Elanco receives investment from Ancora to boost profitability.

Company: Elanco Animal Health (ELAN)

An animal health company, Business, offers products and services to prevent and treat disease in farm animals and pets. Its portfolio caters to a wide range of animals and is divided into two categories: Pet Health, which focuses on parasiticides, vaccines, and therapeutics, and Farm Animal, which includes products designed to prevent, control, and treat health challenges primarily in cattle.

Stock Market Value: $7.34B ($14.90 per share)

Activist: Ancora Advisors

Percentage Ownership:  ~3.0%

Average Cost: n/a

Ancora is not an activist investor, but rather a family wealth investment advisory firm and fund manager with $8.7 billion in assets under management. Its alternative asset management division manages approximately $1.3 billion. Ancora was founded in 2003 and hired James Chadwick in 2014 to pursue activist efforts in niche areas like banks, thrifts, and closed-end funds. The firm's website lists "small cap activist" as part of its products and strategies. In recent years, Ancora's strategy has evolved, with the majority of its activism being 13D filings on micro-cap companies and a greater number of sub-5% stakes in larger companies. The alternatives team has a track record of using private and public engagement with portfolio companies to catalyze corporate governance improvements and long-term value creation.

What’s happening

According to sources, Bloomberg reported on Dec. 14 that Ancora has taken a stake in Elanco and is advocating for the replacement of the CEO, changes to the board structure, and increased profit margins.

Behind the scenes

Elanco is a leading global animal health pharmaceutical company that develops and markets products for both pets and farm animals. The industry in which it operates is growing secularly and has experienced significant consolidation, making it historically resistant to recessions. Elanco is one of four major players in the market, along with Zoetis, Merck Animal Health, and Boehringer Ingelheim, collectively holding 80% market share. In 2018, Elanco spun out from Eli Lilly and was met with excitement, closing higher by 50% on its first day of trading. 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 EBITDA margins were 21%, lower than Zoetis's 38%, but Elanco management targeted 31% EBITDA margins by 2023.

In 2019, Elanco acquired Bayer's Animal Health business, which significantly expanded its scale and changed the mix of its business. As a result, management accelerated its timeline for reaching its margin target goal by a year and announced that it would achieve 31% EBITDA margins by 2022. However, 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. Despite claiming significant cost savings, this is not resulting in margin expansion.

In October 2020, Sachem Head Capital Management filed a 13D on Elanco, raising concerns about the company's EBITDA margins and progress in improving them. On December 13, 2020, Sachem Head and Elanco reached a cooperation agreement, granting the activist three board seats for William Doyle, Scott Ferguson, and Paul Herendeen. Currently, Doyle and Herendeen serve as directors, while Ferguson has resigned from the board.

Ancora, with a 3% market position, aims to enhance margins, refresh the board, and replace the CEO. Ancora considers this a failure of corporate governance and accountability. The company's management has not improved margins over the past five years, overpaid for Bayer, and was late in converting their debt from variable to fixed, resulting in higher interest expenses. Additionally, the board does not seem to hold management accountable. For example, 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.

Ancora is poised to replace four directors at the next annual meeting, including the company's CEO Jeff Simmons. The firm is pushing for board refreshment and the replacement of the CEO, but may be able to do so in one fell swoop if Simmons is not re-elected as a director. Ancora is likely to nominate three industry directors and one Ancora executive, signaling their intention to be a long-term shareholder. All four incumbent directors up for re-election received over 20% "against" votes at their last election in 2021, with two of them over 46% and Simmons over 37%. Elanco was trading at $35.76 per share at the time of the last election, but is now at about $14 per share. Institutional Shareholder Services is recommending voting against Simmons, as they do not like a board that has ignored the will of its shareholders. Even if Simmons can retain his board seat in a proxy fight, 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.

A company with a well-prepared board and management team that can achieve gross margins of 60% and EBITDA margins of over 20% (even below the promised 31%) would significantly increase shareholder value.

Ken Squire is both 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.