Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

Welcome everyone to another episode of the In Practice podcast. Today, we'll be discussing Danaher. Will, when did you first come across Danaher?

I don't even know, actually. Well, to put it this way, too late. Or maybe that's not the right way to put it. It's like I was too slow to realize its potential. I came across it, but did I really come across it?

The right answer would have been you came across it a very long time ago. I mean, we're looking at maybe, what, 10 years ago that you first set your sights on the business?

Anyone who studies, invests in, or looks at these businesses wanting to deploy capital into companies and compound them for a long time will come across Danaher at some point, right? I probably came across it more than 10 years ago. I've always been interested in niche industrial businesses, which Danaher evolved into over the last 20 years. But it's one of those businesses where I came across it, and it's probably a similar story to Constellation Software. You come across it, and it has a great track record, but I didn't fully internalize how unique the business was or is. I'm a slow learner, so it takes a while for me to fully understand and have conviction in any business, frankly.

What I found fascinating is how Danaher has evolved over various different lives over 40 or 50 years since the 1980s. I came across it probably 10 or 12 years ago and followed it loosely. Over the last five or six years, I've studied it more intensely and finally took the plunge, looking at some of the more recent acquisitions it's made over the last five years in bioprocessing and its shift to become a life sciences business today.

In parallel to that, we're also studying how this is possible. How can a company shift over time from an industrial acquisition platform in the 1970s and 1980s to becoming a leader in providing life sciences equipment? Who knows what this will become over time? What's interesting is that this company has a philosophy or framework to operate businesses, known as their DBS business system. I've spent years trying to understand how this works and how it can be applied in both tangible heavy companies like industrials or manufacturing businesses and in higher gross margin or more intangible businesses, like life sciences products and consumables. I've been loosely following it and now more intensely, still trying to understand it, to be honest.

We're going to discuss how you have been trying to understand how this business creates value, how it's evolving, and what that means for its valuation. But first, let's talk about how you consider the opportunity cost of where you spend your time. You are running the IP research first-party business and have two full-time investment analysts reporting to you, with a third joining soon. For the benefit of our existing and new subscribers, let's articulate how you allocate your time and where Danaher fits in our large and mid-cap coverage. We categorize this in the large-cap coverage bucket. Let's discuss what that means and how we think about spending our time.

I don't really think about it in terms of large and small cap necessarily. It's more about why this business is durable. Why can Danaher continue to generate over 20%v free cash flow margins for the next 10 to 15 years? This ties into the opportunity cost question, which is very important. I often think about not spending time on businesses I can't study for five to 10 years because it takes time to understand them. Building longevity into the process is crucial. You want to compound not just capital but also your knowledge in the industry. The business and the industry must be attractive for you to want to invest in them long-term.

Choosing the right business and market is critical. For Danaher, it's about the regulatory lock-in I look for in many businesses. Whether it's TransDigm and the aerospace aftermarket, underpinned by FAA regulations, manufacturing parts for commercial aircraft or military platforms, or Danaher's bioprocessing division, it's about the FDA requirements and regulatory framework. This requires heavy compliance in producing equipment and consumables for customers. That's where the opportunity cost stems from. If the regulatory moat doesn't exist long-term, it affects the durability of the return on invested capital.

How long is the regulatory lock-in going to last for Cytiva and Danaher? Additionally, what is the runway for this industry? Is the organic growth sustainable for 10, 15, or 20 years? This is attractive for study and potential capital investment. It comes down to simple math; the return on invested capital and the reinvestment rate or the organic growth rate. That's what really underpins how I choose where to spend. That could be like the same with Fever-Tree, another one that I've studied for a very long time. But I think it potentially has a long runway. It's a much smaller business, potentially a durable brand and interest in brand equity and potentially a long runway. Ultimately, it's still an implicit judgment on whether that's true or not. It still takes time to kind of understand that.

I think about opportunity costs in terms of allocating time to industries and businesses with durable returns on invested capital and a reinvestment runway for deploying free cash flow. This attracts me to holding companies like TransDigm, Danaher, Constellation Software, and Nordic companies. They focus on the simple math of building infrastructure to manage and protect return on invested capital, i.e., the underlying profitability of owned businesses, and redeploying that capital wisely over a long period. I think Danaher are, arguably, up there, with Berkshire as one of the pioneers of this and they've done it in probably the most unique way.

