Danaher: How To Benefit From A Yield Booster And Potential Arbitrage Profit

Summary:

• In 2019 and 2020, Danaher Inc. issued mandatory convertible preferred stock. The former DHR.PA was converted in April 2022 and the latter DHR.PB is due for conversion in April 2023.
• DHR.PB offers an implied temporary dividend yield of 4.16% p.a. for those looking to establish a position in DHR stock, and occasionally a small but nice arbitrage opportunity.
• Given the considerable spread between DHR and the Threshold Appreciation Price of $199.68, the downside risk is de facto irrelevant. Also, the final dividend payment has already been announced.

Introduction

Danaher Corp. (NYSE:DHR), the life sciences, diagnostics and environmental analytics conglomerate, is an impressive company – no question about it. I covered the stock extensively in mid-December 2022, noting its renowned profitability, management’s knack for acquisitions and secular tailwinds for the industry. While Danaher stock rightly commands a premium valuation, I still found the expansion of valuation multiples over the years to be quite excessive. The ongoing bear market has brought DHR’s valuation at least somewhat back into proportion – the stock is about 25% down from its all-time high – but not enough to make it a compelling long-term investment, in my opinion.

Of course, I may have been too conservative with my assessment, considering that Danaher typically generates solid synergies from its acquisitions and exploits lock-in effects among some of its business units. So I found the recent news that Danaher is interested in acquiring contract manufacturer Catalent, Inc. (CTLT) quite interesting. Putting myself in the shoes of an investor who plans to buy shares of Danaher at the current level, I think it might be worth taking a look at its preferred stock.

Danaher successfully completed the offering of its 4.75% Series A Mandatory Convertible Preferred Stock in March 2019. The shares converted to common stock in April 2022. Danaher conducted a second round of financing in the midst of the pandemic, offering approximately 10 million shares of common stock and 1.7 million shares of 5.00% Series B Mandatory Convertible Preferred Stock (NYSE:DHR.PB).

In this article, I will discuss the strategy of establishing a long position in Danaher common stock via the Series B preferred stock. I will explain the – almost certain – conversion scenario, highlight the potential gains, and the key risks relevant to such an endeavor.

Brief Explanation Of DHR.PB Preferred Stock

The prospectus explaining the details of Danaher’s currently only available preferred stock was issued on May 11, 2020. Briefly, the company issued approximately 1.7 million shares of no par value preferred stock at a price of $1,000 (proceeds to DHR of $970 after underwriting discount) and an annual coupon of 5.00%, payable in quarterly installments in January, April, July and October. The company has the right to deliver shares of common stock or a combination of common stock and cash in lieu of a 100% cash payment. The mandatory conversion is expected to occur in mid-April 2023, but holders have the right to convert early (page S-39 et seq. of the prospectus). The conversion rate is floored at 6.1349 DHR shares, and there is a cap of 5.0081 shares based on DHR stock’s Applicable Market Value to be determined over a settlement period of 20 days prior to the conversion date. Danaher will not issue fractional shares and therefore will pay the difference in cash (page S-44 of the prospectus).

At the time of this writing, only one dividend payment remains outstanding – payable in April. DHR.PB is currently trading at $1,201 per share, so the implied dividend yield is 1.04%, or 4.16% annualized. The question now is whether it makes sense to buy DHR indirectly via DHR.PB and collect a small premium that nevertheless equals almost ten times Danaher’s current dividend yield on an annualized basis. Danaher’s board of directors has already approved the final $12.50 cash dividend per share, so there is de facto no risk that the company delivers DHR stock instead.

Analysis Of The DHR.PB Conversion, Profit Potential, And Risks

Page S-11 of the prospectus notes the barriers of DHR’s Applicable Market Value. The Initial Price determined prior to the offering of the preferred stock is $163 and the Threshold Appreciation Price is $199.68. If DHR’s Applicable Market Value is above the threshold, holders of DHR.PB will receive 5.0081 shares of DHR stock. If DHR’s Applicable Market Value falls below $163 (a decline of more than 33% from DHR’s closing stock price on March 14, 2023), holders will receive 6.1349 shares (page S-44 et seq. of the prospectus). Figure 1 shows the entire conversion profile of DHR.PB as a function of Danaher’s stock price between $100 and $260.

