People walk past the New York Stock Exchange Wednesday, April 3, 2024 in New York.
Peter Morgan | AP
Company: Solventum (SOLV)
Business: Solventum, formerly known as 3M Health Care, is a global health-care company that was spun out from 3M on April 1. It has four main segments. First, there is Medical Surgical, a provider of solutions including advanced wound care, sterilization assurance, temperature management, surgical supplies, stethoscopes and medical electrodes. There is the Dental Solutions segment, which provides dental and orthodontic products and bonding agents that span the life of the tooth. The Health Information Systems segment provides health-care systems with software solutions, including computer-assisted physician documentation, direct-to-bill and coding automation, speech recognition and data visualization platforms. Finally, the Purification and Filtration segment offers filters, purifiers, cartridges and membranes.
Stock Market Value: $9.95B ($57.63 per share)
SOLV’s performance in 2024
Activist: Trian Fund Management
Percentage Ownership: n/a
Average Cost: n/a
Activist Commentary: Trian runs a concentrated portfolio of eight to 10 mid- to mega-cap, publicly traded companies where it actively engages with company management with the goal of enhancing long-term shareholder value. Trian, managed by Nelson Peltz, takes very few positions, but is very active in its positions. Peltz calls his formula “operational activism.” He defines it as working with the management of high-potential but underachieving companies to raise earnings by paring overhead, shedding ancillary businesses and burnishing famous brands.
What’s Happening
Bloomberg News reported on July 22 that Trian has taken a position in Solventum.
Behind the Scenes
Solventum is a global health-care company that was spun out from 3M on April 1, with 80.1% of shares distributed to 3M shareholders and the remaining 19.9% retained by 3M to be monetized within five years following the transaction. Solventum has a leading market position in numerous categories, strong performance-driven products and high brand loyalty. The company operates across four segments which accounted for $8.2 billion of revenue in 2023: Medical Surgical (56.5%), Dental Solutions (16.2%), Health Information Systems (15.7%), and Purification & Filtration (11.6%). The health-care business was consistently one of the strongest segments of 3M when it was part of the conglomerate structure, boasting the highest growth rate of any division and margins that exceeded the company average. For more than two decades, the business grew organically every year. Adding to that, the company has had 25%+ adjusted operating income margins and over $1.4 billion of free cash flow generation for each of the past three years. Despite this, the stock has not performed well since the spinoff, tumbling over 20% since the close of its first day of trading until news of Trian’s position.
As a standalone company, Solventum has been under-covered and misunderstood by the market. Despite being a spinoff from a conglomerate, Solventum itself is a mini conglomerate with four different businesses. While all of them are medical adjacent, none really share the same technology, customers, supply or distribution chain. Accordingly, it is a difficult company for investors and the sell side to analyze, and it has not seen a lot of traction in the investment community. But, as a newly independent company, there are potential tailwinds inherent in most spinoffs such as better management focus and agility and the ability to better align management compensation with the value of the business.
There are also numerous levers for value creation at Solventum, specifically re-accelerating organic growth, restoring margins while investing to drive growth, and simplifying the company’s portfolio of businesses. Beginning with organic growth, Solventum had proved an ability to grow in the low-to-mid single digits within 3M for years while being constrained by the conglomerate structure. As a pure play, it should be more agile in implementing growth initiatives and just getting growth back to 4% would create value against a backdrop of a sell side consensus of no growth. On margins, the company has a 25% earnings before interest, taxes, depreciation and amortization margin, which is a strong profit margin but could be better. That margin includes 800 basis points of corporate costs allocated to these businesses as part of 3M. As a standalone entity, it will need to remake some of these functions, but can also shed a lot of the heavy costs through management discipline. Lastly is simplification of the portfolio. Again, as a mini conglomerate, Solventum has a core business and three non-core and non-synergistic businesses with different products, sales forces, customers, manufacturing and distribution. Its segments likely have the scale to be standalone companies and trade at higher pure-play valuation multiples or could be sold to a private equity firm or a strategic acquirer. A sale of any of these businesses will allow the company to de-lever its balance sheet, currently trading at 4-times net leverage, and initiate a dividend. There is no reason why this company should trade at a price-earnings ratio that’s less than its peers. Certainly, it should not trade cheaper than 3M, as it previously was one of 3Ms best businesses.
Trian is known for being a skilled income statement activist and has helped many companies improve margins and growth. Look no further than the coffee cups in the firm’s office, which read “Sales Up, Expenses Down.” There is also no shortage of examples of Trian being a valuable corporate governance-oriented investor and creating tremendous shareholder value from the board level. But what some may not realize, is that the firm also has extensive experience with spinoffs, such as: (i) Pentair, which spun off nVent Electric plc in 2018; (ii) Kraft Foods’ move to split into two companies in 2012 and rename itself Mondelez; (iii) Dupont’s spinoff of Dow in 2019; (iv) Cadbury’s spinoff of Dr. Pepper; and (v) Ingersoll Rand’s spinoff of Allegion in 2013, to name a few. However, the most relevant spinoff is GE’s health-care division. Trian has been an active shareholder at General Electric since 2015 and called for both operational and strategic improvements. On Jan. 4, 2023, GE spun off its GE HealthCare division, as part of its plan to break into three separate companies. Since then, GE HealthCare Technologies has returned 34.45% versus a return of 26.92% for the Russell 2000 over the same period.
While Trian has a history of being an active shareholder, the firm has also created tremendous shareholder value as an engaged director. We think in this situation, the latter is appropriate. There is no activist with more experience than Trian in operational engagement in a newly spun-off company and addressing the issues and opportunities inherent in spinoffs. Moreover, if there is an opportunity to divest one or more businesses, shareholders would have comfort with a financially astute shareholder representative on the board to evaluate competing offers to assure the maximization of shareholder value. The board consists of 12 members with four directors in each class and will begin the process of phasing out the staggered board in 2025, to be fully de-staggered by 2028. Given the obvious fit, we would be surprised if this does not settle amicably with a Trian representative on the Board, but the director nomination window opens on Dec. 2, and Trian has never been one to shy away from a proxy fight if the firm feels it is necessary. It should be noted that 3M retained 19.9% of Solventum’s common stock, but has agreed to mirror voting, which will compel it to vote these shares in proportion to the votes cast by the company’s other shareholders.
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.
