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Danaher Corporation (DHR)

Danaher is a life sciences, diagnostics and biotechnology powerhouse with global scale and a long runway to grow revenues and earnings. While we have long followed Danaher, there were four main reasons that we initiated an investment in the fourth quarter.

First, the significance of Danaher’s transformation is underappreciated. Beginning in 2004 with the acquisition of the Radiometer diagnostics business and culminating on September 30, 2023 with the spin-off of the Veralto environmental business, Danaher has transformed from a hodge podge of niche industrial manufacturing businesses into a focused science and technology powerhouse. In each stage of this transformation, Danaher followed its proven playbook that has created meaningful shareholder value over the last four decades. Adjacent businesses were entered through the purchase of an anchor asset with new capabilities and scale within a specific niche. Product offerings were expanded organically, and continuous improvements in business operations provided free cash flow growth which fed bolt on acquisitions and acquisitions into adjacent markets which started the flywheel all over again. Following spin outs of the industrial business Fortive in 2016, the dental business Envista in 2019, and the environmental business Veralto in 2023, Danaher is now a higher quality, more economically resilient business with eighty percent recurring revenues and meaningful long term growth drivers.

We have a penchant for businesses with high recurring revenues, and in Danaher’s case they are a key part of the step up in business quality. Recurring services and consumables business fosters a customer feedback loop in which ingrained touch points provide continuous insight into both articulated and unarticulated customer pain points. While much has been written about the historical value creation mechanism inherent in the continuous improvement culture espoused by the Danaher Business System, we think that the recurring revenue supported customer feedback loop and the resulting continuous improvement in customer value proposition are the most underappreciated and powerful of new Danaher’s enduring value drivers. Central to Danaher’s ingrained customer feedback loop are the four thousand field service agents that work onsite with customers in more than one hundred countries. These field agents are deeply ingrained in all aspects of customer business processes beginning with preclinical research and continuing all the way up to building customers’ actual production facilities and scaling manufacturing. In understanding and anticipating customer needs at all times, field service agents then tap into Danaher’s deep bench of scientists and technical resources to solve articulated and unarticulated problems. This research and development partnership nurtures customers through the development process, during which Danaher designs customized consumable products into production processes. These designed in products provide little revenue at the time, but when customers scale up for large trials and commercial manufacturing, Danaher has set the standards (regulatory validation makes it unsafe and non-economical for customers to switch suppliers) and facilitated the drivers of future revenue growth. While its virtue is most often trumpeted in high technology investing, companies that can get protocols designed into the standards of a market then control its future direction. The extent to which Danaher is ingrained in customers’ daily workflow provides a constantly growing platform of opportunities for durable revenue growth as they shape the direction of these new markets. We believe that nearly all of these aspects of Danaher’s business transformation are underappreciated and undervalued.

Second, Covid 19 has created a situation where what short term investors perceive as weakness in actuality begets a great strength. A surge in pandemic induced demand lifted Danaher revenues in 2021 and 2022, and just as demand was normalizing, a surge in interest rates caused customer Chief Financial Officers to scrutinize inventory as they worked to squeeze their working capital. While short term investors are focusing on this one-time pressure on revenues, we see this as a situation not unlike a technology company undergoing a transition from perpetual licenses to subscription software. In such transitions, temporary revenue headwinds pressure valuations while the business quality and the earnings stream are improving. Since the onset of the Covid 19 global pandemic, Danaher has leveraged a surge in bioprocessing demand to increase the installed base of its molecular diagnostics workstation by over 50,000 units (an increase in the installed base of 250%). In a razor and razor blade business such as this, the value that accrues is from the lasting annuity inherent in the servicing and the growing menu of high margin tests that drive recurring earnings growth, not from the top line benefit (and now normalization) of hardware sales. By placing molecular diagnostic workstations in the hands of point of care practitioners, Danaher grows the addressable market of customers, increases the number of use cases, and creates a larger pipeline from which to introduce new ancillary products. While shorter term investors are focused on the revenue headwinds from Covid demand normalization, we see a return to double digit revenue growth backed by increasing recurring revenue, strengthening customer relationships, growing earnings power and free cash

flow, and a strengthening and lengthening of competitive advantages and competitive advantage periods.

