How ValueAct may help boost margins at this Japanese medical device company

Firm: Nihon Kohden (6849.T-JP)

Enterprise: Nihon Kohden is a Japan-based firm engaged within the analysis, growth, manufacture and sale of medical digital tools, in addition to the supply of upkeep and restore providers. The corporate gives a big selection of units to help with medical diagnoses, together with electroencephalographs, evoked potential testing tools, electrocardiographs, cardiac catheterization tools, diagnostic info programs and associated consumables. The corporate can also be engaged within the gross sales promotion for its merchandise, in addition to the overall affair-related and manpower dispatching companies.

Inventory Market Worth: $2.6B ($31.02 per share)

Proportion Possession: 5.01%

Common Value: n/a

Activist Commentary: ValueAct has been a premier company governance investor for over 20 years. ValueAct principals are usually on the boards of half of the agency’s core portfolio positions and have had 56 public firm board seats over 23 years. ValueAct has been a pioneer of U.S.-led worldwide activism, primarily in Japan. ValueAct’s co-CEOs, Rob Hale and Mason Morfit, are additionally co-portfolio managers of the agency’s Japan fund. A major quantity of the portfolio is invested internationally. Hale is on the boards of Japanese corporations, which is considerably of an unprecedented and industry-leading motion for U.S. activist funds. ValueAct has had 26 prior worldwide activist investments and has had a mean return of 36.19% versus a mean of 4.04% for the MSCI EAFE index over the identical durations. Furthermore, two of their greatest worldwide investments have been two Japanese corporations the place Hale is on the board – Olympus (109.48% versus 7.68% for the MSCI EAFE) and JSR (116.86% versus 38.57% for the MSCI EAFE).

On Dec. 25, ValueAct reported holding 5.01% of Nihon Kohden.

ValueAct has been a pioneer of U.S.-led activism in Japan. A major quantity of the agency’s portfolio is invested internationally. Two of its greatest worldwide investments have been a pair of Japanese corporations the place ValueAct co-CEO Rob Hale is on the board: Olympus and JSR. Nihon Kohden is a Japanese medical units producer and distributor with a dominant market presence at house and a very good repute internationally for on-time supply, service and product high quality.

That is the third Japanese medical machine firm ValueAct has invested in. Notably, the agency invested in Olympus in 2017, obtained a board seat in 2019 and stays on the board at this time. Each Olympus and Nihon Kohden are international medical machine corporations. Nonetheless, Olympus derives 80% of its income from outdoors of Japan, whereas Nihon Kohden will get roughly 40% of its income from outdoors of Japan. Nonetheless, each corporations have wonderful merchandise and an ambition to be international, and Nihon Kohden might comply with a path to globalization that is just like the one Olympus has taken.

There are three major levers for worth technology at Nihon Kohden: working margin growth, optimizing the combo of kit versus consumables and providers income, and disciplined capital allocation. First, regardless of having 51% gross revenue margins, Nihon Kohden’s working margins are solely at 10%, whereas rivals in each Japan and overseas are within the mid to excessive teenagers. With roughly 60% market share in Japan, the place a few of its income comes from distributing third-party merchandise, and 10% market share within the U.S., the place the corporate has proprietary merchandise, the expansion and margin potential is bigger within the U.S. Nihon Kohden can use its reputational power to capitalize on the U.S. market. The corporate has a chance to shortly get to fifteen% working margins inside a number of years and may see incremental enchancment in following years.  

Second, Nihon Kohden has traditionally been targeted on {hardware} gross sales and its income is cut up roughly evenly between {hardware} and consumables and providers. Nonetheless, there is a chance for worth creation if the corporate pursues a method to extend its income from consumables and providers as a result of recurring nature and better margins of that sort of income. From these two methods alone, Nihon Kohden can drive 20% revenue development over the subsequent three years.

Third, the corporate is at present sitting on internet money equal to about 15% of its market cap. Like many Japanese corporations, Nihon Kohden might create worth from an accretive capital deployment technique that evaluates returning capital to shareholders or disciplined M&A. Traditionally, shopping for again shares hasn’t been a preferred tactic in Japan, however share repurchases have been rising over current years. The Tokyo Inventory Change has been encouraging them as a part of a course of to get corporations to commerce over one instances guide worth.  

ValueAct has an earned repute as a collaborative and amicable activist, and there’s no motive why this example must be any completely different. Earlier than build up such a place, ValueAct possible has been attending to know administration over the previous 12 months and spent appreciable time with CEO Hirokazu Ogino. Furthermore, ValueAct wouldn’t have made this funding if the agency didn’t have a excessive diploma of respect for Ogino and the remainder of the administration workforce. We count on that ValueAct and administration are aligned on their views, significantly with respect to margin enchancment and capital allocation.

ValueAct doesn’t take board seats by way of worry or pressure, however organically through dialogue and concord. Accordingly, we might count on the agency to proceed to help administration as an energetic shareholder and solely take a board seat at a time that each ValueAct and administration really feel the investor might add worth. At Olympus, that took two years. At JSR, it took over a 12 months. Each corporations have been extremely profitable engagements for them, returning 109.48% at Olympus versus 7.68% for the MSCI EAFE, and 116.86% at JSR versus 38.57% for the MSCI EAFE. ValueAct remains to be on the board at each corporations. An identical final result right here can lead to virtually a doubling of the inventory in two to a few years.

Ken Squire is the founder and president of 13D Monitor, an institutional analysis service on shareholder activism, and the founder and portfolio supervisor of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments.