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Company: Colfax Corp. (CFX)
Business: Colfax is a global diversified technology company. The company operates in two segments: (i) Fabrication Technology: consumable products and equipment, including cutting, joining, and automated welding products, as well as gas control equipment; and (ii) Medical Technology: medical device products used to treat patients with musculoskeletal conditions resulting from degenerative diseases, deformities, traumatic events, and sports related injuries. It offers rigid and soft orthopedic bracings, hot and cold therapy products, bone growth stimulators, vascular therapy systems and compression garments, therapeutic shoes and inserts, electrical stimulators used for pain management, and physical therapy products; and a suite of reconstructive joint products.
Stock Market Value: $7.3B ($51.62 per share)
Percentage Ownership: n/a
Average Cost: n/a
Activist Commentary: Starboard is a very successful activist investor and has extensive operational activism experience helping boards and management teams run companies more efficiently and improving margins. They have made 103 13D filings. In those 103 filings, they have averaged a return of 33.4% versus 14.1% for the S&P 500. Their average 13D hold time is 18.2 months.
Starboard took a position in the company and supports management’s plan to separate into two businesses but sees additional opportunity for value creation by improving margins.
Colfax is comprised of two separate businesses: (i) a fabrication technology segment (“FabTech”) that comprises 2/3 of the Company’s revenue and makes filler metals and welding machines and (ii) a medical technology segment (“MedTech”) that comprises 1/3 of revenue and makes medical devices like joint replacements and braces. FabTech is the number one industry player in many regions internationally and is expanding its market share in North America. MedTech has the number one market share in prevention and rehabilitation and winning share in the reconstructive market.
These are two great businesses that do not logically belong together. And the company announced in March of this year that it will be separating the two businesses and expects that to happen in the first quarter of 2022. This alone should create value for shareholders as the two separate management teams can focus on their core competencies. FabTech’s main peer is Lincoln Electric and while an argument can be made that a standalone FabTech should trade at a higher multiple than Lincoln Electric, it certainly should trade at least at the same multiple, which would give it a $5.4 billion valuation. This would attribute a $3.7 billion valuation to the MedTech business, which equates to a 2x revenue multiple and a 13x EBITDA multiple versus 4x and 19x, respectively, for its peers.
So, the second opportunity for value creation is to close this valuation gap by focusing on margins and growth. In this business revenue growth plus EBITDA margin should equal or exceed 30, as the median for its peers is 30, with the best of its peers in the high 30s. MedTech is at the bottom at 23.5%. As MedTech has a similar gross margin to its peers, this is a selling, general and administrative expense issue.
Starboard has an extensive track record of helping companies improve operating margins. The firm recently did just that at a similar company, Merit Medical, generating a 113% return in under two years versus 36% for the S&P 500. Cutting excess costs here would not only improve margins but allow the company to invest in growth. Again, the company agrees with this and has announced a 25% EBITDA target for the MedTech business. Starboard believes this margin improvement plan could be accelerated with focus, just like Merit Medical did. Adjusted for these margin improvements, a standalone MedTech would trade at 10x EBITDA versus 19x for its peers. Closing this valuation gap would result in a $76 stock price in 2023 and a $94 stock price in 2025.
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.