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Company: Cardinal Health (CAH)
Business: Cardinal Health is a distributor of pharmaceuticals, a global manufacturer and distributor of medical and laboratory products, and a provider of performance and data solutions for health-care 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 top three largest drug distributors (who together make up 90% of the market), behind AmerisourceBergen and McKesson.
Stock Market Value: ~$19B ($69.89 per share)
Activist: Elliott Management
Percentage Ownership: n/a
Average Cost: n/a
Activist Commentary: Elliott is a very successful and astute activist investor, particularly in the technology sector. Their team includes analysts from leading tech private equity firms, engineers and operating partners. When evaluating an investment, they also hire specialty and general management consultants, expert cost analysts and industry specialists. They often watch companies for many years before investing and have an extensive stable of impressive board candidates.
On Sept. 6, Elliott and the company entered into a cooperation agreement, pursuant to which Cardinal agreed to appoint the following four director nominees to the board and nominate them for election at the 2022 Annual Meeting: (i) Steven K. Barg, global head of engagement at Elliott Management; (ii) Michelle M. Brennan, chair of Connect Healthcare Council for Pioneering Collective and board member of Coupa Software; (iii) Sujatha Chandrasekaran, an advisor and independent consultant in the research and technology sectors; and (iv) Christine A. Mundkur, former CEO and non-voting chairman of the board for Impopharma, a developer of complex formulations focused on inhalation pharmaceutical products. The company expanded the size of the board from 11 to 15. Following the 2022 annual meeting, incumbent directors Dean Scarborough and John Weiland will resign, and the board will be 13 members. Additionally, Cardinal 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 there. Elliott agreed to abide by certain customary voting and standstill provisions.
Behind the Scenes
Cardinal is a company that consists of two businesses with no real synergies. The pharmaceutical business is one of three companies in an oligopoly and is growing faster than its peers, increasing revenue by 14% last year. Pharmaceutical peers trade at 10 to 11 times EBITDA while Cardinal is trading at just 8 times EBITDA. This is because of operational issues and missteps, primarily in the medical segment. They made the mistake of sinking money into this segment through acquisitions but were never able to operate those assets. Now this segment has about $16 billion of revenue, but was unprofitable this past quarter after historically having up to $800 million in EBITDA.
There are several opportunities for value creation here. This should start with selling off some non-core assets. In the pharmaceutical business, Nuclear and Precision Health Solutions is an unrelated market-leading asset that could be spun off. In the medical business, Cardinal Health at-Home Solutions, which the company bought a decade ago, has grown well and is in a ripe market for acquisition. This could give Cardinal cash to fix up the two businesses after the company has missed EPS guidance six quarters in a row.
However, all of these initiatives should be done with a reconstituted board. That was made clear in August when Cardinal announced that Mike Kaufmann (who had a 30-year tenure at the company) was stepping down as CEO and would be succeeded by CFO Jason Hollar. The move came with no warning or communication, and the board promoted the CFO to the CEO position. Meanwhile, Hollar has never worked in health care before Cardinal, where he has been for only 2.5 years. He was most recently CFO at Tenneco, an auto parts company, and at Sears Holdings before that. One of the main functions of a corporate board is to analyze and effect CEO succession. It appears that the Cardinal board just phoned this one in. Hollar may be the right CEO for the company, but this transition should only happen after a full search process. Moreover, internal CEO succession generally makes more sense for a company that is doing great and the executive is ready to retire, not a company that is an underperformer and abruptly parts ways with its leader.
The other, and maybe best option, for this company 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 are not implying that Cardinal’s medical division is worth anywhere near that, but Cardinal’s entire company enterprise value is only $20 billion and Medical is the much smaller division. Moreover, at the 10 to 11 times EBITDA multiple that Cardinal’s pharmaceutical peers get, its pharmaceutical division’s $2 billion of EBITDA could be worth approximately $20 billion to $22 billion, attributing negative value to the medical division.
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 13D investments. Squire is also the creator of the AESG™ investment category, an activist investment style focused on improving ESG practices of portfolio companies.