Corporate actions to lift Fresenius

With that in mind, one of the more interesting (if slightly confusing) situations in European markets right now is the tangled relationship between Fresenius Medical Care (DE:FMC) and Fresenius SE & Co KGaA (DE:FRE). Our interest is in the latter, the parent company of a highly diversified medical devices and services conglomerate. Why Fresenius should interest investors now is that it is the latest in a long list of German conglomerates figuring out how to generate more value for their shareholders by restructuring their operations. There is a tacit admission, even within Germany’s notoriously conservative corporate culture, that persistently low share valuations and inefficiently deployed capital are no longer acceptable.

After years of share price declines and sluggish sales growth, Fresenius the group finally seems ripe for the kind of corporate action that could deliver better returns.

The first and most obvious of these concerns the group’s handling of its prize asset, Fresenius Medical Care. For the sake of clarity, it should be noted that while listed independently on the German stock market, FMC is effectively controlled by Fresenius via a 37 per cent block holding, which is why it is also reported as a division in the parent company’s annual report, despite also declaring its own set of independent accounts.

Though unusual in the UK and US, crossholdings between nominally independent companies are more common in continental Europe and Japan. For both Fresenius the parent and its subsidiary, there is a decent argument that the current ownership structure is an obstacle. Accordingly, the future of the stake is the most obvious starting point for any corporate shake-up.  

Fresenius parent and subsidiary compared 

Source: SharePad

Prize assets on the block

There are signs that management finally accepts this premise. At the company’s recent full-year results, the chief executive Stephan Sturm announced that Fresenius wants to publicly list both its Helios division – which owns and runs hospitals in Europe and the developing world – and Vamed, which provides administrative and support services to hospitals and healthcare facilities worldwide.

Sturm also indicated he was open to offers for the group’s stake in FMC, which specialises in manufacturing and running kidney dialysis machines. If either or both of these plans come to fruition, they could start to unlock a conglomerate discount for Fresenius, particularly as shares for the listed FMC have comfortably outperformed the rest of the DAX, so far this year.

At the current share price, Fresenius’s 37 per cent stake in FMC is worth around €5.8bn (£4.8bn) – or likely large enough to require a sale to a trade buyer. This then raises the question as to who might buy it. Five of the Europe’s top 10 medical companies are German, but it isn’t difficult to imagine that the likes of Siemens Healthineers (DE:SHL), or a large US company like Johnson & Johnson (US:JNJ) would be interested in snapping up FMC’s 40 per cent share of the US kidney dialysis market. Siemens has a large US hospital market presence, for instance.

FMC has been going through a corporate overhaul of its own after a few years of underperformance exacerbated by the impact of the pandemic.

Because the company relies on salesmen physically going into hospitals to tout its products, Covid-19 regulations restricted their available face time with hospital managers, particularly in the key US market. It is also fair to say that the company had been coasting prior to the pandemic.

Removing the overhang of Fresenius’s stake is vital to improving the share price performance for FMC, and arguably for Fresenius, too. However, for the group to sell out entirely would require a high price, given FMC contributed €401mn (£337mn) of free cash to FRE’s fourth-quarter total of just over €1bn.

Steady, if unspectacular sales growth

Hail a Kabi

As the above table illustrates, Fresenius comprises four divisions with widely varying rates of growth, depending on the maturity of the underlying business. Rationalising this choppy performance is the priority for management and one course of action might be to double down on Kabi, an intravenous medicines division that sells biosimilars. These are generic versions of biopharmaceuticals – complex medicines whose patent protection has expired, such as older monoclonal antibody treatments.

Biosimilars have only begun to achieve traction in the past few years as companies which specialise in producing generic medicines – such as Ranbaxy and Dr Reddy’s – have had to tool up to produce biopharmaceuticals and gain regulatory approval for their products. As a result, the biosimilar market is expanding at 25 per cent a year, which means more companies are taking advantage of the shift to generics. The reason that Kabi focuses on intravenous medicines is because these are intended for patients who are already hospitalised. An intravenous medicine ensures better dose control and helps patients to stick to treatment plans than with home-administered oral medicines.

Kabi – which last year saw the highest rate of capital expenditure relative to revenues of any Fresenius division – looks to be the beneficiary of any changes in the group’s capital allocation.

Investment will be needed as the division faces headwinds in both the US and China, including delayed medicine launches as well as product recalls. As a result, the segment’s cash profit break-even point has been put back to 2024, although sales reached €7.19bn in 2021. Kabi now needs to reformulate and market a steady stream of monoclonal-based antibody medicines with partners like Dr Reddy’s to achieve scale and profitability.

Left out of rotation

Fresenius has always been a confusing business to unpack – somewhere between an investment fund and a direct market operator – which is why the current plans to simplify the model are so welcome. At the end of the day, the investment case comes down to the valuation and the possibility that the shares can re-rate on the back of significant corporate actions. Getting rid of the conglomerate discount alone could add up to 15 per cent to the value of the shares, based on the average discount values for conglomerates on the German market. Alongside that technical factor, it has chosen to concentrate on an area where margin expansion is possible.

Overall, the balance sheet looks financially stable. A current ratio of 1.2 indicates positive cash generation, while net annual interest payments of €504mn on a net debt pile of €23bn – all with long-dated maturities – look manageable. Currently, Fresenius is rated at eight times’ broker Berenberg’s EPS forecasts for 2023, suggesting the shares have been left out of the value rotation since the start of the year.

Any corporate actions that it now takes would work towards improving that rating and investing in areas that have the potential for growth.