Tickers in this Article: CAH, WAG, CVS, ABC, MCK, OMI
Large piles of cash seem to tempt people into making bad decisions. At the corporate level, large cash balances often attract so-called "activist investors" looking for quick paydays or to embolden management into ill-timed buybacks or illogical acquisitions. That does not seem to be a problem with Cardinal Health (NYSE:CAH), though, as this large medical distributor has used almost $2 billion of its cash on hand to make a pair of acquisitions that seem to make a lot of sense.

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Kinray and Independent Pharmacies
Almost two weeks ago, Cardinal announced the acquisition of privately-held Kinray Inc for $1.3 billion in cash. A pharmaceutical distributor focused mostly on New York City and the Northeast U.S., Kinray will enhance Cardinal's exposure to independent pharmacies. While major chain pharmacies like Walgreen (NYSE:WAG) and CVS Caremark (NYSE: CVS) are a huge part of Cardinal's revenue base, the company makes a lot more money (on a margin basis) serving smaller customers, so expanding that customer base should be pretty accretive for Cardinal.

Buying Further into China ...
On Monday, Cardinal announced its latest deal - paying $470 million in cash (and assuming $60 million in debt) to acquire Zuellig Pharma China. Part of Zuellig Pharma (which in turn is part of the even larger Zuellig Group), Zuelling Pharma China is one of the largest distributors of pharmaceuticals and medical devices and supplies in China. Serving over 123,000 independent pharmacies and 49,000 provider locations, this Zuellig buy certainly enhances Cardinal's scale in what is almost sure to be a major market for medical distribution for some time to come. (For more, see Top Factors That Drive Investment In China.)

... But at a Price
While the "expand into China" thesis certainly makes a great deal of sense at the surface level, this buy is not without some risks to Cardinal.

First, nearly all of the information that is coming out on this deal is coming from Cardinal itself - virtually all of the initial analyst reports talking about the deal are repeating the information that Cardinal itself provided about Zuellig and the Chinese market opportunity. That is not altogether surprising as the Chinese medical distribution market is not easy to observe (a very large number of the major participants are private or otherwise difficult to research), but it makes rosy talk of details like 20%+ potential growth a little harder to independently verify.

Moreover, Cardinal is paying up for this deal. Normally, paying 0.5 times trailing revenue for a growing $1 billion-plus business would seem like a no-brainer. Distribution, though, is a low-margin business and the going price/sales multiple for Cardinal and rivals like AmerisourceBergen (NYSE:ABC), McKesson (NYSE:MCK) and Owens & Minor (NYSE:OMI) ranges from 0.11 to 0.23. Even allowing that, China is far more of a growth opportunity (and potentially more profitable growth at that), Cardinal is not getting Zuellig for a song.

All in all, then, investors will have to have some faith in management on this one. Buying a major Chinese medical distributor certainly sounds like a good idea, but just remember that somebody, somewhere, once thought that changing Coca-Cola's formula was a good idea too.

The Bottom Line
Cardinal is a fairly well-run company in a difficult (albeit lucrative) business. Distribution does not offer the sort of margins that many investors prefer, and the company's in-house manufacturing operations are not large enough to offset that. Nevertheless, with another wave of generics on the horizon, an undemanding valuation, and a management team that seems to not be interesting in frittering away capital, Cardinal is at least a bird worth watching. (For more, see Check Out The "Healthy Portfolio".)

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