San Diego’s Medical Technology Startups Get Reborn in CareFusion Spinoff

8/31/09Follow @bvbigelow

San Diego has long been known as an incubator for new technology companies. But as the hometown for established Fortune 500 companies, San Diego is barely on the map. You can count San Diego’s Fortune 500 companies on three fingers: Qualcomm (at No. 244), Sempra Energy (No. 252), and SAIC (No. 266).

This is because San Diego operates like a botanical nursery. Technology startups seeded here are typically sold and often transplanted. Sometimes part of a company’s operations remain in San Diego while corporate finance and other executive functions are consolidated elsewhere. That’s the way it was in 1996 when Dublin, OH-based Cardinal Health paid $920 million to acquire San Diego-based Pyxis, a medical technology startup that pioneered the development of computerized drug dispensing systems for hospitals. And again in 2004, when Cardinal paid $2 billion to acquire San Diego’s Alaris Medical Systems, a leading maker of intravenous drug pumps.

But now we’re watching a complete turn of the great corporate circle of life. Cardinal decided more than a year ago it was time to spin off its medical technology business—which includes Pyxis and Alaris—as CareFusion, a full-blown publicly traded company with 15,000 employees and roughly $3.7 billion in annual sales. David Schlotterbeck, who was a vice chairman at Cardinal and the CEO of Alaris, is heading CareFusion—which is headquartered in San Diego.

“I am very happy to see San Diego regain a large publicly traded company headquarters,” Pyxis CEO Ron Taylor said in an e-mail last week. “Over the years we have sold many local companies to bigger out-of-town buyers and lost the HQ.”

The spinoff becomes official tomorrow (September 1), when trading in CareFusion shares begins on the New York Stock Exchange under the symbol CFN. CareFusion shares began trading provisionally under the symbol CFN-WI just over a week ago, on Aug. 21, to establish a market for the stock, according to CareFusion spokesman Jim Mazzola. At noon today,  they were trading at $19.02 a share, giving the new San Diego company a market valuation of more than $4.3 billion.

The split leaves Cardinal Health, the country’s No. 2 drug distribution company, with a more centralized focus on its core business. It also enables CareFusion to focus more precisely on medical technologies that address two key needs among hospitals, reducing patient medication errors and preventing hospital-acquired infections.

Why did Cardinal spin off it’s medical technology business?

“It is likely that the very high gross margin businesses like Pyxis and Alaris just did not fit with the very low margin distribution businesses like Cardinal and its medical supply business that originally was American Hospital Supply,” Taylor told me. “Management of these businesses is different. In the case of Pyxis, you need to sell new equipment every quarter; new contracts, new buying decisions. In the case of drug distribution, it is more like an annuity; it is a recurring business—not guaranteed, but predictable.”

So by focusing on its mature distribution business, Cardinal also has removed some uncertainty in its business model, making it easier for the company to make regular dividend payments to shareholders. “Pyxis and Alaris are not so predictable, and that is one reason the margins are higher,” Taylor added. Technology innovation, however, remains a key to success at CareFusion.

With its focus on efficiency in its drug distribution business, Cardinal did not heavily invest in research and development. But it’s anticipated that will change now at CareFusion. “What we’re spinning out from Cardinal Health is the medical development business,” Mazzola says. “That is something where we will always differentiate ourselves through innovation.”

Of course, it will be interesting to see if CareFusion can foster a culture of technology innovation. Cardinal built the medical technology business that it is now spinning off by acquiring nearly two-dozen device companies over the past 13 years, so the real question may be whether the inventive spirit underlying these startups has survived under Cardinal’s management.

In 2006, long before Cardinal christened its spinoff CareFusion, the healthcare giant purchased Care Fusion, a McLean, VA-based leader in wireless, barcode-enabled patient identification systems used in hospitals. The company’s other core products include software and related drug-dispensing technologies originally developed by Pyxis to help hospitals maintain tight inventory controls of drugs and other medical supplies; intravenous infusion pumps developed by Alaris; critical care respiratory equipment, re-usuable stainless steel surgical instruments; and ChloraPrep products developed by Enturia of Leawood, KS, to treat wounds and as a pre-surgical skin disinfectant.

With $3.7 billion in revenue, CareFusion isn’t big enough to rank among the Fortune 500. It would place on the 2009 ranking somewhere between Redwood City, CA-based Electronic Arts (at No. 590) and San Francisco’s Del Monte Foods (No. 586). But CareFusion will instantly become the fourth-largest company in San Diego.

Wall Street analysts have generally greeted the move with enthusiasm, since CareFusion accounted for less than 10 percent of Cardinal’s revenue but nearly 40 percent of its earnings. More than 80 percent of CareFusion’s common stock has been distributed to Cardinal Health shareholders. Cardinal plans to retain the remaining shares itself, and gradually sell them off in the coming year.

Bruce V. Bigelow is the editor of Xconomy San Diego. You can e-mail him at bbigelow@xconomy.com or call (619) 669-8788 Follow @bvbigelow

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