Starboard may be poised to build value amicably at contract research firm Fortrea

Business: Fortrea Holdings is a global contract research organization, or CRO, that provides clinical advancement and patient access solutions to the life sciences industry. CROs work with drug companies through all conditions of the drug development process, from drug discovery and preclinical development to Phase I through IV post-approval work. The establishment was originally part of Covance from 1997 to 2015, where it had central lab preclinical and Phase I through IV clinical maturity capabilities. Covance was acquired by Labcorp in 2015, and Labcorp (LH) spun out Fortrea in July 2023.

Stock Market Value: $2.6B ($29.77 per part)

Percentage Ownership:  8.75%

Average Cost: $28.42

Activist Commentary: Starboard has made 113 previous to 13D filings and has an average return of 26.61% versus 11.88% for the S&P 500 over the same period. Of these 113 filings, 13 receive been on companies in the health-care sector, where Starboard has an average return of 38.64% versus 13.23% for the S&P 500 throughout the same period.

On Oct. 17, Starboard reported an 8.75% position in Fortrea Holdings.

Fortrea was spun out from Labcorp on July 3, as a Phase I through IV clinical development business. The company is one of the top seven commitment research organizations that control 80% of the market. Over the years, drug companies have spent an wax amount of money on research and development. With a material portion of that outsourced, the CRO industry has grown accordingly. So, there are offensively secular tailwinds driving growth for the CRO industry, but to be a successful contract research organization, it helps to have global ascend. Fortrea has operations in more than 90 countries with a focus on more than 20 therapeutic courtyards, which has allowed them to conduct over 5,000 trials over the last five years. However, regard for having global reach and scale, the company’s adjusted 2023 earnings before interest, taxes, depreciation and amortization sides are only 9% (with projected 2024 margins of 13%), significantly below the peer median of 18%. This is not curious for a company that has recently been spun out of a larger company as it could be saddled with a bloated cost framework in the spinout and could have been somewhat neglected operationally as a smaller part of a large company.  

So, now it is in a position to be run sundry efficiently with management solely focused on the CRO business. The crucial factor in achieving this is having the right CEO for the job, and Fortrea has that. In January, Tom Pike joined Labcorp as president and CEO of its Analgesic Development Clinical Development business unit and retained his CEO seat at Fortrea, upon completion of the spin-off. Pike has a tail find record for improving CRO profitability. When he was CEO at Fortrea peer IQVIA (formerly known as Quntiles), he increased margins by 425 heart points between 2012 and 2016, and led the stock to substantially outperform the market by 48% over that time. He has already sentenced to increasing margins at Fortrea to 13% from 9%, but this still falls short of peer performance. Starboard thinks that the institution can reach pure margin levels of 18%. The firm has a great deal of experience helping portfolio companies run numberless efficiently and improve margins either as an active shareholder or member of the board.

Finally, there may also be compelling strategic moments to create shareholder value. Private equity firms and strategics have been frequent acquirers of CRO assets and up to date transactions have been at higher multiples, with a median of 14x EBITDA. Moreover, this is a consolidating industry equity now. Elliott Management recently partnered with Patient Square Capital and Veritas Capital to acquire Fortrea spy Syneos Health Inc (SYNH) for $7.1 billion. That acquisition is expected to close in the second half of 2023. Elliott also just got operation of Catalent, an outsourced manufacturer in the pharma industry, to pursue a strategic review. Once margins are improved and the company is continual efficiently, there may be significant private equity and strategic interest here as well.