Third, Danaher’s end markets are supported by several reinforcing long term secular tailwinds. First among these secular tailwinds is the shifting standard of care in medicine from traditional (chemical reaction synthesized) pharmaceuticals to biologically produced medicines. Biologically produced medicines are exponentially more complex in their production requirements because single cells must be modified to produce specific proteins. Given the fragility and size of a single cell, protein production requires personalized workflow requirements for food, chemicals, virus inactivation, purification, and chromatography. It is within these personalized workflow requirements where Danaher’s research and development partnerships and standard setting shines. Danaher has established the broadest and deepest designed in presence in over ninety percent of all approved monoclonal antibodies (the largest class of

biologics), and in the thousands of biologic and genomic based therapies in development. This designed in presence provides a path to meaningful earnings growth as Danaher sets the stage to industrialize biologic production. The historical fact pattern from the beginning of the biotechnology industry provides an illustrative example of how we see this process unfolding. In the beginning of the biotechnology industry, the potential of protein therapeutics was known, but businesses lacked the expertise to develop and manufacture them. The potential of protein therapeutics was only met when the industry converged onto a consensus platform and fed-batch bioreactors enabled the transfer of processes from the laboratory to the manufacturing plant. As it relates to biologic medicine, Danaher is industrializing production by linking a

common operating system to enable plug and play interoperability. The plug and play interoperability at the core of this operating system is enabled by single use consumables. Historically, batch production in stainless steel equipment necessitated high upfront investment and high operating costs. With single use consumables, biomolecule production can be done with low upfront investment, allowing for flexibility to produce specialized volumes. In enabling flexibility for localized manufacturing in smaller plants with shorter cycle times, Danaher unlocks customer savings in infrastructure costs and ongoing cost of goods sold. Driving down costs for customers then helps the biomolecule market grow as increased affordability drives increased reimbursements in Western markets and creates room for cost plus applications in non-Western

markets. As Danaher drives customer cost savings and industry growth, positioning recurring services and consumables revenues in the middle of its entrenched customer feedback loop sows the seeds of future innovation. Tailwinds of standard of care transitioning to biologics, the industrialization of biologics, and the industry transition to single use production methods are all reinforced by a high volume of biologic drugs coming off patent. As these biosimilars aid in driving down the cost curve and enabling global penetration and production capacity growth, the secular tailwinds supporting mix and market growth only strengthen.

Fourth, Danaher’s durable competitive advantages and the size and growth trajectory of life science, diagnostics, and biotechnology markets provide a long pipeline of high return on invested capital opportunities. When we assess the sustainability of value creation in a company’s growth curve, the size and duration of the runway of excess returns are of paramount importance. A great company should be able to source low-cost capital that it can then use to invest in profitable growth opportunities that are not quickly competed away. In perfecting continuous learning curve advantages to drive low-cost production, Danaher has a thirty-year record of free cash flow exceeding net income. This prodigious internally generated cash

flow then provides low-cost capital to feed a growing pipeline of new products that provide the picks and shovels to the life sciences, diagnostics, and biotechnology industries. Ingrained customer relationships and the inherent protection of standard setting and patents provide a competitive advantage period that we believe is underappreciated. In size, rate of growth, and barriers to entry, there are perhaps no better positioned markets than those in life sciences, diagnostics, and biotechnology, and within these end markets, there is no company better positioned than Danaher.

In Danaher, we see an underappreciated business transformation, a strengthening in competitive

positioning, growing secular tailwinds, and a long runway to reinvest in protected, profitable growth opportunities.


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