Danaher's Trading Value Belies Logic

Summary

• DHR's revenue is growing in the low-single digit range, and its operating income is in decline.
• Its 22x EBITDA multiple belies logic.
• Sell DHR.
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Danaher employee. Source: Fortune

Danaher (NYSE:DHR) made major news in February when the company announced it would acquire GE Biopharma (GE) for $21.4 billion. The transaction drew attention for its sheer size and potential to make a dent in GE's debt load. It could also goose Danaher's growth. GE Biopharma is expected to fit into the company's Life Sciences division, which offers research tools that scientists need to study genes, proteins, metabolites and cells, in order to understand the causes of disease and test new drugs and vaccines.

Danaher has historically been able to grow its top line in the high single-digits, yet growth slowed in Q1 2019. Total revenue of $4.9 billion grew 4% Y/Y, unbecoming of a growth company.

Life Sciences is the company's largest segment at 33% of total revenue. It is also the fastest-growing, exhibiting revenue growth of 10% Y/Y. The company's other business segments generated revenue of about $3.3 billion that only grew 1% Y/Y. The Dental business (offers products and services to treat ailments for teeth and gums) experienced a revenue decline.

Operating profit of $724 million actually declined 3% Y/Y. Gross profit grew 3% as gross margin was flat at 56%. However, growth in SG&A (up 5% Y/Y) and R&D costs (up 4% Y/Y) outstripped growth in gross profit. Operating profit margin was 15%, down about 100 basis points versus the year earlier period. On a segment basis, Dental reported a 7% operating profit. Its profit margins are much less than the total company's, which likely explains why Danaher wants to spin off the operation into a separate publicly-traded company.

Key Events

The following key events could potentially goose top line growth and improve margins.

Acquisition Of GE Biopharma

Market chatter suggests the purchase price for GE Biopharma represents 17x 2019 EBITDA. I also understand GE Biopharma generated 2018 revenue of about $3 billion. This would potentially increase annual revenue for Life Sciences by over 40% and increase exposure to a high growth market. However, it would negatively impact the company's credit metrics.

• Danaher's EBITDA for the last twelve months ("LTMQ119) was $4.7 billion. The implied EBITDA of GE Biopharma is about $1.3 billion.
• Combined EBITDA would be nearly $6 billion post-deal.
• New debt of $18.4 billion ($21.4 billion purchase price less $3.0 billion of new equity already raised) would leave Danaher with $6 billion of proforma EBITDA and $28 billion of proforma debt at debt/EBITDA of 4.7x.

Such a high debt load could amplify Danaher's interest expense and decrease its cash flow. It could also give the company less flexibility to make a sizeable acquisition in the future.

IPO Of Dental

As I mentioned earlier, Dental represents a drag on growth in revenue and operating income. Sans Dental, the company's total revenue would have grown by 5% Y/Y. Dental generated segment operating income of about $48 million. Management's ambition is to establish it as a separate publicly-traded company:

So we're excited about the cadence of new production introductions, and believe that with expanding portfolio solutions we'll further distinguish our Dental business going forward. We're also making good progress as we work to establish the platform as a separate publicly traded company in the second half of this year.

What type of earnings multiple the market would place on the unit is unclear. It would probably trade for much less than the 22x EBITDA DHR trades for now. That said, separating the unit could potentially amplify growth of the remaining parts.

Conclusion

Given Danaher's single-digit top line growth and decline in operating income, its $104 billion enterprise value and 22x EBITDA multiple belie logic. DHR is up about 35% Y/Y. The GE Biopharma deal could goose growth in the short term, but future acquisitions could be stymied due to its increased debt load. Sell DHR.

Disclosure: I am/we are short GE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.