A new agreement between Cerner and activist investor Starboard Value was seen as welcome news by many financial analysts as a plan to increase the company's profitability.
The news — which included Cerner allowing Starboard to name four members to its board and the authorization of a $1.2 billion stock buyback — almost immediately buoyed Cerner's stock to jump 10.3% on Tuesday.
But some analysts question whether the changes and activist involvement will be enough to improve the EHR giant's operating performance and address "structural problems."
"I am not super optimistic that activist will result in anything more than financial engineering," Andrew Freedman, managing director at Hedgeye Risk Management told FierceHealthcare. He noted a number of structural problems facing Cerner, notably slowing EHR demand, margin headwinds from services and cultural problems.
During its annual earnings call in February, Cerner reported it had missed revenue and earnings expectations despite an increase in bookings. Cerner reported $774 million in operating earnings for its fiscal 2018, down 19% from 2017, and $5.4 billion in revenue, up 4% from 2017.
During that call, CEO Brent Shafer, who took the helm only a year ago, made promises that the company had plans in place to increase profitability and predictability.
Cerner will now be taking strategic direction from an investment firm that only owns 1.2% of its outstanding shares. As part of the agreement with Starboard, Cerner said it will also increase its margin targets.
Cerner’s board approved the expanded stock repurchase program to enable the company to buy back $1.2 billion of its common stock. Cerner said it will fund the repurchase program with cash from operations and by issuing debt.
Freedman said activist involvement was "inevitable."
"With the stock underperforming for the last three years, and new CEO in place and Cliff (Illig) off the board, activists seem to see that as an opportunity to ask for more," he said. Illig, Cerner co-founder and vice chairman, resigned in January.
As part of the agreement, Cerner also will establish a new finance and strategy committee to oversee operational and financial improvement initiatives and is launching a comprehensive portfolio review to assess the efficiency of its product offerings.
"Establishing an independent oversight committee is a smart idea to hold management accountable, something the company has struggled with for some time," Freedman said.
According to Bloomberg, following the news, Cerner’s shares rose as much as 16%, the biggest intraday gain since October 2012. The stock is up 3.3% in the last 12 months, sharply lagging the 58% rise in the S&P 500 Health Care Index, Bloomberg reported.'
Cerner said it will increase its adjusted operating margin target to 22% for the fourth quarter this year and 22.5% for the fourth quarter of next year. The company is looking to make other operational improvements by eliminating the president role, changing executive responsibilities and finding opportunities to operate more efficiently.
In February, Cerner initiated a dividend and announced a soft plan for operating margin expansion as part of a shift in capital allocation strategy.
Healthcare IT analyst Richard Close, with Canaccord Genuity, told FierceHealthcare he was encouraged by the agreement with Starboard and that the moves build on the company’s previously announced efforts to improve operational performance.
“We previously commended the company in initiating a dividend and were optimistic that a renewed focus on re-accelerating revenue growth and margin improvement could jump-start the stock price and potential returns for investors,” Close said. “This announcement further solidifies that the management is focused on driving shareholder returns while also delivering on commitments to existing and potential client partners.”
Investment bank Evercore’s analysts said Cerner’s path to 20% margin by the fourth quarter of this year appears “possible/reasonable” while the 2020 target “looks aggressive.”
The hedge fund Starboard Value is run by Jeffery Smith and its 1.2% stake in the company makes it one of the company’s top-20 holders, according to Bloomberg.
It's not the first time in recent history an investor has put such visible pressure on a healthcare company to make changes.
Notably, health IT company Athenahealth experienced a massive shakeup after activist investor Elliott Management took a 10% stake in the company in May 2017. Elliott subsidiary Evergreen Coast Capital and private equity firm Veritas Capital bought Athenahealth for $5.7 billion last year.
Freedman believes Starboard's involvement could lead to a similar big shakeup at Cerner. "A private equity takeout would be the most likely option," he said.
As part of the “board refreshment” plan, the four new directors joining Cerner’s board are John Greisch, former president and CEO of Hill-Rom Holdings; R. Halsey Wise, former chairman and CEO of MedAssets; Melinda Mount, former president of Jawbone and George Riedel, former chairman and CEO of Cloudmark and a former senior partner of McKinsey & Co.
Starboard Value executives said in a statement the new board members would bring “fresh perspectives and added expertise” to the board.
“I, along with our entire Board and leadership team, have been reviewing Cerner’s operational and financial performance to identify opportunities to unlock the Company’s significant potential,” said Brent Shafer, chairman and CEO of Cerner, in a statement.
“We are focused on effectively implementing a refined operating model to improve efficiency and profitability, while also innovating at scale for our clients and preparing Cerner for its next phase of growth and shareholder value creation. We are committed to delivering significant operating margin improvement and returning capital to our shareholders while maintaining an unwavering focus on delivering value to our clients," Shafer said.
“We are pleased to have reached this agreement with Cerner, which includes a meaningful refreshment of the Board, as well as important steps towards implementing operational improvement initiatives that will drive profitable growth,” Peter Feld, managing member of Starboard, said in a statement.
Denis Cortese, M.D., emeritus president and chief executive officer at the Mayo Clinic, will retire from the board at the end of his term.
Nine directors on the enlarged 10-person board will be independent after the company’s annual shareholder meeting this year. Cerner has refreshed more than half of its Board since 2017, according to the company.