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Updated Analysis Following Release of Pro-Forma Numbers Ahead of Upcoming RMT

We have updated our analysis on Henry Schein, Inc. (HSIC) and its upcoming Spin-Merger of its animal health distribution segment (to merge with private Vets First Choice) to form Covetrus, Inc. (CVET), the first pure-play animal health distribution company. New filings have increased clarity on how this situation will play out, as well as revised timing for the Spin-merger.

What's Interesting? The Edge Intelligence...
In-line with previous successful animal healthcare separations like Zoetis, Inc. (ZTS, which tripled its share price in the last 5 years) and Elanco Animal Health, Inc. (ELAN, up +31.5% from its IPO price of $24 compared to the Index return of -11.8% in last 4 months to date), Henry Schein, Inc. (HSIC), a healthcare products distribution company, will perform a Reverse Morris Trust (RMT) transaction via Spinning off its high growth (FY19E growth of 8.8%) animal healthcare segment that will then merge with privately-held animal healthcare technology platform Vets First Choice to form a new listed entity called Covetrus, Inc. (CVET, Spin-merged entity). This merger will allow CVET to operate as a high-margin animal healthcare distribution business with a higher EBITDA margin profile of 7.2% in FY19E, compared to its closest peer margin profile of 4.8% in the same period.

The Edge View (HSIC)...
HSIC (Parent ex-RMT) will focus on its niche high-growth dental distribution business, which has shown the highest segmental growth (8.9% in FY17) compared to overall growth (7.9%) in the same period. As part of the RMT, CVET (Spin-merged entity) will transfer $1.1bn of cash to HSIC, which will improve its debt profile to 1.1x on a net debt to EBITDA basis for FY19E (from the current 1.9x), thereby boosting earnings through lowering its interest outflow.

Moreover, the biggest disruptor of this century Amazon, Inc. (AMZN) already sells dental supplies on its platform but is still far from selling dental devices (the space in which HSIC is currently a leader in North America with a market share of 35-40%). AMZN is investigating a bigger foray into the healthcare distribution space in collaboration with Berkshire Hathaway and JP Morgan. We see HSIC (ex-RMT) as a potential acquisition target that will provide AMZN an instant leadership of the US dental distribution market and access to entire portfolio of HSIC’s intellectual properties.

The separation will allow HSIC (ex-RMT) to focus on its niche high-growth dental distribution business, where HSIC is currently the market leader (market share of 35-40% in North America). Furthermore, we believe HSIC’s inorganic growth remains strong with 25 acquisitions in the last 5 years, especially on the technology side (with 14 acquisitions), which is a higher-margin business (EBITDA margin: 32.9% compared to dental and medical margins of 7.6%). Additionally, HSIC’s FY19E leverage will fall to 1.1x on net debt to EBITDA (from current 1.9x) through this RMT, thereby boosting near-term cash-flow. We believe this increased cash flow will be utilised to further enhance its existing market leadership and bring additional growth to the company in the near-term. As mentioned above, HSIC (ex-RMT) is a potential acquisition target by AMZN in the long-term as it will provide AMZN an instant market leadership in the dental distribution space.