i've been reading probably at this point 100+ substacks of investment pitches and this is the best one. i like the focus on roic comparison.
the only thing i'd love to know more about is how they compete head to head versus the peer group and why customers choose their solutions instead of veolia, thermo fisher, pentair, etc?
Cheers Jarvis, I like the business but hasn't pulled the trigger since I wonder why would DHR spins out VLTO if it is such a good business, even though it's different to its core, and DHR runs a decentralised model so it should be able to accommodate VLTO?
Hi Trung! Thanks for the comment - btw I really love your work, was literally reading the Crowdstrike piece last night :)
On your question:
1. Danaher has been doing this (portfolio “purification” towards Life Science) for a long time. There was 2016 spin-off of industrial business Fortive, which itself spun off Vontier; as well as 2019 spin-off of dental business Envista. I wouldn’t say it was because they were bad business, but rather they operate in mostly different end markets, no visible synergies of keeping them - but obvious capital reallocation benefits to capture more opportunities if separated, especially for Veralto.
2. Under thesis 1, experts’ notes on “prioritization issues” before spin-off somehow implied that even if each segment is run decentralized, M&A decisions are made centrally; yes sure each segment may have their own experts look at their own pipelines, but at the end of the day, segments are competing for the same pool of centralized FCF (thats why 85% FCF transfer happened under CFFF), and management had to make “tradeoff” between sexy life science big deals (could 2-3x in N5Y) and MSD/HSD-growth water deals => if keep Veralto as a segment, it could only be an ATM for life science, but there are so many good water opportunities out there, regulation tailwind and great organic/inorganic runways, so a spinoff is a rational choice here (also unlocks SoTP discount).
That's an excellent reply, thank you, Jarvis, for taking the time! I'll need to re-read your comment again when I dive in the business! The fact that the DHR's co-founder owns a bit of VLTO gives me some comfort that he believes in VTLO. However, it would be even nicer if DHR itself owns some of VLTO, like CSU with Topicus and Lumine. But, I am getting too greedy here. Other questions are do you think the CEO has what it takes to lead the M&A strategy and have the board shared details about how they will run the portfolio companies, will it be roll ups like SiteOne or accumulation like CSU or consolidation? the pipeline, the incentives for acquirees, the target hurdle IRR rates/prices, organic vs inorganic growth? Lots of questions and I appreciate your work! Thank you again.
It would be even nicer if DHR itself owns some of VLTO, like CSU with Topicus and Lumine.
- Yes it would have been very nice too see similar set-up to CSU (in fact my investment club talked to CSU’s CFO in person a while ago - absolutely mind-blowing strategy/execution, I will definitely look more into their business model later). But again, I think this is another evidence for how determined that DHR is to “purify” its portfolio and become a life science pure-play.
Do you think the CEO has what it takes to lead the M&A strategy
- Jennifer Honeycutt, the CEO, was involved with the 2000 acquisition of Hach, the first water business, and for next 23 years, she has been brand/segment presidents at Life Science (Beckman Coulte/Pall), Water (Hach), Product ID (Linx). Therefore, we have high conviction that DHR DNA (M&A + optization) is deeply rooted in her management philsophy.
- Moreover, she also gets the best team to execute well on M&A strategy, such as ex-Goldman Chemicals/NR M&A Managing Director (CFO). The majority of leadership team has very strong M&A expertise.
- In terms of execution and integration, I’d like to refer it back to our second half of thesis 1, where the expert confirmed that Hach and Videojet are top performers of DBS, which @scuttleblurb and 2011 HBS case study did a good job analyzing - key takeaway is DBS is the best optimization “culture” on earth.
- Last but not least, most employees stayed at Veralto after spin-off, the same exact group of people who achieved 80 M&A + 20% ROIC + HSD/LDD sales/Op.Profit track record with massive underinvestment in P20Y. So yeah the CEO and her team get what it takes for sure.
Pipeline? Have the board shared details about how they will run the portfolio companies, will it be roll ups like SiteOne or accumulation like CSU or consolidation?
- so far nothing because Veralto only started trading this Oct, and they won’t do any M&A till 1H24, so I cannot comment on current deal pipelines either - but based on expert’s comment, they have been constantly looking at M&A opportunities, just could not spend $$ on them; now they have much more cash, making 2024 a perfect time to pick up where they left off
- Based on historical data, they mostly do rollups (otherwise VLTO will have 80 brands now), but when they acquired a big enough player that can bring meaningfully new market opportunities, they could make it an independent brand like ESKO.
The incentives for acquirees?