Danaher has transitioned from buying commoditized industrial businesses to owning the future of biologic manufacturing, including gene therapy assets. This still amazes me, and I don't fully understand it. Regarding opportunity cost, I work with analysts to ensure we're focusing on areas, companies, and markets with attractive dynamics. This includes aerospace aftermarket, vertical market software, and holding companies like Constellation and Danaher. The auto aftermarket has similar attributes with less regulatory lock-in but a similar runway.

We apply this approach to various industries, including the luxury market, which has stood the test of time for thousands of years. Opportunity cost is embedded in our implicit judgments and assumptions about a company's potential durability and redeployment rate.

Let's delve deeper into our coverage map on the site. We've categorized it into large cap and mid cap sections, as you've explained. Internally, we don't focus much on this categorization; it's just an efficient way to represent things. There's a wide range of businesses, many of which we've studied for a decade or more, and most for at least five years.

We cover everything from Markel to Netflix, CCC, and Fever-Tree. When considering what to focus on, talk about Danaher, which has been on our radar. We've been publishing since we founded IP five years ago. One of our most viewed interviews was published four years ago on the Danaher Business System (DBS).

Could you articulate your process for prioritizing a company at a given time for our community's benefit? There are around 80 companies listed as core to IP's first-party research coverage. How do you filter this on a month-to-month basis in terms of your focus?

It's marginally more professional than a monkey throwing a dart at a board, but it largely stems from the quality of the executives we can source. Ultimately, whatever is published on the platform is founded on great executives. We won't conduct work or interviews unless we find exceptional people in that space.

When and how we choose our team to find companies and executives is a good question. To be honest, it's the million-dollar question of idea generation. I follow these companies closely, so if there's a problem in the business or the equity trades cheaply based on historical measures, or there's an issue that makes it interesting, it flags on my radar.

It's a mix of how attractive the investment is today and whether we have the executives to help understand what drives the investment thesis. Whether it's mid-cap or large-cap, I don't look at it that way, but I typically have a rough list of businesses that are interesting from an investment standpoint. This list is prioritized based on market conditions, company trades, earnings, and other factors. It's never perfect, but it's based on current attractiveness and executive resources.

For companies like Danaher, which I've studied for a long time, I'm always working with our team to submit new projects and angles. For example, with Danaher, we focused on the biotechnology part, mainly the bioprocessing assets. They also have diagnostic products and cell and gene therapy businesses. The free cash flow from the bioprocessing business is being redeployed into these areas, such as cell and gene therapy companies like Aldevron and IDT.

That's the next part of the process. We spent time on bioprocessing, and now we're looking at where this free cash flow is being deployed, mainly in cell and gene therapy solutions. There's no magical way to predict what I'll cover, but I have a sense of the next few months. It changes, for example, CCC came on my radar. I've studied Copart and auto insurers for a while and finally looked at CCC. The stock hasn't done much since it was listed, and there's a potential dynamic where people might want to sell their equity in CCC regardless of performance over the next 18 months.

Another example is Just Eat Takeaway, which I've looked at on and off for years but never got comfortable with. They recently sold Grubhub, which was a thorn in their side, so we'll circle back on Just Eat and review that business next week. It's unpredictable, but it's a function of what's attractive from an investment standpoint and whether research angles can help. Sometimes there's no need for primary research. It might not necessarily aid your research process.

Exactly. Hopefully, for our audience, what comes across is an evergreen fieldwork process. We're a research-first organization with several businesses that have a track record of compounding. We're trying to figure out what the next 10 years might look like for them. We also have a category of businesses in the emerging compounder or potential compounder category. We believe there's some aspect of quality in the nature of the moat, the quality of the management team, etc. We'll try to uncover whether that quality is actually present.

On the evergreen point, it's only evergreen if the businesses are evergreen. You have to survive to study the company. That's part of the opportunity cost. We need to ask if we are studying businesses we think are durable. Let's start there.

