15 September 2023


Danaher was established in 1984 and initially consisted of a group of discrete manufacturing businesses.

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The underperformance of a subsidy, Jacobs Vehicle Systems (JVS), proved to be an ‘eureka’ moment for the group. JVS had been suffering from quality challenges and intensifying competition. To rectify these issues, management travelled to Japan to shadow and learn from the best in lean manufacturing at that time –Toyota Motor Corporation.

Toyota employed a business philosophy of continuous improvement, known as Kaizen. When JVS’ management applied Kaizen, the improvement in operating performance was dramatic, far exceeding expectations and made them one of the first US companies to adopt lean manufacturing.

The implementation of these practices led to the development of the Danaher Business System (DBS). Part cultural philosophy, part managerial platform - DBS drives the business through a never-ending cycle of change and improvement. Underpinning it are the four “Ps”: exceptional people develop outstanding plans and execute them using world-class tools to construct sustainable processes, resulting in superior performance. Superior performance and high expectations attract exceptional people, who continue the cycle.

This system of planning and execution remains fundamental to how the company operates today, and over time has been supplemented by growth and leadership tools. Danaher views DBS as its ultimate source of competitive advantage, allowing it to continue to improve the operations of both its existing businesses and the businesses it acquires. Over the past five years, revenue and earnings per share growth have compounded at +11% and +22% respectively. Around two thirds of its growth has been organic and the remainder has come from mergers and acquisitions (M&A).

Today, Danaher is a very different business from its start in the industrial sector. It is now a global science and technology conglomerate with more than 20 operating companies focused on biotech, life sciences and diagnostics.  The Environmental & Applied Solution division is expected to be spun off in the fourth quarter of 2023. These companies develop, manufacture and sell thousands of different products and services to many different customers, providing the group with a diversified sales base. 

Aside from their large size and high growth rates, Danaher’s decision to operate in science and technology markets is due to their fragmented nature: many niche markets and no one player dominating.

The pivot to these sectors has meaningfully improved Danaher’s business quality from debt-heavy cyclical industrials to more predictable, structurally growing science and technology companies. Supporting its growth is the biopharma industry’s increasing investment in the development and use of biologics (more targeted drug treatment), cell and gene therapies (treating inherited diseases), and molecular diagnostics (analysing the genome to identify the potential emergence of disease).

Such businesses also have good earnings visibility: over 80% of Danaher’s revenue is recurring thanks to a largely razor/razor blade business model.¹ For example, Cytiva (a business which sits in Danaher’s biotech division) sells chromatography systems – used to separate components of a mixture for chemical analysis – and generates recurring revenue from the resin needed for each use of the system.

Aside from their large size and high growth rates, Danaher’s decision to operate in science and technology markets is due to their fragmented nature: many niche markets and no one player dominating.  Such market structures allow Danaher’s competitive advantage, DBS, to have an outsized impact versus smaller peers who have neither the scale nor experience to match Danaher’s rate of innovation and profitability.

Danaher navigated into these markets with a shrewd M&A strategy. When entering a new market, Danaher typically starts with a large platform acquisition  (i.e. scaled business which is already performing well) which serves as a centre of gravity for making smaller, bolt-on acquisitions. 

When the COVID-19 pandemic hit, the biopharma industry raced to diagnose and treat the virus, massively increasing their demand for equipment and consumables: Danaher saw its organic sales rise c.44% from 2019 to 2022. What was a tailwind for the business has now become a headwind². Many biopharma firms boosted their inventory levels during the pandemic, in anticipation of more sustained demand, but with the pandemic over, they are running down their excess inventory and are reducing order sizes. This has not been helped by the rapid hike in global interest rates over the past year and a half, which has caused funding for early stage biotech firms to dry up. These headwinds have been more pronounced than even Danaher’s management had expected, forcing them to downgrade 2023 financial guidance in each of the last two quarters; consensus now expects earnings per share to decline by -18% this year. 

Although the long-term outlook for Danaher’s end markets remains encouraging, there is still uncertainty over when the near-term headwinds will ease. With a valuation of 29x December 2023 earnings, such concerns do not appear to be fully reflected within shares. 

¹ A razor/ razor blade business model is one where a product or service is sold at cost or at a low price, while a secondary product or service needed to facilitate regular use of the original product is sold at more elevated prices.
² ‘Tailwinds’ are factors or events that have a positive impact on growth in a company or sector. Conversely, ‘headwinds’ have a negative impact.

Illustration by Emily Nault

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