- Better access to capital and R&D, and thus much greater business optimization and growth. a few samples I found in terms of how DHR fully unlocked portcos’ potential:
- With Leica Biosystems, DBS helped it generate 33 more patents, 1.5x revenue, and >10% market share gain.
- With Water Quality and PID, Danaher took low-teens operating margins and low-single digit organic growth to 25% margins and mid/high-single digit growth.
- With Sciex, they ramped R&D, released 15 new products over the next 5 years (vs. just 1 new product in the previous 5 years), and lifted growth from flat to mid-single digits. When Danaher acquired it for 7x revenue in November 2016, Cepheid was breaking even.
- Within 3 years, they brought operating margins to 20% while boosting R&D spend and maintaining double-digit growth.
- After applying hundreds of kaizens across R&D, manufacturing, and logistics, Pall, a $14bn acquisition that constitutes one of the two pillars of Danaher’s bioprocessing franchise, dramatically improved on-time delivery (+20%), reduced waste (-40%), and accelerated product launches (+25%). Organic growth accelerated from low-singles to mid-singles while operating margins expanded 10 points, to 25%.
- Videojet, Radiometer, SCEIX, Hach, and ChemTreat all saw their ROICs carried from mid-single digits to 15%-20%+
The target hurdle IRR rates/prices, organic vs inorganic growth?
- something from 2001 DHR 10k: “Our MINIMUM hurdle rate is 10% after-tax ROIC within three years on average, with bolt-ons frequently reaching this threshold more quickly and platform-establishing transactions taking a little longer, but not exceeding five years.”
- In terms of prices they pay for M&A, we played around numbers disclosed in the P3Y (see more in M&A tab in our model), the closest combination we tried are 10x multiple and 15% EBITDA margin.
- organic growth is MSD as it has been in P20Y, it is a GDP+ business
- inorganic growth, using 9.5% total rev CAGR, is MSD as well, but we estimate it could be much bigger with more cash on hand to spend on M&A, pushing total rev growth to low-teens even high-teens if there are enough opportunities out there.
You know your stuffs Jarvis! Congrats! I am very happy to come across your newsletter and this writeup. Deep dives are not dead! :) there is just so much value in your write up and a lot more to unpack in your comments! Thank you for your time. You have pushed VTLO to the top of my research list now and I am looking forward to more M&A disclosures in the coming quarters and expand our discussion here.
i've been reading probably at this point 100+ substacks of investment pitches and this is the best one. i like the focus on roic comparison.
the only thing i'd love to know more about is how they compete head to head versus the peer group and why customers choose their solutions instead of veolia, thermo fisher, pentair, etc?
Cheers Jarvis, I like the business but hasn't pulled the trigger since I wonder why would DHR spins out VLTO if it is such a good business, even though it's different to its core, and DHR runs a decentralised model so it should be able to accommodate VLTO?
Hi Trung! Thanks for the comment - btw I really love your work, was literally reading the Crowdstrike piece last night :)
On your question:
1. Danaher has been doing this (portfolio “purification” towards Life Science) for a long time. There was 2016 spin-off of industrial business Fortive, which itself spun off Vontier; as well as 2019 spin-off of dental business Envista. I wouldn’t say it was because they were bad business, but rather they operate in mostly different end markets, no visible synergies of keeping them - but obvious capital reallocation benefits to capture more opportunities if separated, especially for Veralto.
2. Under thesis 1, experts’ notes on “prioritization issues” before spin-off somehow implied that even if each segment is run decentralized, M&A decisions are made centrally; yes sure each segment may have their own experts look at their own pipelines, but at the end of the day, segments are competing for the same pool of centralized FCF (thats why 85% FCF transfer happened under CFFF), and management had to make “tradeoff” between sexy life science big deals (could 2-3x in N5Y) and MSD/HSD-growth water deals => if keep Veralto as a segment, it could only be an ATM for life science, but there are so many good water opportunities out there, regulation tailwind and great organic/inorganic runways, so a spinoff is a rational choice here (also unlocks SoTP discount).
That's an excellent reply, thank you, Jarvis, for taking the time! I'll need to re-read your comment again when I dive in the business! The fact that the DHR's co-founder owns a bit of VLTO gives me some comfort that he believes in VTLO. However, it would be even nicer if DHR itself owns some of VLTO, like CSU with Topicus and Lumine. But, I am getting too greedy here. Other questions are do you think the CEO has what it takes to lead the M&A strategy and have the board shared details about how they will run the portfolio companies, will it be roll ups like SiteOne or accumulation like CSU or consolidation? the pipeline, the incentives for acquirees, the target hurdle IRR rates/prices, organic vs inorganic growth? Lots of questions and I appreciate your work! Thank you again.
