Cardinal Health Looks to Build China Business, but Has Long Way to Go

For pharmaceuticals distributor Cardinal Health (NYS: CAH) , China represents a world of opportunity.

Now -- after the $470 million acquisition last year of Chinese drug distributor Yong Yu and the recent opening of a new logistics center in Shanghai -- Cardinal just needs to figure out which of those opportunities to pursue.

In addition to growing its drug distribution business, China could represent a large market for Dublin, Ohio-based Cardinal to boost its medical devices, nuclear pharmacy and retail pharmacy businesses, said Chief Financial Officer Jeff Henderson.

"There are a lot of thing we could pursue in the country, and we need to be able to prioritize over time which of those can be the most economically attractive," Henderson said.

Still, any missteps could be costly, simply because China is so important to Cardinal's future. Henderson called China "one of our most significant growth platforms over the next 3 to 5 years and well beyond that."

To achieve that growth, Cardinal will need to begin consolidating what Henderson called a "fragmented" and "inefficient" Chinese drug distribution industry in a rapidly shifting health care market -- and Cardinal's starting from a small base. Using its drug distribution infrastructure and personnel as its growth platform, Cardinal can then begin exploring other business opportunities in China.

But it's Cardinal's core pharmaceuticals distribution business that represents the biggest and most obvious opportunity in China. And judging from the market's growth rates, it's not difficult to see why the opportunity is extremely attractive to Cardinal.

China's drug distribution industry grew an average of 15 percent per year from 2000 to 2009, with sales increasing 17 percent to about $104 billion last year, China Daily reported.

And then there are the broad trends that make China appealing to Cardinal, or virtually any health care company, for that matter.

"There's a large opportunity, given the size of the population in China, as well as the economic growth and what's likely to be much faster growth in the pharmaceuticals market over there" compared with the U.S., said Matthew Coffina, an equities analyst with Morningstar in Chicago.

Even better for Cardinal, the distribution industry is ripe for consolidation and that's exactly what's likely to happen; in its latest 5-year plan, the Chinese government said it aims to have between one and three large-scale drug distributors in the country.

Most of Cardinal's Chinese acquisitions will target other drug distributors, Henderson said, and the Ohio company will have plenty of choices due to the market's fragmentation.

Yong Yu, Cardinal's acquisition, is the 9th-largest drug distributor in the country, with just a 2 percent market share, so clearly Cardinal has lots of room to grow. Perhaps the greatest illustration of the Chinese drug distribution market's fragmentation is that the top 10 Chinese distributors account for just 34 percent of the overall market, Henderson said.

"That entire framework will change over time as consolidation happens," Henderson said.

In that respect, Cardinal's greatest opportunity could also be its greatest challenge: the fact that it's starting from such a small base in China with Yong Yu's miniscule market share. That likely translates to acquisitions, and lots of them -- at least in the early going.

"In order to get some regional scale and expand into new areas of the country, I'd think they'd start with acquisitions, but further down the line, the hope would be to grow organically," Coffina said.

Cardinal has already acquired one small distributor for a price that Henderson put at less than $10 million, giving the company a presence in seven Chinese cities.

So Cardinal is already off to a strong start in China. But because it's starting so small, it'll likely be awhile before its Chinese operations have a big effect on its overall business, according to Coffina.

"All of this is a 10-year story, more so than the next couple years, at least when it comes to the overall impact on the company," he said.

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