LBA Monthly View | July 2023


• More pressure on the consumer? According to a survey released by Deloitte, back-to-school shopping, the second-largest spending event after the holiday season, is primed for a retreat. Parents indicated they expect to spend $597 per child, which is 10 percent less than last year; they plan to focus more on supplies and less on apparel and technology. Reflecting this trend, the overall back-to-school market is expected to decline by 9 percent to $31.2B.1

• BUT, the good news for back-to-school shoppers is that the price of online goods has fallen for ten consecutive months, with a 2.6 percent drop in June alone.2

• The government’s debt problem has worsened. In June, federal interest payments on a twelve-month basis exceeded defense spending for the same period. Meanwhile, the average interest rate paid on the debt has jumped considerably, from roughly 1.6 percent in January 2022 to nearly 2.8 percent in June 2023.

• It’s not a surprise that remote work is affecting commercial real estate, but its impact might be more substantial than you think. According to a recent report, McKinsey predicts that by 2030, office property values in nine global cities will have fallen by 26 percent relative to 2019 values, equating to a loss of roughly $800B.3

• The New York Fed recently reported the rejection rate for credit applications increased by 21.8 percent to the highest levels since 2018. While rejections affected all age groups, they were highest among those with credit scores below 680. The New York Fed also reported the auto loan rejection rate increased to 14.2 percent, the highest level on record.4

• Playing catch-up or dystopian nightmare? FedNow, the Federal Reserve’s payment network for near-instant interbank settlements, launched on July 20. The system has been in development since 2019 and brings real-time payments to the US; countries including Brazil, India, the UK, and the EU have operated similar services for years. Privacy advocates are concerned that the new system, together with central bank digital currencies (CBDCs), could enable the government to monitor and potentially control each and every financial transaction involving US networks—a privacy nightmare. Concerns over the Fed’s involvement in the nation and economy are not new: Alfred Owen Crozier’s U.S. Money Vs. Corporation Currency, written in 1912 (a year before the Fed’s creation), included a cartoon illustrating the many problems that could stem from a central bank’s existence.5

Company Highlights

Amazon (AMZN)
Total spending during Prime Day increased by 6.1 percent this year, reaching $12.7B, a new Prime Day record fueled once again by smartphones (46.5 percent of sales this year). One area of tremendous growth was the Buy Now Pay Later (BNPL) category; it constituted 6.5 percent of orders (~$927M in sales), up 20 percent from last year.6

Keurig Dr Pepper (KDP)
KDP is much more “green” than meets the eye. In its recently released 2022 sustainability report, the company conveyed it sources 74 percent of its electricity from renewables; it aims to source 100 percent by 2025. Further, it reduced virgin plastic use by 11 percent while increasing use of recycled plastic content (used for plastic beverage bottles) by 18 percent.

Thermo Fisher Scientific (TMO)
TMO announced the acquisition of CorEvitas for $912.5M, a move that will help bolster Thermo Fisher’s contract research organization (CRO) and clinical trials businesses. CorEvitas manages registries in growing disease markets such as autoimmune and inflammatory. The deal is expected to be completed by the end of 2023 and accretive shortly thereafter (in 2024).7

Visa (V)
Visa announced Chris Suh will become the company’s next CFO. Mr. Suh was previously CFO of Electronic Arts and, prior to that, of the Cloud and AI group at Microsoft. His appointment, prompted by the retirement of long-time CFO Vasant Prabhu, follows Visa’s February CEO transition. While executive turnover can sometimes be concerning, we’re confident in Visa’s new team and optimistic that these changes will reinvigorate the company.

Microsoft (MSFT)
A US judge squashed the FTC’s antitrust case against Microsoft—a case in which the FTC sought an injunction to block Microsoft from acquiring gaming company Activision Blizzard—when she wrote, “Despite the…production of nearly 1 million documents and 30 depositions, the FTC has not identified a single document which contradicts Microsoft’s publicly stated commitment to make Call of Duty available on PlayStation.”

