August 31, 2009

Spin-off Idea: Cardinal Health

By end of business today Cardinal health, CAH, will spin-off its medical care division, Carefusion, CFN, and it will focus on drug distribution. The spin off is very interesting midst all the talk of health-care reform because whenever there is uncertainty it pays to go long.

The market is very hot for the CFN spin off. Although CFN accounts for only a small portion of CAH's revenue, maybe less than 7%, it makes third of its profit. The business is very high margin and its potential for growth is solid. The independent company will be able to focus on new products and free to allocate capital to R&D. But it is fully valued when the when issued shares trade at $19. I figure its value is around $20-$23.

What is interesting is the parent company. The market is betting against it. Short volume has increased significantly over the last month or so. Wagers against health-care shares rose more than 7 percent, the most of 10 groups, to 890.3 million as President Barack Obama proposed an industry overhaul. Shorts thesis is earnings will come be under pressure due to health-care reforms. May be it is true. But CAH margins will stay intact and it will be part of the solution.

Once the spin off is complete, CAH is no more than a logistics provider to drug makers. It provides supply chain services to them and have no R&D commitments. Drugs like goods funnel in and through its distribution network reaches customers. So if health-care reforms lead to reduced costs of drugs, CAH's input costs and revenue will come down in tandem. Its margins will not be affected. Sure the absolute level of revenue and earnings will decline but the company value will be still intact.

I am liking going long CAH rather than CFN, it gives better odds.

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