Recently, with my work on Fever-Tree, I'm amazed at how much I continually learn about certain industries. I might not have understood how to distribute FMCG products as well as I thought. There's so much nuance in all industries and businesses. You don't need to know every single detail about every company. Some might argue that if you feel the need to know all those details, it's not a good investment opportunity, which is also true.

I've done three interviews a couple of weeks ago on Fever-Tree and probably spent 20 to 30 hours looking at it last week. The layers of nuance in distributing products on-premise and off-premise are vast. I learned so much last week, and I'm sure I'll continue to learn more. We interviewed the right people, and they were great. The compounding of the research process can be very powerful.

If I think about the times that I thought I'd done three or four, five, even six, seven calls within a short space of time on an industry and thought I kind of knew really how it worked. I've done 50, 60, even 70 calls on Fever Tree over the last five to seven years and am still learning the real nuances of selling a product to Kroger or Walmart and how they work in different states. The power of compounding knowledge is a reminder when you work on the same company for a long period. To do that, you need businesses that are evergreen.

Let's look at Danaher and how we transition from viewing this business as interesting and understanding its current intriguing phase in history, whether it's due to valuation or a major transformation, the evolution of the business might require some effort to comprehend fully. How do we transition from recognizing this interest to identifying key areas worth investigating for long-term shareholders? How do we move from that to what can we fruitfully investigate through field work?

We are investors studying and researching companies, and we publish our findings. Our goal is to focus on areas that can be fruitfully investigated through fieldwork. We often see investors exploring areas where fieldwork might not be as useful or have limited potential. How do we avoid this pitfall?

Danaher serves as a good example. Post-Covid, the main challenge with Sartorius and Danaher has been the industry's inventory levels. Depending on one's understanding of Danaher, investors might focus on destocking. They would conduct channel checks to determine inventory levels and future purchasing plans to predict when Danaher and Sartorius will resume organic growth based on the growth of biologics.

At our firm, we could conduct channel checks or interview numerous customers to gather data. However, that's not our primary focus. We've started from first principles, regardless of the destocking issue, which is more of a two to three-year cycle investment thesis.

We question why bioprocessing is considered sticky, given its integration into the FDA process and high switching costs. If we can deploy capital for 10 to 15 years at scale, we want to understand the stickiness of these products and their life cycle. While they are sticky, we also consider if new products might emerge that are superior and will be adopted in new installations or manufacturing lines.

Firstly, for us, it was about understanding why we are even looking at Danaher. There's this assumption or potential regulatory moat the company has. When you buy Cytiva, you know, chromatography resins and equipment, you pretty much cannot swap them out. It's very difficult, and therefore, you have pricing power and effectively a moat built around being specified into the manufacturing plant.

Danaher sells many other products besides chromatography resins and skids. They sell various filtration products and filters that are used across upstream and downstream processes, with different use cases and competition per filter. To understand Danaher and the durability of the business, especially in the bioprocessing segment, we need to understand the jurisdiction and how deep the regulation is.

Our research was just starting, and we didn't focus on destocking or inventory levels, which are shorter-term concerns for many investors. Instead, we approached it by understanding the business over the next 10 years. We went back to understand exactly what these assets are, as Danaher's bioprocess products are made up of products acquired from businesses 20 to 30 years ago. We looked at GE's filings when Danaher bought GE Healthcare and Life Sciences.

We also examined Danaher's acquisition of Amersham, a UK business, and Amersham's acquisition of Pharmacia, which originally owned the intellectual property for chromatography products. We dug through old Amersham filings, looked at the old product lines, and found an old Pharmacia employee who worked at Amersham and GE, and spent time with Danaher during the acquisition.

Our work on Danaher was built on conversations with two or three key individuals, mainly two people. One of them was in the business for over 30 years, originally at Pharmacia, and involved in selling both filtration and chromatography products. It wasn't too complicated at a high level; it was about going back to first principles. We focused on understanding the regulatory moat by having conversations about why these businesses are durable.

