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Danaher: Sensing The Spin?
Danaher Corporation (DHR) will spin off its Environmental & Applied Solutions (EAS) division into a separate public company. The move will be tax-free for the company’s shareholders. Does this make business sense, or is this just another case of a company parting with an underperforming business to focus on the more successful ones?
Change Is The Constant
Danaher’s history goes back to 1969, when its founders conceptualized it during a fishing session! It started as a Massachusetts Real Estate Investment Trust (REIT) under the name DMG. After another round of name changes, it adopted its current name in 1984.
As part of its strategy to become a manufacturer, it acquired 12 companies between 1984-86 and adopted the Kaizen manufacturing principles, a Japanese philosophy of continuous improvement and waste elimination.
Danaher manufactures everything - from gas pumps to microscopes. It has a simple business model - acquire and operate manufacturing companies. The company has completed over 400 acquisitions over the last three decades. It only looks to acquire companies in markets with no significant competition and hence shies away from paying a premium just for a brand.
The company operates in three business segments - Life Sciences, Diagnostics, and Environmental & Applied Solutions. The Life Sciences business provides advanced filtration, separation, and purification technologies, used in the creation of biopharma. It contributes half of Danaher’s overall revenue.
It safeguards patients' health with advanced tools and software through its Diagnostics business, known for automated processes and mobile equipment. A third of Danaher’s revenue comes from this business.
Lastly, the Environmental & Applied Solutions business is split into two categories. The product identification business caters to industrial & pharmaceutical products, while the Water Quality business provides advanced purification technology for analysis and water treatment.
A Compulsive Move?
Last week, Danaher announced that it would spin off its Environmental & Applied Solutions (EAS) division into a separate public company. The move will help Danaher focus on its life sciences and diagnostics business. The transaction is tax-free for shareholders and will likely close in Q4 2023.
The independent company will be known as EAS until renamed. President Rainer Blair sees plenty of advantages for the EAS business as a standalone company to pursue high-impact organic and inorganic investments. The division reported $4.7B in revenue in 2021, 57% of which was recurring. Incidentally, that is the lowest recurring revenue among the company’s three businesses, as the other two have that figure ranging between 70% to 90%.
This spin-off will also enable the company to focus on its core life sciences and diagnostics businesses. In addition, the standalone entity will have an investment-grade credit rating.Â
Danaher joins the likes of Kellogg, 3M, General Electric, and Johnson & Johnson, among others, who have recently decided to spin off a part of their business for better reorganization. But is this move driven by business compulsions, or is the company just trying to rid itself of an underperforming entity?
Danaher’s life sciences business has doubled in size during the pandemic and tripled over the last six years. Similarly, the Diagnostics business has nearly doubled in size over the same time frame. However, the EAS business has grown only 26% in six years.
The same is valid on the margins front. The EAS business has constantly maintained its margins between 23%-24% without any meaningful growth. On the other hand, margins of the Diagnostics segment have grown from 15% in 2016 to 23% in 2021.Â
This is not the first time Danaher has decided to spin off a business. It spun off its Industrial Technology Segment, Fortive Corp., in 2016 and its Dental Business - Envista Holdings Corp., in 2019. However, both entities have underperformed the parent after going public.
On the financial front, the company expects core revenue growth in the low-single digits for the current quarter and mid-single digits for the full year. Sales growth for the core business is expected in the high-single digits for the current quarter and 2022.
Analysts have attributed the spin-off of the EAS business to the stagnation in margins, adding that the move further optimizes the company's focus on its other businesses. However, some also welcomed the move, saying they see more value for the EAS business as a standalone company, and Danaher can see its multiples expand as a pure-play life sciences company.
Danaher has joined the spin-off bandwagon, but history tells you that it is a long and tedious process. The success of this spin-off now boils down to execution. The stock is down 14% this year, and investors would hope that the spin-off acts as a catalyst to spin things back in their favor going forward.
Market Reaction
DHR ended at $274.37, down 1.64%.
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