Cardinal Health board reaction could pave way for activist fund Elliott to create value – Reuters


Jose Luis Pelaez Inc | Digital vision | Getty Images Company: Cardinal Health (CAH) Company: Cardinal Health is a pharmaceutical distributor, a global manufacturer and marketer of medical and laboratory products, and a provider of data and performance solutions for healthcare facilities. The company operates through two segments: (i) pharmaceutical and (ii) medical supply and distribution. The pharmaceutical segment has revenue of approximately $165 billion (91%) and the medical segment has revenue of approximately $16 billion (9%). The company is the smallest of the three largest drug distributors (which together account for 90% of the market), behind AmerisourceBergen and McKesson. Market Cap: ~$19M ($69.89/share) Activist: Elliott Management Ownership Percentage: n/A Average Cost: n/A Activist Comment: Elliott is a very successful and astute activist investor, especially in the technological sector. His team includes analysts from leading technology private equity firms, engineers and operating partners. When evaluating an investment, they also engage specialist and general management consultants, expert cost analysts and industry specialists. They often look at companies for many years before investing and have an impressive pool of board candidates. What is happening? On September 6, Elliott and the company entered into a cooperation agreement, pursuant to which Cardinal agreed to nominate the following four candidates to the board of directors and propose them for election at the 2022 annual meeting : (i) Steven K. Barg, Global Head of Engagement, Elliott Management; (ii) Michelle M. Brennan, President of the Connect Healthcare Council for Pioneering Collective and Member of the Board of Directors of Coupa Software; (iii) Sujatha Chandrasekaran, independent advisor and consultant in the research and technology sectors; and (iv) Christine A. Mundkur, former CEO and non-voting chairman of the board 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. In addition, 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 participate. Elliott has agreed to comply with certain customary voting and standing quo provisions. Behind the scenes Cardinal is a company made up of two companies with no real synergies. The pharmaceutical business is one of three businesses in an oligopoly and is growing faster than its peers, increasing revenue by 14% last year. Pharmaceutical peers trade at 10-11x EBITDA, while Cardinal trades at just 8x EBITDA. This is due to operational problems and errors, especially in the medical segment. They made the mistake of pouring money into this segment through acquisitions, but were never able to capitalize on these assets. Today, this segment generates roughly $16 billion in revenue, but was unprofitable in the last quarter after historically posting up to $800 million in EBITDA. There are several opportunities for value creation here. This should start with the sale of some non-essential assets. In the pharmaceutical sector, Nuclear and Precision Health Solutions is a market-leading independent asset 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 companies after the company missed EPS guidance for six consecutive quarters. However, all these initiatives must be done with a reconstituted city council. That 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 notice or communication, and the board promoted the CFO to CEO. Meanwhile, Hollar never worked in health care before Cardinal, where she has only been for 2.5 years. He was most recently CFO of Tenneco, an auto parts company, and before that of Sears Holdings. One of the main functions of a board of directors is to analyze and carry out the succession of the CEO. Looks like the Cardinal board just called this one. Hollar may be the right CEO for the company, but such a transition should only happen after a thorough vetting process. Also, internal CEO succession generally makes more sense for a company that is doing well and whose leader is ready to retire, rather than for an underperforming company that is abruptly parting ways with their leader The other option, and perhaps the best, for this business is a strategic review. Last year, a group of private equity firms came together to buy Medline Industries, a direct competitor to Cardinal’s medical business, for $34 billion. At $20 billion in revenue, Medline is slightly larger 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. Also, at the 10-11x EBITDA multiple achieved by Cardinal’s pharma peers, its pharma division’s $2 billion EBITDA could be worth about $20-22 billion, putting the division at negative value medical Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and is the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of 13D activists. Squire is also the creator of the AESG™ investment category, an activist investment style focused on improving the ESG practices of portfolio companies.
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