Company: Elanco Animal Health (ELAN)
Business: Elanco is an animal health company that delivers products and services to prevent and treat disease in farm animals and pets. Its portfolio serves animals across its core species and offers products in two categories: Pet Health, which is focused on parasiticides, vaccines and therapeutics; and Farm Animal, which consists of products designed to prevent, control and treat health challenges primarily focused on cattle.
Stock Market Value: $7.34B ($14.90 per share)
Activist: Ancora Advisors
Percentage Ownership: ~3.0%
Average Cost: n/a
Activist Commentary: Ancora is not an activist investor. It is primarily a family wealth investment advisory firm and fund manager with $8.7 billion in assets under management, with an alternative asset management division that manages approximately $1.3 billion. It was founded in 2003 and hired James Chadwick in 2014 to pursue activist efforts in niche areas like banks, thrifts and closed-end funds. Ancora’s website lists “small cap activist” as part of its products and strategies and their strategy has evolved in recent years. From 2010 to 2020, the majority of Ancora’s activism was 13D filings on micro-cap companies and in the past few years they have taken a greater number of sub-5% stakes in larger companies. The alternatives team has a track record of using private and when necessary, public engagement with portfolio companies to catalyze corporate governance improvements and long-term value creation.
On Dec. 14, Bloomberg, citing people familiar, reported that Ancora has taken a position in Elanco and is pushing for a replacement of the company’s CEO, changes to the company’s board composition and improved margins.
Behind the scenes
Elanco is one of the largest global animal health pharmaceutical companies, developing and marketing products for both pet health and farm animals. It operates in a secularly growing industry, which has seen a massive wave of consolidation, and has been historically recession resistant. The company is one of four players – including Zoetis, Merck Animal Health and Boehringer Ingelheim – who collectively have 80% market share. Elanco spun out from Eli Lilly in 2018 and was met with a lot of excitement: In its first day of trading, the stock closed higher by 50% from its IPO price. The reason why the stock was received so well was because management publicized opportunities to grow revenue at or above industry growth rates and to improve margins by approximately 1,000 basis points over five years. In 2018, Elanco’s earnings before interest, taxes, depreciation, and amortization margins were 21% versus 38% for Zoetis, its closest peer. While Zoetis’s product mix allows for higher margins, that gap is still way too big and Elanco management targeted 31% EBITDA margins by 2023.
Then, on Aug. 20, 2019, Elanco announced an agreement to acquire Bayer’s Animal Health business. Elanco explained this acquisition as being too good of an opportunity to pass up, as it would significantly expand scale and change the mix of the business. As a result, management accelerated the timeline of its margin target goal by a year and announced that because of this acquisition they would reach their goal of 31% EBITDA margins by 2022. But then, in 2020, management revised its guidance and stated that it was now hoping to achieve 31% EBITDA margins by 2024, a year later than its first projection and two years later than its last projection. To confuse and frustrate shareholders even more, management claimed that they have realized significant cost savings, but this is not resulting in margin expansion.
In October 2020, Sachem Head Capital Management filed a 13D on Elanco also taking issue with the company’s EBITDA margins and progress in improving them. On Dec. 13, 2020, Sachem Head and Elanco came up with a cooperation agreement, giving the activist three board seats for William Doyle, Scott Ferguson and Paul Herendeen. Scott Ferguson has since resigned from the board, but Doyle and Herendeen currently serve as directors.
Now, Ancora has taken an approximately 3% position and intends to push for margin improvements, a board refreshment and CEO replacement. Ancora sees this as a failure of corporate governance and accountability. Aside from management’s failure to improve margins over the past five years, they overpaid for Bayer and were late in converting their debt from variable to fixed resulting in much higher interest expenses. Further, the board that does not appear to hold management accountable. For instance, at the 2023 annual meeting, 62% and 71% of voting shareholders were against the election of two directors. Despite the results, the board did not make any changes. The director who received 71% of votes against him is the chairman of the company, R. David Hoover.
The board’s chickens may be coming home to roost. Ancora will have the opportunity to replace four directors at the next annual meeting, one being the company’s CEO Jeff Simmons. Ancora is pushing for board refreshment and the replacement of the CEO, but the firm might be able to do that in one fell swoop. If Simmons is not re-elected as a director, it will be hard for even this board to keep him as CEO. Ancora will likely nominate three industry directors and one Ancora executive, signaling their intention to be a long-term shareholder. Of the four incumbent directors up for re-election at the next annual meeting, all received over 20% “against” votes at their last election in 2021 (with two of them over 46% and Simmons over 37%) and were not even being contested. That was when Elanco was trading at $35.76 per share. It is now at about $14 per share. Shareholders should be waiting for Ancora with flowers and chocolate. We think Ancora should easily win three seats in a proxy fight, and it could have a better than even chance of winning the fourth. Institutional Shareholder Services understandably does not like recommending voting against a sitting CEO, but it also does not like a board that has ignored the will of its shareholders. Even if Simmons can retain his board seat in a proxy fight, if this goes to a vote, the large number of shares voted against him will send a strong message to the board and likely be the writing on the wall for him.
We rarely see a company set up so well for board refreshment and management change. A refreshed board and management team that can get gross margins from the mid-50s to the 60s and EBITDA margins up to the high 20s (even below management’s promised 31%) would substantially increase shareholder value.
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.