Anti-dilution adjustments apply, but I doubt they will be significant – after all, DHR.PA holders received 6.6632 DHR shares in 2022, compared to the minimum conversion ratio of 6.6368 shares (page S-15, DHR.PA prospectus) – a difference of only 0.4%.

Based on today’s closing price ($1,201), DHR.PB holders would receive 5.0081 DHR shares for each preferred share, valuing the common stock at $239.8, so a 2.1% arbitrage profit on top of the dividend payment due in April. This is represented by the intersection of the green and blue lines in Figure 2 just below the red line. Of course, the closing price of the stock is probably not 100% relevant and should be considered as an example, but there are intraday opportunities where DHR.PB trades at a modest implied discount to DHR.

Applying the conversion criteria to the historical share price of DHR.PB, we get the trajectory of DHR’s implied share price (Figure 3). In my view, DHR.PB preferred stock is currently a good way to build a position in DHR and, along the way, earn a dividend payment of $12.5 per share payable in April and potentially a small but still nice arbitrage profit.

Of course, the main risk is liquidity, but this is very manageable. If I were currently interested in opening a long position in DHR, I would only do so with a tight execution limit on my DHR.PB order – or with a strategic limit to take advantage of the heightened volatility due to renewed uncertainty following the collapse of SVB Financial Group (SIVB). A market order should be avoided at all costs. For illustration purposes, I have included the daily volume in Figure 3 (green bars). Beyond that, I don’t think the approach is overly risky, but as always, you should consider this article as a first step in your own due diligence. Given the substantial spread between DHR’s current price and the Threshold Appreciation Price of more than 22%, I seriously doubt that DHR.PB’s conversion profile in the sub-$199.68 region will come into effect. Other risks are described on page S-18 et seq. of the prospectus.

Conclusion

In the process of conducting deeper research on Danaher Inc., I came across its preferred stock DHR.PB. It currently offers a compelling opportunity to capture a dividend payment of $12.5 per share payable on April 17, which equates to an annualized yield of over 4%, and potentially a small but still nice arbitrage profit. Following the conversion, prospective holders of DHR will be entitled to receive the regular quarterly common stock dividend of $0.27, already taking into account the 8% increase announced in February and representing an annualized dividend yield of 0.44%.

I still rate both DHR and DHR.PB as Hold, as my thesis on Danaher stock and my desired purchase price have not changed. However, from a risk-reward perspective and assuming I would be interested in building a long position in DHR at this time, the path via DHR.PB looks compelling due to the upcoming preferred stock dividend and arbitrage potential.

However, as always, please consider this article as a first step for your own due diligence. Although DHR.PB trades on the NYSE, the average volume of 9,600 shares per day is not what I would call highly liquid. There are days when not a single share is traded, so avoiding a market order and instead placing a strategic limit order is paramount.

Thank you for taking the time to read my article. Regardless of whether you agree or disagree with my conclusions, I always welcome your opinion and feedback in the comments section below. And if there is anything you would like me to improve or expand upon in future articles, drop me a line as well.

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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The contents of this article and my comments are for informational purposes only and may not be considered investment and/or tax advice. I am neither a licensed investment advisor nor a licensed tax advisor. Furthermore, I am not an expert on taxes and related laws – neither in relation to the U.S. nor other geographies/jurisdictions. It is not my intention to give financial and/or tax advice and I am in no way qualified to do so. I cannot be held responsible and accept no liability whatsoever for any errors, omissions, or for consequences resulting from the enclosed information. The writing reflects my personal opinion at the time of writing. If you intend to invest in the stocks or other investment vehicles mentioned in this article – or in any form of investment vehicle generally – please consult your licensed investment advisor. If uncertain about tax-related implications, please consult your licensed tax advisor.

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