Company: Smith & Nephew (SN.-GB)
Business: Smith & Nephew is a British portfolio medical technology company that operates worldwide. The company develops, manufactures, markets and sells medical devices and services. Its segments include Orthopedics, Sports Medicine and Ear, Nose and Throat, as well as Advanced Wound Management. Its Orthopedics segment includes a range of hip and knee implants to replace damaged or worn joints, robotics-assisted and digital enabling technologies, as well as trauma 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 broad and complex clinical needs.
Stock Market Value: ~9.6 billion British pounds (11 pounds per share). The stock also trades in the U.S. as an American depositary receipt under the ticker “SNN.”
Activist: Cevian Capital
Percentage Ownership: 5.11%
Average Cost: 9.68 pounds
Activist Commentary: Cevian Capital, founded in 2002, is an international investment firm acquiring significant ownership positions 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. It is often called a “constructive activist” and 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 earn its return through an increase in the real long-term value of the companies. The firm’s work at companies is typically supported by other owners and stakeholders.
What’s happening
Cevian acquired a 5.11% position in the company because the firm thinks that Smith & Nephew operates a fundamentally attractive business. The investor thinks there could be significant potential upside from improving the operating performance of the company’s businesses.
Behind the scenes
Smith & Nephew is a global leader in medical technology. The company develops and sells medical devices and services across three segments, maintaining a dominant global market position in each: Orthopedics, Sports Medicine and ENT, and Advanced Wound Management. Smith & Nephew is well known for its product quality and its brand perception is very strong. In addition, the company operates in fundamentally growing and consolidated markets with good competitive dynamics. In general, there is very predictable customer behavior as well as stable market shares for the 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 only has 11% operating margins, while Sports and Wound have twice that with 22% operating margins.
Despite its leading market position and the favorable industry dynamics, Smith & Nephew has not generated shareholder value for many years – down 44% since Jan. 1, 2020 and off by 33% since its Jan. 1, 2021 post-Covid price. This is not surprising, and the reason seems obvious: operating margins in its largest business, Ortho. In 2019, Ortho had operating margins of 23%, which declined to 13% in 2020. They are now at 11% today. This is due to self-inflicted issues relating to supply chain management, logistics and manufacturing causing back orders and either the implants or the required tools not being at the right place at the right time. This issue is somewhat unique to Ortho as it is a much more complicated business than Wound and Sport and requires the timely delivery of not only a variety of sizes of implants, components and devices for each procedure, but also the specific tools associated with the procedure. Another major contributor to the company’s missteps is that Smith & Nephew has seen a significant amount of management turnover over the past five years.
Management has now released a 12-point plan of which a major component is fixing Ortho to regain momentum and win market share. While this is a step in the right direction and this management team may be able to successfully implement this plan, it is not going to happen with continued management turnover. It is impossible to implement a long-term operational plan when there is 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. The two things Smith & Nephew needs more than anything is a long-term mindset and operational improvements. Cevian is a long-term activist – the firm’s average holding period is four to five years, but often it will hold positions for eight to 10 years – with an operational performance focus. The firm has extensive history of helping companies improve operations either as an active shareholder or board member. There is no reason why the company should not be able to boost the operating margins of the Ortho division at least back to its pre-pandemic level and maybe even higher, closer to peers like Stryker and Zimmer Biomet.
We expect that Cevian would look to assist in this endeavor from a board level because they take board seats in most of their activist positions. Currently, Cevian’s professionals serve on the boards of 10 portfolio companies in six different countries. Given the firm’s experience and the fact that it is the company’s second-largest shareholder, we would expect that Cevian would be able to get a board seat here the way it does in most of its engagements – amicably or by invitation.
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.