RFP might be viewed as a four-letter word by Cardinal Health (NYSE: CAH) these days. Requests for proposals are a standard part of the business, but each one raises uncertainty about prospects for the future. And the uncertainty is actually preferable to the certainty when things don't go well.
Once bitten, twice shy
In April, Express Scripts (Nasdaq: ESRX) asked Cardinal to submit a response to its request for proposal following its acquisition of Medco. Even though Express Scripts had worked with Cardinal for the past 11 years, AmerisourceBergen (NYSE: ABC) landed the deal in July.
Still reeling from that $9 billion revenue loss from its third-largest customer, Cardinal Health now faces another spin of the RFP roulette wheel. This time it's the company's second-largest customer requesting proposals.
Walgreen (NYSE: WAG), which accounted for 21% of Cardinal's revenue in fiscal 2012, issued a request for proposal in August. The current agreement between the two companies expires in August 2013.
While Cardinal Health probably wants to project confidence publicly, management surely feels at least a little nervous about the possibility of a second loss of a major customer. There is one other factor at play also.
The contract with Cardinal's largest customer, CVS Caremark (NYSE: CVS), expires in June 2013. This agreement represents around $23.7 billion in annual revenue. CVS Caremark hasn't announced an RFP process so far, though.
Risks
Shares of Cardinal Health are down over 12% since the Express Scripts announcement. That drop exceeds the 8% revenue loss that Cardinal will incur, perhaps a reflection of the uncertainty that the company faces.
However, the market doesn't seem to be pricing in a high probability that Cardinal will lose the Walgreen contract. Observers likely expect that the company will be very aggressive in its response to the RFP in an attempt to prevent rivals from winning the account.
The ramifications of losing either Walgreen or CVS Caremark would be catastrophic for Cardinal. That's why the company will undoubtedly do everything it can to keep both in its fold.
Opportunities
If you suspect that there's a relatively high risk that one of the top two customers will actually leave, Cardinal Health could present a good opportunity for selling short. Few seem to hold that opinion, though. The short percentage of float as of Aug. 15 stood at only 1%.
Another opportunity is to take advantage of what could be viewed as an overreaction to the Express Scripts loss. Assuming Cardinal retains both Walgreen and CVS Caremark, shares probably will respond positively. The mean analyst estimates for the stock are at $46.58 per share, more than 23% higher than the current price.
I'm on the fence with this one. While I don't think Cardinal is likely to lose either of its remaining large customers, I don't think that the stock will move up considerably, either.
A big driver for pharmaceutical distributor earnings is the introduction of generic drugs. 2013 doesn't look to be that great of a year for generic launches compared to the past couple of years.
What I see with this stock is a little risk but no big potential for reward. For my preferred kind of RFP -- race for profits -- Cardinal Health doesn't appear to be the fastest runner.
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