As a shareholder, I’m of two minds about spinoffs. On the one hand, I figure if management doesn’t see any point in hanging onto the business, why should I get excited about it?
On the other hand, spinoffs seem to go up: about 60% so far on the 2004 Hospira (HSP) spinoff from Abbott (ABT) and 20% so far on the Harris Stratex (HSTX) spinoff from Harris Corp (HRS) three months ago. In both these cases the spinoff outperformed the parent, and research studies say this is typical. (Investopedia, “Parents And Spinoffs: When To Buy And When To Sell,” 2009.)
After the market closes tonight, pharmaceutical and healthcare products distributor Cardinal Health (CAH) will spin off a new company called CareFusion (CFN). But this time my eyes aren’t on the spinoff; they’re on the Cardinal Health dividend.
As previously announced by the company, the entire dividend amount will stay with the ‘new’ Cardinal Health. According to some observers, this means CAH’s current 2% yield could rise considerably, depending on how much CAH’s stock price drops tomorrow to account for the spun-off value of CFN. (SmartMoney magazine, “Stock Screens,” September 2009.)
In early afternoon trading today, CAH “when issued” shares ((CAH-WI)), which trade without rights to the CFN spinoff, were priced at a 27% discount to the combined company shares, implying a 2.8% yield on the new CAH.
But the fun doesn’t stop there.
In presentations about the post-spinoff CAH, management made clear they intend to increase the dividend in line with future earnings growth. Indeed, simply searching the presentation transcript for the word “dividend” turns up 21 mentions, many in the context of assurances about future increases. Management also notes they aim to take the payout ratio to an estimated 30% from the current 20%. (Cardinal Health website, Investor Relations section.)
The ‘old’ CAH was no slouch with dividend increases, so there’s no reason to doubt management’s desire. In June 2005, CAH doubled their dividend and began declaring significant annual increases, including a 25% boost in June 2009. Prior to 2005, data from Yahoo Finance shows CAH had a long history of raising dividends regularly, though not necessarily annually.
The company also has a long history of scandals and missteps, and at least some analysts praise the spinoff as a way to bury the past and focus on improving operations. And indeed, the ‘new’ CAH will need to show it’s gotten a lot better than its same old self in order for me to pull the buy trigger. (Associated Press, “Cardinal Health Spinoff Signals New Direction,” August 31, 2009.)
According to Reuters, the 3-year and 5-year dividend increases are magnificent at over 27% and 36%, respectively, but corresponding EPS growth is barely 5% over the 3-year period and slightly negative over the 5-year period. Revenues don’t seem at the heart of the problem: with consistent 8% to 9% sales growth rate, surely more profits should be dropping to the bottom line. In addition, Morningstar data shows cash flow growth has been erratic over recent years.
The ‘old’ CAH’s internal rates of return and balance sheet aren’t a problem: return on equity of 14% and a long-term debt to equity ratio of about 40%, and CAH just announced it will use the spinoff proceeds to pay down $1.2 billion of debt. Sounds like a plan considering Fitch’s reaction to the to the spinoff was to issue a downgrade. (Yahoo Finance, August 26 and 27, 2009.)
Morningstar has also been a little equivocal about the big idea. They note the combined company is priced at meaningful discount and investors might benefit from the greater focus of the new businesses, yet also report somewhat strangely, at least in a literal sense, they don’t expect CAH will be better off as two companies. (Morningstar, Cardinal Health “Stock Analyst Notes,” August 7, 2009 and “Full Report” August 7, 2009.)
And, of course, any company with ‘health’ in its name may have unforeseen reform in its future, though it seems excessive to avoid new investments in the sector on that basis alone.
So as we continue the countdown to tonight’s spinoff launch, the ‘new’ CAH has found a place on my watchlist, though not a spot in my portfolio.
Disclosures: Long ABT, HRS, HSP, HSTX