Guru Dan Loeb leads Third Point LLC and recently built up a large stake in Baxter International (BAX, Financial), which now makes up about 15% of his portfolio. Since that time he has requested and been granted two board seats and helped to install the new CEO. Loeb has not taken the aggressive approach (given the soft tone of his letter to the company) he is known for that usually tends to grab the attention of the financial media. It’s a bit of a stretch to say this one is flying under the radar, but it definitely has not attracted as much attention as his Sotheby’s (BID) or Sony campaigns.
There are a few clear reasons for his soft approach. Baxter was already in need of a new CEO; Loeb just wanted to get involved in that search and he brings a lot of expertise to the table. He is, after all, somewhat of a specialist in kicking people out, which inevitably requires you put in someone new who is actually an improvement. His usual venemous rhetoric was not required to get a shareholder value centric CEO Joe Almeida of Covidien (COV), installed. Almeida really has a pretty good track record for value creation:
After getting him on board, there is simply not a lot of pushing required. Almeida is going to execute like he does and if he is getting results, Loeb will just sit back and watch his stake increase in value.
It is interesting to note that Almeida willingly sold Covidien from under himself to Medtronic, which was a tax-inversion type of deal. If there is an opportunity to do the same thing at Baxter, it quickly starts to make sense how this could be a great investment.
Another reason that may have played a role in Loeb’s interest is the difficulties of separating Baxter’s financials from that of the spun-off BioScience company. This was highlighted by comments made by previous CEO Parkinson on the most recent earnings call (emphasis mine):
Before I walk you through the P&L I wanted to take a moment to make some comments regarding our historical financial statements, which we detailed this morning in our 8-K filing. First, I want to start by acknowledging your patience with respect to these statements. Given the highly integrated nature of the BioScience and Medical Products businesses pre-spin, the preparation of the historical filings required significant time.
Second, I wanted to highlight that these statements have inherent complexities associated with them when comparing current results with those of prior periods. More specifically, for the most part prior periods do not reflect income we received from Baxalta related to transition service agreements and deferred country closings. In addition given the highly integrated nature of our businesses, we were not able to clearly isolate select expense categories between Baxalta and Baxter in the discontinued operations presentation.
And lastly, the historical P&Ls included payroll expenses for certain positions initially determined as backfills for employees that transitioned to Baxalta. Upon further evaluation post-spin, some of these roles have since been eliminated and will not be replaced. Investors should consider all of these factors when comparing Baxter's current results to historical periods.
When the financials are hard to understand completely, hedge fund operations with great specialized analysts may have a little bit more of an edge as compared to situations where financials are easier to understand.
Meanwhile on a fundamental basis, the company is fairly attractive. There is $6 billion of debt on the balance sheet, but it’s almost entirely offset by the same amount of cash. If we take into account Loeb likely selected this target after identifying it as a good target to cut some fat and he brought in a specialist who did exactly that at a similar company, the ~13x cash flow the company trades at starts to look very good. The average cash flow multiple for both its industry and sector are deep into the 20s. Loeb may see an opportunity to expand both margins and take earnings up, while the multiple gap is closed at the same time, which would lead to an extremely high return on his investment. This is certainly not the worst stock to ride his coattails on.
