For business: ElancoOne of the world’s largest animal pharmaceutical companies. It develops and markets products for farm and pet animals. You can find products to prevent worms and fleas in your pet’s health, like vaccines and parasiticides that are effective against ticks and lice under the Seresto and Advantix brands. There is also a variety of vaccines and antibiotics for chicken and fish production under the Baytril and Rumensin brands.

Stock market value15.6B = 33.15 pesos

Eli Lilly was the one who spun Elanco. September 2018 and was met with a lot of excitement – in its first day of trading, the stock closed +50%. Because management made public opportunities for growth in revenue and margins that were at the same time or higher than industry growth rates, Elanco stock received so well. 2018 Elanco had 21% EBITDA margins compared to 38% Zoetis. Further, Zoetis was a relevant case study for Elanco as it was also spun out from a larger company and management was able to execute on its value creation plan, resulting in Zoetis’ stock price outperforming the S&P500 by 330% since its IPO.

Elanco’s management targets 31% EBITDA margins for 2023. Management of Elanco made it clear that its strategy was not dependent upon large transactions and would instead be focused on developing its pipeline. But, there was one problem. Aug. 20, 2019Elanco’s announcement of the Bayer Animal Health Business acquisition for $7.6 Billion stunned the markets and drove the stock down by 24%. Elanco stated that this deal was too great to miss as it would greatly expand the scale of the company and alter the business’ mix. Management accelerated its timeline for achieving the margin goal goal by one year, and they announced that this acquisition would help them reach their target of 31% EBITDA margins in 2022.

Elanco and Zoetis were closer in scale, and had similar geographical/portfolio mix. However, Elanco (including Bayer’s) margins were much lower than Zoetis which had EBITDA margins 40% as of 2019. While Zoetis did have some highly valued products that had high pricing power, Elanco only targeted 31%. Management revised their guidance in 2020 and said that they were now aiming to reach 31% EBITDA margins for 2024. This was a year after its original projections and 2 years after its previous projections.

Managers claim that there have been significant cost reductions but not margin growth, which is a confusing and annoying way to frustrate shareholders. The gap between Elanco & Zoetis is 2,455 base points in 2020, and 2,086 basis point estimated for 2021. It had led to a lack in confidence in management’s execution. A low stock price, a large margin of error and multiple gaps with Zoetis trading 26x EBITDA in 2022 and Elanco at 18x. This can be fixed by improving operational execution. It will increase shareholder confidence and improve the valuation multiple. Starboard has estimated a stock price of $47 for Elanco, with 31% EBITDA margins. There is no multiple improvement. A $74 stock market price would be available with 31% EBITDA and Zoetis-like multiple. Starboard projects a $91 stock price with a 37.1% margin improvement.

Starboard is not Elanco’s only activist. Sachem Head submitted a 13D to Elanco in October 2020. The firm reached a settlement with Elanco in December 2020 for the three seats on its board for Scott Ferguson (Paul Herendeen) and William Doyle. Starboard granted the company some time with the new directors, and will likely allow it to continue for more. However, the board and management must show that they are capable of executing. Starboard isn’t the only shareholder frustrated. At last year’s annual meeting, there were significant votes cast against each director up for election – Art Garcia (46.34%), Denise Scots-Knight (46.54%), Jeffrey Simmons (37.04%) and William Doyle (21.09%).

Elanco can create shareholder value via margin improvement. Starboard is an experienced board member who has vast experience improving the margins at portfolio companies. Starboard will be unable to make any director nominations before January 2022. But this is a reasonable situation and Starboard should consider inviting Starboard on the board.

Ken Squire founded 13D Monitor and is its president. The institutional research company focuses on shareholder activism. Squire also created and manages the 13D Activist Fund mutual fund, which invests in a variety of 13D activist investments. Elanco owns the fund.