Danaher (DHR) is on the verge of divesting its environmental-and-applied solutions segment, and the Club holding’s potential to deliver returns for shareholders is stronger than ever before. These returns can come from two sources: Danaher stock and shares of Veralto (VLTO), the soon-to-be-independent company specializing in water quality. We believe that Danaher is undervalued and that Veralto has a favorable outlook after its spin-off. When we receive Veralto shares on Monday, we plan to keep them based on their current expected value.
Danaher has been attracting attention in recent weeks, with Jim Cramer recommending its stock as a buy during the Club’s September Monthly Meeting. This week, the spin-off process reached a significant milestone, as a “when-issued” market was established for both Danaher and Veralto stock. This market provides an initial indication of how investors are valuing the two companies independently. The initial indications suggest that Danaher is currently undervalued, which adds to its potential for upside once the market recognizes its status as a faster-growing, higher-margin firm.
The spin-off transaction follows a traditional playbook, with investors receiving one share of Veralto for every three shares of Danaher they own. This tax-free maneuver allows Danaher to focus on the life sciences industry, while giving Veralto management the autonomy and flexibility to run and invest in the company. In our case, once the spin is complete, Jim Cramer’s Charitable Trust will continue to own 520 shares of DHR and will also own 173 shares of Veralto.
According to the “when-issued” market, Danaher is expected to trade slightly above $220 per share on Monday, while Veralto is anticipated to open at $84.65 per share. This suggests that Danaher is undervalued compared to a Wells Fargo analysis earlier this month, which valued Danaher at $252 per share. The analysis stated that if Veralto were to trade at $85 per share, it should lead to a $224 stock price for Danaher.
We have been arguing that Danaher should receive a higher valuation since last year when the company initially announced plans to spin off its water business. We believe that a faster-growing company with stronger margins deserves a higher multiple. Additionally, Danaher’s pending acquisition of Abcam should further enhance its growth-and-margin profile. Mergers and acquisitions are part of Danaher’s value-creation strategy, and the ongoing transformation of its portfolio aligns with what has worked for investors in the past. While value creation will take time, we remain long-term investors in the life sciences firm.
If Veralto maintains its price level of around $85 per share on Monday, we plan to retain our investment in the near term. However, spin-off debuts can be volatile, and if Veralto shares experience a significant increase, we may consider capitalizing on that and taking profits. Nevertheless, when examining Veralto’s fundamentals alone, we find plenty to like. Under Danaher’s ownership, both of Veralto’s units – water quality and product quality & innovation – have demonstrated mid-single-digit organic revenue growth over the long term. Moreover, Veralto’s products and services have far-reaching impact on everyday life, from disinfecting municipal water supplies to printing expiration dates on food packaging.
The water quality unit contributes about 60% of Veralto’s $5 billion revenue as part of Danaher. Over the past three years, Veralto has consistently generated free cash flow conversion of over 100%, indicating efficient cash generation. Once Veralto becomes an independent entity, it will have more flexibility to execute mergers and acquisitions, similar to Danaher’s value-creation strategy. Some Wall Street analysts view Veralto optimistically and anticipate upside from the market’s implied stock price of $84.65. Deutsche Bank projected a standalone equity value for Veralto between $95 and $105 per share. Based on our analysis of competitors in the water and product quality industries, we lean towards a $90-per-share target for Veralto.
Longer term, Danaher’s transformation into a pure-play life sciences firm is well-timed. It aligns with a favorable business cycle and comes after a period of post-pandemic inventory overhang and weakness from Chinese biopharmaceutical customers. While Danaher’s stock is currently attractively valued, we don’t feel obligated to choose between Danaher and Veralto. We are pleased to receive shares in a high-quality company like Veralto and plan to keep them as long as the valuation remains reasonable. However, if there is a significant price increase immediately after the spin-off, we won’t hesitate to lock in profits.
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