Savant Investors Idea Spotlight Series #1
Originally Posted on Twitter: 12/14/23
We are highlighting some of the top ideas posted since our launch last month. The first in the series is a Fortrea long pitch by a PM at Penn Davis McFarland. $FTRE is a recent spin off with depressed margins and 80% upside.
Idea: Fortrea is a massively under-earning business spun out from Lab Corp in June of 2023 which is now being led by a top leader in the CRO industry. The author views this as a classic spin-off situation, where margins are half that of peers due to lack of focus under a larger organization and transient revenue disruption from spin-off dynamics. Trading below peers on NTM valuation on a depressed margin structure, with focused execution under strong leadership in a standalone entity, Fortrea is set for 80% upside in a year.
Business description: Fortrea is a Clinical Research Organization (CRO). CRO’s help drug companies design, run, and manage clinical trials. Fortrea’s predecessor, Covance, was a pioneer in the CRO space with decades of experience. It is considered a top five CRO today and was spun out from Lab Corp at the behest of activist pressure.
Industry overview: The CRO business is attractive, with 6-9% long-term market growth driven by secular tailwinds of growing pharma R&D spend that’s increasingly being outsourced.
Thesis 1) Margins Have a Clear Path to Expansion.
Adj. EBITDA margins in 2023 are 9%, down from the 13% level achieved in 2022, and less than half that of the closest peer Icon Plc.
There are duplicate costs currently weighing on margins, as FTRE is building out its own infrastructure while still paying Lab Corp under a transition service agreement (TSA). These TSA’s will be exited by 2024. This is ~400bps of expansion potential.
There are excess SG&A costs that are currently being dealt with through layoffs and offshoring. This has not shown through yet as retention improved dramatically for the business in the quarter post-spin off but will start showing through in early 2024.
This is ~300bps of margin expansion potential.
In total, the Author is conservatively estimating 15% Adj. EBITDA margins in 2025 (leaving 100bps of cushion).
Thesis 2) Revenue Growth Should Recover.
Compounding the margin issue, revenue has been impacted by customers temporarily moving to the sidelines while the company was preparing for its spin off. Book-to-bill was 0.6x in 2Q23 as a result of these temporary spin concerns. Book-to-bill has returned to industry leading levels of 1.2x. This should flow through to M-HSD revenue growth in 2H24, that the Street is not modeling.
Thesis 3) Fortrea Has Strong Management.
CEO Tom Pike has the track record to see this through. In January 2023, Tom Pike was hired as the CEO of Fortrea ahead of the 3Q separation. He previously led industry bellwether Quintiles through its May 2013 IPO and, three years later, its acquisition by IMS Health for $9 billion (subsequently renamed IQVIA). His track record at Quintiles was consistently good. As Tom put his new team in place to lead the independent Fortea, he brought back many of his former Quintiles colleagues.
Valuation.
As the company gets its cost structure in order, $FTRE will be able to get EBITDA margins from 9% in 2023 (guidance) to industry benchmarks of 15-20%. Assuming the top-line grows low- to mid-single digits and margins conservatively get to 15%, by 2025 Fortrea should be doing around $3.3 billion in revenue and roughly $500 million in EBITDA.
Peers trade at >13x EBITDA, which would be $6.5 billion in EV (on 2025 EBITDA) and ~$5 billion in market value, which gets FTRE into the mid-$50s on a fundamental basis. That is ~80% upside from current levels.
To read the full thesis, leave a comment with your thoughts/questions, or DM with the author of this post, apply to Savant Investors today.