Smith & Nephew's medical device company may benefit from activist Cevian's stake.

Company: Smith & Nephew (SN.-GB)

The British portfolio medical technology company operates worldwide and develops, manufactures, markets, and sells medical devices and services. Its segments include Orthopedics, Sports Medicine and Ear, Nose and Throat, as well as Advanced Wound Management. The Orthopedics segment includes hip and knee implants, robotics-assisted and digital enabling technologies, and trauma products. The Sports Medicine and ENT businesses offer advanced products and instruments for repair or removal of soft tissue. The Advanced Wound Management portfolio provides a comprehensive set of products to meet broad and complex clinical needs.

The stock's value in the UK is approximately 9.6 billion pounds, with each share priced at 11 pounds. In the US, it trades as an American depositary receipt under the ticker "."

Activist: Cevian Capital

Percentage Ownership:  5.11%

Average Cost: 9.68 pounds

Cevian Capital, founded in 2002, is a global investment firm that acquires significant ownership stakes in publicly listed European companies. The firm's strategy is to enhance long-term value through active ownership, and it is often referred to as a "constructive activist." Cevian Capital is the largest and most experienced dedicated activist investor in Europe, and its work is typically supported by other owners and stakeholders. The firm's goal is to help its companies become more competitive and increase their long-term value, ultimately earning its return through this process.

What's happening

The investor believes that Smith & Nephew has a fundamentally attractive business and acquired a 5.11% position in the company with the expectation of significant potential upside from improving the operating performance of its businesses.

Behind the scenes

Smith & Nephew is a global leader in medical technology, with a dominant market position in each of its three segments: Orthopedics, Sports Medicine and ENT, and Advanced Wound Management. The company is known for its product quality and has a strong brand perception. It operates in fundamentally growing and consolidated markets with good competitive dynamics, and there is predictable customer behavior and stable market shares for industry leaders. In 2023, the company generated $5.55 billion in revenue, with 40% coming from Ortho, 31% from Sports Med, and 29% from Wound. However, the profitability profile is quite different, with Ortho having only 11% operating margins, while Sports and Wound have twice that with 22% operating margins.

Despite its dominant market position and favorable industry conditions, Smith & Nephew has not generated shareholder value for several years. Its operating margins in its largest business, Ortho, have declined from 23% in 2019 to 11% today, due to self-inflicted issues with supply chain management, logistics, and manufacturing. This has resulted in back orders and the implants or required tools not being available at the right time. Ortho is a more complex business than Wound and Sport, requiring the timely delivery of a variety of sizes of implants, components, and devices for each procedure, as well as the specific tools associated with the procedure. Additionally, Smith & Nephew has experienced significant management turnover over the past five years.

The management team has released a 12-point plan to fix Ortho and regain market share. However, continued management turnover makes it difficult to implement a long-term operational plan. The company needs an activist to help with operational improvements and a long-term mindset. Cevian is the perfect activist for this company, with an average holding period of four to five years and a focus on operational performance. The firm has a history of helping companies improve operations, either as an active shareholder or board member. With Cevian's help, Smith & Nephew can boost the operating margins of the Ortho division at least back to its pre-pandemic level and maybe even higher, closer to peers like Stryker and Zimmer Biomet.

Cevian, as a board-level participant in most of their activist positions, is expected to assist in this endeavor. The firm currently holds board seats in 10 portfolio companies across six countries. Given their experience and status as the second-largest shareholder, it is likely that Cevian will obtain a board seat here, either amicably or by invitation.

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.