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Company: Cardinal Health (CAH)
Company: Cardinal Health is a pharmaceutical distributor, a global manufacturer and distributor of medical and laboratory products, and a provider of performance and data solutions for healthcare facilities. The Company operates through two segments: (i) pharmaceutical and (ii) medical supply and distribution. The pharmaceutical segment has approximately $165 billion in revenue (91%) and the medical segment has approximately $16 billion (9%) in revenue. The company is the smallest of the three largest drug distributors (which together account for 90% of the market), behind AmerisourceBergen and McKesson.
Market value: ~$19 billion ($69.89 per share)
Activist: Elliott Management
Percentage of ownership: n / A
Average cost: n / A
Activist Comment: Elliott is a very successful and shrewd activist investor, especially in the technology sector. Their team includes analysts from leading technology private equity firms, engineers and operational partners. When evaluating an investment, they also hire specialist and general management consultants, expert cost analysts and industry specialists. They often watch companies for many years before investing and have a large stable of impressive board candidates.
What is happening?
On September 6, Elliott and the company entered into a cooperation agreement, pursuant to which Cardinal agreed to appoint the following four directors to the board of directors and propose them for election at the 2022 annual meeting: (i) Steven K. Barg, global head of engagement at Elliott Management; (ii) Michelle M. Brennan, President of the Connect Healthcare Council for Pioneering Collective and member of the Coupa Software Board of Directors; (iii) Sujatha Chandrasekaran, independent advisor and consultant in the research and technology sectors; and (iv) Christine A. Mundkur, former CEO and non-voting chair of the board of directors of Impopharma, a developer of complex formulations focused on inhalant pharmaceuticals. The company has expanded the size of the board of directors from 11 to 15. After the 2022 annual meeting, outgoing directors Dean Scarborough and John Weiland will step down and the board will consist of 13 members. Additionally, Cardinal has agreed to form a new Business Review Committee to support a comprehensive review of its strategy, portfolio, capital allocation framework and operations. The committee will be chaired by CEO Jason Hollar, and Barg and Akhil Johri will also serve on it. Elliott has agreed to abide by certain customary voting and standstill provisions.
In the wings
Cardinal is a company made up of two businesses with no real synergies. The pharmaceuticals business is one of three businesses in an oligopoly and is growing faster than its peers, increasing revenue by 14% last year. Pharmaceutical peers are trading at 10-11x EBITDA while Cardinal is trading at just 8x EBITDA. This is due to operational issues and missteps, mostly in the medical segment. They made the mistake of investing money in this segment through acquisitions, but were never able to leverage these assets. Today, this segment generates approximately $16 billion in revenue, but was not profitable in the last quarter after historically recording up to $800 million in EBITDA.
There are several value creation opportunities here. This should start with the sale of some non-essential assets. In the pharmaceutical sector, Nuclear and Precision Health Solutions is a leading independent asset in the market that could be spun off. In the medical sector, Cardinal Health at-Home Solutions, which the company bought a decade ago, has grown well and is in a market ripe for acquisition. That could give Cardinal some cash to fix both businesses after the company missed EPS guidance six quarters in a row.
However, all of these initiatives should be done with a reconstituted council. This was made clear in August when Cardinal announced that Mike Kaufmann (who had a 30-year tenure with the company) was stepping down as CEO and would be replaced by CFO Jason Hollar. The move came without warning or communication, and the board promoted the CFO to CEO. Meanwhile, Hollar never worked in health care before Cardinal, where he has only been for 2.5 years. He was most recently chief financial officer at Tenneco, an auto parts company, and at Sears Holdings before that. One of the main functions of a board of directors is to analyze and effect the succession of the CEO. Looks like Cardinal’s board just called this one. Hollar may be the right CEO for the company, but this transition should only happen after a thorough research process. Moreover, internal CEO succession generally makes more sense for a company that is doing well and whose leader is ready to retire, and not for an underperforming company that is abruptly parting ways with its leader.
The other, and perhaps best, option for this business is a strategic review. Last year, a group of private equity firms teamed up to buy Medline Industries, a direct competitor to Cardinal’s medical business, for $34 billion. With $20 billion in revenue, Medline is a little bigger than Cardinal’s business. We’re not implying that Cardinal’s medical division is worth anything but Cardinal’s total enterprise value is only $20 billion and Medical is the much smaller division. Additionally, at the 10-11 times EBITDA multiple achieved by Cardinal’s pharmaceutical peers, its pharmaceuticals division’s $2 billion EBITDA could be worth around $20-22 billion, putting a negative value on the division. medical.
Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and he is the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist investments 13D. Squire is also the creator of the AESG™ investment category, an activist style of investing focused on improving the ESG practices of portfolio companies.