Activist Ananym calls for cost cuts at Henry Schein. What to expect

Ownership: n/a

Average Cost: n/a

Activist Commentary: Ananym Capital Management is a New York-based activist investment firm which launched on Sept. 3. It’s run 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 firm would prefer to work amicably with its portfolio companies, but it’s willing to resort to a proxy fight as a last resort. It holds approximately 10 positions in its portfolio and currently manages $250 million.

Henry Schein is a leading global distributor of health-care products and services primarily to office-based dental and medical practitioners. The company operates through two segments that offer different products and services to the same customer base: (i) health care distribution and (ii) technology and value-added services. Health care distribution covers Henry Schein’s distribution of dental and medical products, such as laboratory products, pharmaceuticals, vaccines, surgical products, dental specialty products and diagnostic tests. This segment, which accounts for 93.5% of net sales, is sub-divided between dental (61.1% of total 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 brand portfolio of products and manufactures certain dental specialty products. In terms of scale, the company is the global leader in dental distribution and second in medical distribution to office-based physicians. Henry Schein’s other segment, technology and value-added services (6.5% of net sales) covers the sale of practice management software and other value-added products. With a market cap of roughly $9 billion, the company generates approximately $1 billion of free cash flow 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 past five years on a total shareholder return basis (0%, as of Nov. 15), versus 59% for the S&P 500 health-care index and 105% for proxy peers. The main source of this underperformance is relatively clear: cost control. Since 2019, the company has grown revenue at a 5% compound annual growth rate and gross profit at a 6% CAGR. But it has spent all that extra revenue and then some on operating expenses resulting in 8% annual operating expense growth and adjusted earnings before interest, taxes, depreciation, and amortization margins falling to 8% from 10%. Putting it differently, in 2019 the company had $10 billion in revenue, $3.1 billion in gross profit and $916 million in EBITDA. Today, it has $12.5 billion in revenue, $3.9 billion in gross profit and $815 million in EBITDA. Part of the reason for this is that the company has spent more than $4 billion (nearly 45% of its current market cap) on poor acquisitions that have delivered a return on invested capital well below the company’s cost of capital. Moreover, management has failed to integrate these acquisitions leading to bloated selling, general and administrative expenses. The first thing that needs to be done is for Henry Schein to execute 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 increase earnings per share by 35% or more.

Next, the company needs to do a better job with capital allocation. It must stop using cash flow to make acquisitions or pay back its debt that has a 6% cost and start using it to buy back stock at these prices. The company trades at a 13-times the next 12 months price-earnings multiple — near a 15-year low point. 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 acquire 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 share repurchases (< 5% of market cap) it has announced for 2025. This would further increase EPS by potentially 50%. In addition to these steps, the company’s medical business presents a strategic opportunity. While Henry Schein has successfully carved into the office-based physician niche as the No. 2 player, the business environment is far more competitive and will favor larger distributors. This asset could be worth $2.5 billion or more in a sale, which would be share price accretive and could be used to further repurchase the company’s discounted shares.

Many companies have serious issues and need an activist to endure. This is a company that does not need an activist to survive, but it would greatly benefit from an activist who could help optimize its operations and balance sheet. Henry Schein is a great company that has gotten sleepy and been allowed to coast when it could have 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 private company and Schein’s three-year return of -12% has blown away Patterson’s -41%, but Schein should be benchmarking itself against the largest U.S. health-care distribution companies like Cardinal Health (+135%), Cencora (+93%), and McKesson (+173%). Perhaps not in terms of scale or end-markets, but more in aspiration and dedication to shareholders. This would require a refreshed board. Several directors have been in their seats at Henry Schein for over a decade and the board lacks best-in-class distribution expertise. 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 company can retain top management. But under the current board, the company has experienced a concerning level of executive turnover since 2021.

Ananym does not have an activist history yet, but knowing Charlie Penner and Alex Silver as we do, we would expect them to strive to work amicably with management to create value for shareholders. We do not expect that the firm will insist on a board seat for an Ananym principal. However, we do expect that Ananym will suggest several well-qualified industry executives who can help make the changes necessary to create significant shareholder value from a board level. But do not confuse the investor’s friendly demeanor and amicable engagement 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 open until Jan. 21, 2025, and we would expect that the parties will work out an agreement before 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, a mutual fund that invests in a portfolio of activist 13D investments.