On Our Minds

As you all know, we are passionate about the companies in which we invest and could spend endless hours telling you all about what they are up to. Since several LBA companies have recently made acquisitions, we thought this would be a good month to share our perspective on acquisitions—and what makes a good one.

An acquisition allows a company to expand a product line, improve the performance of the target company, acquire skills or technologies that would be more costly to develop in-house, or increase geographic reach and market share. We can analyze the financial side of an acquisition by studying earnings, cash flow, balance sheet implications, and financing terms to determine if projected financials justify the price. But numbers only go so far—success really depends on management and its ability to (1) correctly assess the potential benefits of an acquisition, (2) integrate smoothly, and (3) leverage long-term synergies.

Since deals vary widely (in terms of size, price, and desired outcome) and evaluative performance metrics aren’t quickly generated post-acquisition, determining their success or failure takes time. Some are clear, high-profile winners, such as the Google/YouTube acquisition in 2006. But others, such as Google’s $12.5 billion acquisition of Motorola in 2012, do not go so well. In that case, the quality of Motorola’s handsets fell short of expectations, spurring Google to divest Motorola just two years later for $2.9 billion.

Coloplast (CLPBY) is an LBA holding that sells ostomy, continence, wound, and skin care products; it recently announced its acquisition of Kerecis, an Icelandic a wound care company, for $1.3 billion. Kerecis’s patent-protected tissue matrices rely on intact fish skin to create products, such as skin grafts, designed to promote healing in patients with severe skin injuries (e.g., burn victims). Fish skin retains a texture and exhibits behavior that is very similar to human skin, making it a compelling and more natural alternative to bioengineered skin substitutes. The cod skins Kerecis uses are typically waste products and therefore inexpensive, setting the company up for both strong margins and֫—given the prevalence of cod—scalability. The company broke even in FY21/22 and is growing at a rapid pace—more than 50 percent annually—suggesting a compound annual growth rate (CAGR) of 30 percent through 2025/2026. If correct, Kerecis would be the fastest growing company in the biologics wound care segment, according to CLPBY.

We can see why the Kerecis acquisition makes sense for CLPBY: its existing portfolio of wound care products will be enhanced by Kerecis’s dynamic new technology. However, while CLPBY estimates Kerecis will generate operating margins of ~10 percent this year, ~20 percent in 2025/2026, and 30 percent in the long term, this acquisition will be margin-dilutive in the short term. CLPBY’s operating margins were already pressured by inflation and impacted by the Atos acquisition, so Wall Street is not overly excited by this deal.

CLPBY has raised its growth forecast by 1 percent (to ~8-10 percent annually) while keeping long-term EBIT guidance unchanged. But looking further out, we believe the impact of CLPBY’s acquisitions seems more powerful: it has now acquired two companies with growth profiles that are stronger than that of Coloplast’s core business. These companies will (1) strengthen CLPBY’s go-to-market strategy via new products for large, unmet healthcare needs and (2) leverage CLPBY’s robust distribution network to drive significant efficiencies and synergies. Long term, we see these acquisitions upgrading CLPBY’s growth profile and operating margin. Although near-term return on invested capital (ROIC) is impacted, we think the acquisitions position CLPBY to generate greater economic profits, free cash flow, and operating earnings in the long term.

Since acquisitions are not an exact science, we must be patient: only time will tell whether CLPBY’s management has accurately assessed this new technology and the long-term growth it will provide. We will watch closely to make sure CLPBY meets its growth and operating margin projections as Kerecis is integrated. Coloplast has made successful acquisitions in the past, and we are confident in its assessment of Kerecis. Plus, the technology is very cool—take a look at this video!

  1. 2023 Deloitte back-to-school survey
  2. US Online Prices Are Falling at the Fastest Pace Since May 2020
  3. The impact on real estate
  4. SCE Credit Access Survey
  5. Fed launches long-awaited instant payments service, modernizing system
  6. Adobe Analytics: Prime Day drove record U.S. online spending, bolstered by deep discounts
  7. Thermo Fisher Scientific to Acquire CorEvitas

POSTED IN: LBA Monthly View