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A lot of attention has historically been paid to CareFusion Corporation (UNKNOWN: CFN.DL ) in the context of its place in the infusion pump oligopoly with Baxter (NYSE: BAX ) and Hospira (UNKNOWN: HSP.DL ) . There is a lot more to this story, though, as the company is a leader in medication dispensing, pre-op skin prep, and respiratory care. The acquisition of Vital Signs from General Electric will add scale in respiratory care and anesthesia, but leaves the company with enough dry powder to continue making additive deals. CareFusion is not a slam-dunk bargain, and there aren't many of those left in med-tech, but it is a name worth consideration today or at least a spot on investor watchlists.
Infusion share gains likely won't last forever, but wins can be sticky
CareFusion's infusion business has prospered in the wake of regulatory problems with the pump businesses at rivals Hospira and Baxter. By my calculations, these product quality stumbles at the competition have allowed CareFusion to move to the top of the market with roughly 40% share. Pumps tend to be long-lived assets that hospitals buy in large numbers only periodically, so CareFusion should be looking at years of more or less locked-in follow-on disposables/consumables sales to this customer base.
Eventually I expect Baxter and Hospira to be back and to regain some of the share they have lost, and I wouldn't rule out the possibility of B.Braun trying to step up its game in the U.S.. I also cannot rule out the possibility that CareFusion too will eventually have its own regulatory troubles with its infusion pumps, as the company has had some recalls recently and that just seems to be the way of things in the pump business.
The pump business at CareFusion rightly gets a significant amount of attention, but the medical dispensing business arguably gets less than its share. This business sells automated systems (that are something like ATMs) to hospitals so that they can better secure and manage their pharmacies. Given rules and regulations regarding patient safety and controlled substances, these systems are essential equipment in hospitals.
With its Pyxis platform, CareFusion enjoys almost two-thirds share in the market, having put a fair bit of distance between itself and Omnicell (NASDAQ: OMCL ) and McKesson (NYSE: MCK ) . This isn't a fast-growing market (largely a replacement/upgrade market) in the U.S., and Omnicell has been gaining some share lately by focusing on innovation and a high-touch marketing and customer service effort. CareFusion is hoping to recapture some of that momentum with its new Pyxis ES platform – an upgrade that offers improved real-time data, better integration with hospital information systems, and enhanced error reduction systems.
Growing Through Tuck-In/Add-On Deals
It was almost a year ago that CareFusion earmarked up to $1 billion for growth- and market-expanding acquisitions. CareFusion has long been an active acquirer, with deals like those for PHACTS, Rowa, Intermed, UK Medical, and Sendal adding complementary products in existing pharmacy, repiratory, and disposables markets.
Most recently CareFusion added Vital Signs, paying $500 million to GE for this manufacturer of respiratory and anesthesia disposables, as well as temperature management and patient monitoring products. The respiratory part of Vital Signs should complement its existing business, and I find it interesting that CareFusion is adding more disposables while its largest rival Covidien (UNKNOWN: COV.DL ) has been focusing more on the capex side with deals to add monitors and ventilators.
Vital Signs is a logical deal for CareFusion and at about 2x revenue, it's a pretty respectable price. It's not the deal that many on the Street expected, though, as rumors have circulated for a while that CareFusion was in talks to acquire Smiths Medical (part of Smiths Group) and or ICU Medical (NASDAQ: ICUI ) . Either deal would make sense; while CareFusion may not want to acquire a business (ICU Medical) that gets more than a third of its sales from Hospira, the infusion assets are definitely complimentary. Smiths Medical likewise makes a lot of sense with the company's position in medication delivery (pumps), respiratory care and monitoring, and vascular access, but Smiths Group has been holding out for a strong price and CareFusion has been trying for years to make a deal here.
The Bottom Line
CareFusion doesn't need to stretch its balance sheet or overpay for Smiths. With that, I would expect more Vital Signs-like deals than major transformative acquisitions. I'm not modeling additional M&A deals at this time, and am looking for CareFusion to grow revenue at a modest 3% to 4% clip. I do see some scope for further margin and cash conversion improvements, and I'm looking for free cash flow growth closer to 6%. With that, my DCF model produces a price target near $41.
A price target of $41 may not be exciting, but there are increasingly fewer medical device stocks trading at any sort of discount, and many of those have clear execution risks in front of them. As it is, I think CareFusion is priced to generate high single-digit or low double-digit capital appreciation, and that makes CareFusion a worthwhile name to consider right now.
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