BR, Trung
It would be even nicer if DHR itself owns some of VLTO, like CSU with Topicus and Lumine.
- Yes it would have been very nice too see similar set-up to CSU (in fact my investment club talked to CSU’s CFO in person a while ago - absolutely mind-blowing strategy/execution, I will definitely look more into their business model later). But again, I think this is another evidence for how determined that DHR is to “purify” its portfolio and become a life science pure-play.
Do you think the CEO has what it takes to lead the M&A strategy
- Jennifer Honeycutt, the CEO, was involved with the 2000 acquisition of Hach, the first water business, and for next 23 years, she has been brand/segment presidents at Life Science (Beckman Coulte/Pall), Water (Hach), Product ID (Linx). Therefore, we have high conviction that DHR DNA (M&A + optization) is deeply rooted in her management philsophy.
- Moreover, she also gets the best team to execute well on M&A strategy, such as ex-Goldman Chemicals/NR M&A Managing Director (CFO). The majority of leadership team has very strong M&A expertise.
- In terms of execution and integration, I’d like to refer it back to our second half of thesis 1, where the expert confirmed that Hach and Videojet are top performers of DBS, which @scuttleblurb and 2011 HBS case study did a good job analyzing - key takeaway is DBS is the best optimization “culture” on earth.
- Last but not least, most employees stayed at Veralto after spin-off, the same exact group of people who achieved 80 M&A + 20% ROIC + HSD/LDD sales/Op.Profit track record with massive underinvestment in P20Y. So yeah the CEO and her team get what it takes for sure.
Pipeline? Have the board shared details about how they will run the portfolio companies, will it be roll ups like SiteOne or accumulation like CSU or consolidation?
- so far nothing because Veralto only started trading this Oct, and they won’t do any M&A till 1H24, so I cannot comment on current deal pipelines either - but based on expert’s comment, they have been constantly looking at M&A opportunities, just could not spend $$ on them; now they have much more cash, making 2024 a perfect time to pick up where they left off
- Based on historical data, they mostly do rollups (otherwise VLTO will have 80 brands now), but when they acquired a big enough player that can bring meaningfully new market opportunities, they could make it an independent brand like ESKO.
The incentives for acquirees?
- Better access to capital and R&D, and thus much greater business optimization and growth. a few samples I found in terms of how DHR fully unlocked portcos’ potential:
- With Leica Biosystems, DBS helped it generate 33 more patents, 1.5x revenue, and >10% market share gain.
- With Water Quality and PID, Danaher took low-teens operating margins and low-single digit organic growth to 25% margins and mid/high-single digit growth.
- With Sciex, they ramped R&D, released 15 new products over the next 5 years (vs. just 1 new product in the previous 5 years), and lifted growth from flat to mid-single digits. When Danaher acquired it for 7x revenue in November 2016, Cepheid was breaking even.
- Within 3 years, they brought operating margins to 20% while boosting R&D spend and maintaining double-digit growth.
- After applying hundreds of kaizens across R&D, manufacturing, and logistics, Pall, a $14bn acquisition that constitutes one of the two pillars of Danaher’s bioprocessing franchise, dramatically improved on-time delivery (+20%), reduced waste (-40%), and accelerated product launches (+25%). Organic growth accelerated from low-singles to mid-singles while operating margins expanded 10 points, to 25%.
- Videojet, Radiometer, SCEIX, Hach, and ChemTreat all saw their ROICs carried from mid-single digits to 15%-20%+
The target hurdle IRR rates/prices, organic vs inorganic growth?
- something from 2001 DHR 10k: “Our MINIMUM hurdle rate is 10% after-tax ROIC within three years on average, with bolt-ons frequently reaching this threshold more quickly and platform-establishing transactions taking a little longer, but not exceeding five years.”
- In terms of prices they pay for M&A, we played around numbers disclosed in the P3Y (see more in M&A tab in our model), the closest combination we tried are 10x multiple and 15% EBITDA margin.
- organic growth is MSD as it has been in P20Y, it is a GDP+ business
- inorganic growth, using 9.5% total rev CAGR, is MSD as well, but we estimate it could be much bigger with more cash on hand to spend on M&A, pushing total rev growth to low-teens even high-teens if there are enough opportunities out there.
Jarvis
You know your stuffs Jarvis! Congrats! I am very happy to come across your newsletter and this writeup. Deep dives are not dead! :) there is just so much value in your write up and a lot more to unpack in your comments! Thank you for your time. You have pushed VTLO to the top of my research list now and I am looking forward to more M&A disclosures in the coming quarters and expand our discussion here.
BR, Trung
P/S Thank you for recommending my newsletter.
That’s so kind of you! Definitely stay in touch :)
Jarvis