Activist Elliott reaches key agreement with Charles River. Here are three ways to create value

Company: Charles River Laboratories (CRL)

Business: Charles River Laboratories is an early-stage contract research company. The company engages in laboratory animal medicine and science (research model technologies), and it has developed a portfolio of discovery and safety assessment services. The company operates in three segments: Research Models and Services (RMS), Discovery and Safety Assessment (DSA), and Manufacturing Support (Manufacturing).

Stock Market Value: $6.82B ($138.79 per share)

Activist: Elliott Investment Management

Ownership: 12.5%+

Average Cost: n/a

Activist Commentary: Elliott is a very successful and astute activist investor. The firm’s team includes analysts from leading tech private equity firms, engineers, operating partners – former technology CEOs and COOs. When evaluating an investment, Elliott also hires specialty and general management consultants, expert cost analysts and industry specialists. The firm often watches companies for many years before investing and has an extensive stable of impressive board candidates. Elliott has historically focused on strategic activism in the technology sector and has been very successful with that strategy. However, over the past several years Elliott’s activism group has grown, and the firm has been doing a lot more governance-oriented activism and creating value from a board level at a much larger breadth of companies.

What’s happening

On May 6, Elliott and Charles River Laboratories entered into a cooperation agreement in which four incumbent directors won’t seek re-election and the following four individuals will be appointed as directors: Steven Barg (global head of engagement at Elliott) and Mark Enyedy (former president and CEO of ImmunoGen) (both are known as the “investor designated directors”), along with Paul Graves (CEO of Rio Tinto Lithium) and Abraham Ceesay (CEO of Rapport Therapeutics). Additionally, Charles River agreed to appoint at least one investor designated director to each of the strategic committee, the compensation committee, and the corporate governance and nominating committee. Finally, Charles River agreed that the strategic committee will conduct a strategic review, during which the investor designated directors will be appointed to the strategic committee.

Behind the scenes

Charles River is involved in supporting early-stage drug research and development. The company discovers its own drug candidates, determines whether they have potential to be effective and whether they’re safe enough for human trials. Charles River operates through three segments: Research Models and Services (20.48% of revenue), Discovery and Safety Assessment (60.52%), and Manufacturing Solutions (19.00%). Charles River is by far the leader in pre-clinical development, with each segment of its business occupying 35% to upward of 40% market share, which is generally twice the size of the No. 2 player. The business has grown organically for years while they have simultaneously consolidated the industry through accretive and smart mergers and acquisitions. These major growth trends continued through Covid-19, which, like it did for many peers, supercharged the business as funding flooded in fueled by a growing interest in investing in new and novel science. As a result, Charles River traded as high as $460 per share in the fall of 2021.

Since then, challenges have begun to emerge. Post-pandemic, there was a pullback in pre-clinical research demand. While this pullback was more of a normalization, it still decreased the amount of funding flowing in and caused large pharma companies to reevaluate and reprioritize their pipelines, which weighed on Charles River and the sector broadly. The second challenge has been the current headlines coming out of the U.S. Food and Drug Administration and the current administration regarding the future of animal testing. Charles River’s business in part relies on animal testing and this momentum away from that has weighed on the share price. Because of these factors, the company’s shares have slumped, down 50.95%, 52.30% and 19.66% over the past 1-,3- and 5-year periods, respectively.

Amid these headwinds, Elliott Investment Management has entered into a cooperation agreement with Charles River pursuant to which the company agreed to appoint four directors following the 2025 annual meeting on May 20, including Steven Barg, the global head of engagement at Elliott. Additionally, the company agreed to initiate a strategic review. This is an exceptionally high-quality business and, as a result, there are numerous paths to shareholder value. The first does not involve operations, capital allocation, governance or any other direct function of Charles River: It is a simple reconciliation of value. The market has likely overreacted to the company’s challenges, specifically regarding the uncertainty around animal testing. While the scrutiny the industry is facing is real, it has been real for decades. But despite what headlines may imply, this transition away from animal testing is not happening overnight, rather it is going to continue to be a gradual process over decades. Not only has Charles River been aware of this shift, but it has also been at the forefront of developing alternative methods. Over the last 10 years, the number of basic mice Charles River uses in testing has been cut in half. With Charles River remaining the industry’s one-stop shop for preclinical research, leading in both animal-based and alternative solutions, this should not have the effect on them that recent market reactions have suggested.

Beyond this natural recovery, there are many ways to create value through the strategic review process, which seems like a focus for Elliott given the term of the settlement. First, an evaluation of the Manufacturing Solutions business. This segment is a hidden gem: an exceptionally high-quality business with low capital intensity that has grown revenue organically by over 10% annually for 20 years. However, it’s quite different from the core preclinical business as it’s primarily exposed to commercial manufacturing. As a result, while a consistently strong asset, Manufacturing Solutions has been out of focus for both Charles River and the market. This is exactly the type of business larger life sciences companies like Thermo Fisher, Denna and KGA would want to acquire and could fetch, at minimum, a transaction multiple in the high teens, but could likely be north of 20-times earnings before interest, taxes, depreciation and amortization given the clear cost and commercial synergies for a strategic acquirer. A sale at these levels would imply a valuation for Manufacturing Solutions at approximately half of Charles River’s current market cap, despite only representing 20% of the company’s earning power. If there were a sale of Manufacturing Solutions, it would leave behind the core preclinical business, which is in the early innings of a natural recovery and remains the clear market leader. A sale of Manufacturing Solutions at these levels would imply an approximately 5-times valuation for the remaining business, which should eventually re-rate to higher peer multiples. Proceeds from the sale could then be used to continue buying back shares at these levels and potential investments in the core business.

This brings us to the second opportunity to create value through a strategic review: the acquisition of smaller competitors. Management has historically done a great job of conducting value-accretive M&A, such as the acquisitions of Explora BioLabs and ChanTest. Moreover, the fact that Barg is going on the board is an indicator to us that strategic acquisitions will be explored. Elliott does not put one of its principals on boards unless the firm believes he or she has a relevant skillset that an independent candidate does not have. While Barg has various skills and experiences, including board representation at pharma companies like Cardinal Health and Catalent, having access to him and the Elliott team to evaluate potential acquisitions with an eye toward shareholder value is one of the largest benefits of having a hedge fund investor on the board.

Lastly, the board could explore a sale of the whole company. While this is likely not the main goal, it should not be ruled out given the business’ quality and strategic value. There is arguably no single business more mission critical to drug development globally than Charles River, having its hand in over 80% of new drugs that were approved by the FDA in the last five years, working with every large pharma company and almost every large biotech company. This reach and control make Charles River an extremely valuable strategic asset. Moreover, the company’s high cash flow generation and depreciated share price also makes it appealing to potential financial acquirers. As we have seen before, one of those financial acquirers could be Elliott. The firm is already the company’s largest shareholder with at least a 12.5% economic ownership, and it has a private equity arm that has acquired companies like this before. In fact, Elliott, along with Patient Square Capital and Veritas Capital, acquired Syneos Health in 2023. This is not a primary thesis for them, but it is a powerful and enviable tool for an activist to have the capability to acquire the company if changes are not made in the public market.

Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments.