Baxter (NYSE:BAX) remains the firm’s largest position and Third Point Partner and Head of Equities Munib Islam serves on the Board of Directors. In past quarterly letters, we detailed our initial investment thesis and highlighted the extraordinary transformation that CEO Joe Almeida has overseen at the company since joining at the end of 2015. Baxter has generated more profits than any investment in our history. We have used open windows to maintain the size of the position as it has grown through appreciation, the best reason to have to right-size an investment. Today, we remain enthusiastic about the direction of Baxter and the investment opportunity ahead. As a framework, we use the three major growth vectors that Joe outlined during his first investor presentation in January 2016: 1) operational excellence; 2) capital allocation; and 3) portfolio optimization.
Operational Excellence: Without question, Baxter has clearly improved operational efficiency over the last three years. The company just reported FY 2018 results, achieving operating margins of 17.4%. And the company expects to extract further efficiencies over the next 5 years, targeting 2023 operating margins of ~23-24%.
Capital Allocation: Since January 2016, Baxter has returned $4 billion back to shareholders through share repurchases and dividends, and used another $1 billion for business development purposes, acquiring the generic injectable pharmaceutical manufacturer Claris in 2017 and two approved products from Mallinckrodt in 2018. Despite this activity, Baxter remains underlevered versus peers, with a net debt to EBITDA ratio below 1.0x vs the group at 2.0-2.5x. The balance sheet flexibility should allow Baxter to continue targeted business development efforts, although we fully expect the company to remain disciplined in its efforts.
Portfolio Optimization: Portfolio optimization at Baxter can be divided into two areas. Over the past three years, the company exerted more discipline over its existing portfolio, voluntarily walking away from low or negative margin contract business. Further, Baxter refined its R&D efforts to focus on high value strategic projects. Over the next 12-24 months, Baxter expects to start reaping the fruits of its labor with several new product launches including Spectrum IQ and Evo IQ pumps, and new generic injectable drugs. The innovation cycle should serve to drive revenue growth acceleration and contribute positively to underlying operating margins.
We retain high conviction in Baxter based on expectations of continued development across the three vectors that should sustain earnings growth and free cash flow generation over the next several years. We have confidence that Joe and his management team will continue to execute on his strategy, driving Baxter forward and delivering substantial returns for its investors.
From Daniel Loeb (Trades, Portfolio)'s fourth-quarter 2018 Third Point shareholder letter.
