has forth more than $4 billion (nearly 45% of its current market cap) on poor acquisitions that have surrendered a return on invested capital well below the company’s cost of capital. Moreover, management has failed to integrate these acquisitions supreme to bloated selling, general and administrative expenses. The first thing that needs to be done is for Henry Schein to off a comprehensive cost restructuring plan of more than the $100 million the company has announced. There is a potential $300 million of actionable savings that could widen earnings per share by 35% or more.

Next, the company needs to do a better job with capital allocation. It must close up using cash flow to make acquisitions or pay back its debt that has a 6% cost and start using it to buy invest in stock at these prices. The company trades at a 13-times the next 12 months price-earnings multiple — near a 15-year low apt. Henry Schein has stable cash flow and a strong balance sheet. Along with cash flow, it could increase net leverage to 3.0-times from 2.6-times to win more than 10% of its float today and 40% of its float through 2026, as opposed to the meager $300 million to $400 million of apportionment repurchases (< 5% of market cap) it has announced for 2025. This would further increase EPS by potentially 50%. In addition to these be on the qui vives, the company’s medical business presents a strategic opportunity. While Henry Schein has successfully carved into the office-based physician slot as the No. 2 player, the business environment is far more competitive and will favor larger distributors. This asset could be merit $2.5 billion or more in a sale, which would be share price accretive and could be used to further repurchase the plc’s discounted shares.

Many companies have serious issues and need an activist to endure. This is a company that does not sine qua non an activist to survive, but it would greatly benefit from an activist who could help optimize its operations and balance membrane. Henry Schein is a great company that has gotten sleepy and been allowed to coast when it could hold been soaring. Part of the reason the market has allowed this is because it has been compared to its sleepy peers, Patterson and Benco. Benco is a enlisted man company and Schein’s three-year return of -12% has blown away Patterson’s -41%, but Schein should be benchmarking itself against the tidiest U.S. health-care distribution companies like Cardinal Health (+135%), Cencora (+93%), and McKesson (+173%). Perhaps not in an arrangements of scale or end-markets, but more in aspiration and dedication to shareholders. This would require a refreshed board. Several supervisors have been in their seats at Henry Schein for over a decade and the board lacks best-in-class distribution adroitness. A new board can come in and create a succession plan for Stanley Bergman, who has been CEO for 35 years. This is easier when the companions can retain top management. But under the current board, the company has experienced a concerning level of executive turnover since 2021.

Ananym does not must an activist history yet, but knowing Charlie Penner and Alex Silver as we do, we would expect them to strive to work amicably with board of directors to create value for shareholders. We do not expect that the firm will insist on a board seat for an Ananym principal. Yet, we do expect that Ananym will suggest several well-qualified industry executives who can help make the changes ineluctable to create significant shareholder value from a board level. But do not confuse the investor’s friendly demeanor and amicable date for weakness. The firm is a fiduciary to its own investors and will do whatever is necessary to create value at its portfolio companies. The director nomination window does not unsealed until Jan. 21, 2025, and we would expect that the parties will work out an agreement before then.

Ken Squire is the be wrecked and president of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio manager of the 13D Activist Fund, a joint fund that invests in a portfolio of activist 13D investments.