Activist Cevian Owns Stake in Medical Device Maker Smith & Nephew, How It Could Help Improve Margins – NBC10 Philadelphia

Company: Smith & Nephew (SN-GB)

Business: Smith & Nephew is a British medical technology company operating globally. The company develops, manufactures, markets and markets medical devices and services. Its segments include orthopaedics, sports medicine and ENT, as well as advanced wound management. Its orthopaedic segment includes a range of hip and knee implants for replacing damaged or worn joints, robotic and digital assistive technologies, and trauma care products used to stabilize severe fractures and correct hard tissue deformities. Its sports medicine and ENT businesses offer advanced products and instruments used to repair or remove soft tissue. Its Advanced Wound Management portfolio provides a comprehensive set of products to meet a broad and complex clinical need.

Market value of shares: ~9.6 billion British pounds (£11 per share). The shares are also traded in the US as an American Depositary Certificate under the symbol “SNN”.

Activist: Cevian Capital

Percentage of ownership: 5.11%

Average cost: 9.68 pounds

Activist comment: Cevian Capital, founded in 2002, is an international investment firm that takes significant stakes in publicly listed European companies where long-term value can be enhanced through active ownership. Cevian Capital is a long-term, hands-on owner of European listed companies. Often referred to as a “constructive activist”, it is the largest and most experienced dedicated activist investor in Europe. Cevian’s strategy is to help its companies become better and more competitive over the long term and to monetize them by increasing the long-term real value of the companies. The firm’s work in companies is typically supported by other owners and stakeholders.

What’s going on

Cevian has acquired a 5.11% stake in the company because the company believes that Smith & Nephew is fundamentally an attractive business. The investor believes that improving the operating performance of the company’s businesses could provide significant growth potential.

Behind the scenes

Smith & Nephew is a global leader in medical technology. The company develops and sells medical devices and services in three segments, maintaining a dominant global market position in each of them: orthopedics, sports medicine and ENT, and advanced wound care. Smith & Nephew is well known for the quality of its products, and brand perception is very strong. In addition, the company operates in fundamentally growing and consolidated markets with good competitive dynamics. Overall, there is very predictable customer behavior, as well as stable market shares for industry leaders. In 2023, the company generated $5.55 billion in revenue, of which 40% came from Ortho, 31% from Sports Med, and 29% from Wound. However, the profitability profile is quite different. After allocating overhead, Ortho has only an 11% operating margin, while Sports and Wound has twice as much with a 22% operating margin.

Despite its leading market position and favorable industry dynamics, Smith & Nephew has not generated shareholder value for many years—down 44% since January 1, 2020, and down 33% since January 1, 2021, at a post-Covid price. This is not surprising, and the reason seems obvious: operating margins at its largest company, Ortho. In 2019, Ortho had operating margins of 23%, which fell to 13% in 2020. They are now 11%. This is due to self-inflicted issues with supply chain management, logistics, and manufacturing, resulting in order delays and implants or required instruments not being in the right place at the right time. This problem is somewhat unique to Ortho, as it is a much more complex company than Wound and Sport, and requires on-time delivery of not only implants, components, and devices of varying sizes for each procedure, but also specific instruments related to the procedure. Another major factor contributing to the company’s failings is the fact that Smith & Nephew has experienced significant management turnover over the past five years.

The board has now released a 12-point plan, the centerpiece of which is fixing Ortho to regain momentum and gain market share. While that’s a step in the right direction, and this management team may be able to implement that plan effectively, it won’t happen with constant management turnover. You can’t implement a long-term operating plan when you have a new CEO every few years. This is a company that clearly needs an activist, but the good news is that Cevian is the perfect activist for a company like this. Two things Smith & Nephew needs more than anything are a long-term mindset and operational improvements. Cevian is a long-term activist—the average holding period for a company is four to five years, but positions often last eight to 10 years—with a focus on operational results. The company has a strong history of helping companies improve their operations as an active shareholder or board member. There is no reason why the company cannot increase its Ortho division’s operating margin to at least pre-pandemic levels, if not higher, bringing it in line with competitors like Stryker and Zimmer Biomet.

We expect Cevian to be willing to help with this endeavor from the board level, as they hold board seats in most of their activist positions. Cevian professionals currently serve on the boards of 10 portfolio companies in six different countries. Given the company’s experience and the fact that it is the company’s second-largest shareholder, we would expect Cevian to be able to obtain a board seat here, just as it does in most of its engagements – either amicably or by invitation.

Ken Squire is the founder and president of 13D Monitor, an institutional research service dedicated to shareholder activism, and the founder and portfolio manager of 13D Activist Fund, an investment fund investing in 13D’s activist investment portfolio.