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

Business: Fortrea Holdings is a worldwide contract research group, or CRO, that gives scientific improvement and affected person entry options to the life sciences business. CROs work with drug firms by all phases of the drug improvement course of, from drug discovery and preclinical improvement to Phase I by IV post-approval work. The firm was initially a part of Covance from 1997 to 2015, the place it had central lab preclinical and Phase I by IV scientific improvement 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 share)

Activist Commentary: Starboard has made 113 prior 13D filings and has a mean return of 26.61% versus 11.88% for the S&P 500 over the identical interval. Of these 113 filings, 13 have been on firms within the health-care sector, the place Starboard has a mean return of 38.64% versus 13.23% for the S&P 500 over the identical interval.

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

Fortrea was spun out from Labcorp on July 3, as a Phase I by IV scientific improvement enterprise. The firm is without doubt one of the high seven contract research organizations that management 80% of the market. Over the years, drug firms have spent an growing sum of money on research and improvement. With a fabric portion of that outsourced, the CRO business has grown accordingly. So, there are robust secular tailwinds driving development for the CRO business, however to be a profitable contract research group, it helps to have world scale. Fortrea has operations in additional than 90 nations with a concentrate on greater than 20 therapeutic areas, which has allowed them to conduct over 5,000 trials during the last 5 years. However, regardless of having world attain and scale, the corporate’s adjusted 2023 earnings earlier than curiosity, taxes, depreciation and amortization margins are solely 9% (with projected 2024 margins of 13%), considerably beneath the peer median of 18%. This isn’t uncommon for an organization that has just lately been spun out of a bigger firm because it might be saddled with a bloated price construction within the spinout and will have been considerably uncared for operationally as a smaller half of a big firm.  

So, now it’s able to be run extra effectively with administration solely centered on the CRO enterprise. The essential consider reaching that is having the appropriate CEO for the job, and Fortrea has that. In January, Tom Pike joined Labcorp as president and CEO of its Drug Development Clinical Development enterprise unit and retained his CEO seat at Fortrea, upon completion of the spin-off. Pike has a observe report for bettering CRO profitability. When he was CEO at Fortrea peer IQVIA (previously referred to as Quntiles), he elevated margins by 425 foundation factors between 2012 and 2016, and led the inventory to considerably outperform the market by 48% over that point. He has already dedicated to growing margins at Fortrea to 13% from 9%, however this nonetheless falls in need of peer efficiency. Starboard thinks that the corporate can attain pure margin ranges of 18%. The firm has quite a lot of expertise serving to portfolio firms run extra effectively and enhance margins both as an energetic shareholder or member of the board.

With Pike as CEO and margin steering moving into the appropriate path, we count on Starboard will be an engaged shareholder right here and search for a board seat provided that issues don’t progress as deliberate. In that case, there isn’t a purpose why this might not be amicable. Both Starboard and Pike share the identical views concerning margin enchancment and appear to be rowing in the identical path. With peer margins and peer multiples, Starboard sees this as a $47 to $72 inventory.

Finally, there may additionally be compelling strategic alternatives to create shareholder value. Private fairness corporations and strategics have been frequent acquirers of CRO belongings and up to date transactions have been at increased multiples, with a median of 14x EBITDA. Moreover, this can be a consolidating business proper now. Elliott Management recently partnered with Patient Square Capital and Veritas Capital to purchase Fortrea peer Syneos Health Inc (SYNH) for $7.1 billion. That acquisition is predicted to shut within the second half of 2023. Elliott additionally simply received management of Catalent, an outsourced producer within the pharma business, to pursue a strategic review. Once margins are improved and the corporate is operating effectively, there may be vital non-public fairness and strategic curiosity right here as nicely.

Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio supervisor of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments. Fortrea Holdings is owned within the fund.