This built the foundation of our learning journey, structured to address important points like how these products are specified into a manufacturing line, how sticky they are, why they are sole-sourced and not dual-sourced, and what might change that. We also looked at the product life cycle and why Cytiva's chromatography resins have lasted 20 to 30 years with around 80% market share. We probed these questions rather than focusing on destocking issues.

As we bring today's discussion on our methods and Danaher to a close, I want to talk about how you structured the learning journey, particularly why you made the choices you did. This is with the aim of helping our subscribers and anyone interested in IP and this business understand our thinking.

Whether you have an IP account or not, you can access the Danaher Biotechnology, Cytiva, and Downstream Bioprocessing piece published on October 8. At the top right, there's an article index. We start with Cytiva's history and then proceed through a series of headers that organize the work we've been discussing for the last half hour. Could you tell us about some of the choices you think are important when curating work like this?

That's a good question. A lot of it is kind of unconscious; you're trying to get me to explain my conscious thoughts. The first part, like the Cytiva histories, should be self-explanatory. I tend to do this with every business I look at; I go back to the essence of it. This one is particularly interesting because, as I mentioned, there are three different lives of these assets before they were owned by Danaher. You had Pall, which was part of the filtration portfolio mainly owned by GE before, and we mentioned GE, Amersham, and Pharmacia for the chromatography business. It's nothing more complicated than going back and looking at where the essence of these businesses comes from.

What's particularly interesting is that, specifically for the Pharmacia business, these assets have been generating 30% plus ROEs for decades. This is not just a business that got to scale and started printing free cash flow; these have been highly profitable, high market share assets for a very long time. That gave me my research question there and then; how is this possible? There's not many other businesses that I know - Google Search maybe - that has 80%, 90% market share for 20 plus years. That was the obvious starting point.

These learning journeys, the way I think about them, is really it's a curation of the research process but the aim is to serve both people who want to get up to speed on the name or the business quite quickly, that maybe have read the filings and roughly know the companies. They see it's interesting. I want to actually learn about Danaher, the bioprocessing business from scratch.

It's also interesting for someone who owns Danaher and knows the business well. That's what's tricky about doing these; I try to write them with two audiences in mind. You can write in a way that helps people get up to speed on the company or dive deeper into it when they might not know much about bioprocessing. It should also add value to someone who really knows this business and industry well. That duality is challenging, but I try to write it so both types of investors can get value. Whether that happens or not, I'm not sure, but that's the aim.

The history part is where I start with everything, and then it's designed around what really matters about this business's durability. For example, why have core parts of Cytiva maintained such high market share for over 20 years with the ROEs we're discussing, over 30%? It's organized in a way that first looks at the history, then levels set to ensure we understand what bioprocessing and biologic manufacturing entail. We cover the various stages of upstream, downstream, filtration, chromatography, and other filtration methods. Then we get to the FDA approval process and how these products are specified into the manufacturing line, which is critical to the business's moat, stickiness, and pricing power. There are two main parts of this business; the chromatography and filtration parts of Cytiva.

We separate and examine the durability, stickiness, and product lifecycle, which I've focused on more over the past 18 months. It's important to understand how often these products evolve, as frequent changes can increase disruption. I prefer products that remain stable and are locked in, like those in the aerospace aftermarket. Once they receive FAA approval, it's difficult to change them. Bioprocess equipment shares similar characteristics.

This organization is structured in that way. The final part of the thesis potentially explains why Danaher acquired these businesses. They purchased Pall Filtration and the Amersham pharmaceutical chromatography businesses, consolidating them under the new brand Cytiva. Although they might not explicitly state it, they are likely looking to bundle filters and chromatography resins. This is because the filtration side isn't as competitive, and the technology isn't as unique as the chromatography resins.

This could be a core part of the long-term thesis here which is, are these businesses specified in for long periods of time? What are the switching costs and/or how are they better together under one roof? And that pretty much gives you like a breakdown of that learning journey that hopefully makes sense to people, not just me.

For those interested in where the next $10,000 to $20,000 of our fieldwork budget is going, we've listed further research questions for this business. We conduct these on any learning journey and at the end of any IP research piece, so you're aware of our direction and the questions we're asking. We always welcome feedback. Thank you for listening today, everyone. We appreciate it.