There is no shortage of data, analysis, and opinion out there about the virtues (or lack thereof) of spinoffs and corporate splits. They don't always work, but I do believe that Agilent (NYSE:A) will be one of those companies that benefits, as there really never were meaningful synergies or counter-cyclical offsets between the test and measurement operations and the life science tools and diagnostics operations. Agilent still looks a little undervalued today and even with the added cost burden of the split, the life science and diagnostic operations in particular look well worth following.
Unwinding the coil
Agilent has sometimes better resembled that one drawer or room that everybody has – the one where unrelated things just amalgamate together over time. Some companies (like Agilent's rival in both T&M and life sciences, Danaher (NYSE:DHR)) can make it work, but Agilent has struggled to generate value from its M&A and running both the T&M and life sciences/diagnostics operations together under one roof really never created or added much value.
Now the company is well under way with splitting the two operations. The life sciences and diagnostic operations will continue on under the Agilent name, while the T&M business will be spun off as "Keysight". The spin-off should be tax-free and management believes they will be able to complete the transaction in or by November of 2014.
A good life sciences operation
Keysight is, and likely will remain, a competitive player in the T&M space. It is among the market leaders with companies like Danaher, Anritsu, and Rohde & Schwarz in oscilloscopes, electronic design automation, mobile radio test, signal analyzers, and network analyzers. I am more interested in the life sciences/diagnostics part, though, so I will focus from here on the prospects for the "new Agilent."
Agilent is among the global leaders in separation technology, including significant presences in gas chromatography and liquid chromatography (including high-performance and ultra high-performance liquid chromatography). Combined with mass spectroscopy, Agilent is number one in GC-MS (ahead of Thermo Fisher (NYSE:TMO)), and number three in LC-MS behind Waters (NYSE:WAT) and Danaher, but ahead of Thermo Fisher. Agilent is a somewhat limited player in nuclear magnetic resonance but among the leaders in the convoluted world of mass spec – ranking in the top three or four with Danaher, Thermo Fisher, and Waters.
Agilent's life sciences tools business address a market worth around $20 billion to $22 billion, growing around 4% to 6% a year worldwide. There is some cyclicality to this business, not only due to the fact that Agilent addresses a sizable non-academic/govt lab market, but also due to the fact that research spending is tied fairly closely to budget cycles. Agilent hasn't always had the best reputation for reinvesting and developing this business, but the company has been stepping up its game of late with some disruptive new products.
Dako still a long-term project
Back in 2012, Agilent took a page from Danaher's book and bought a fixer-upper diagnostics business in Dako. Among the leaders in anatomical pathology and immunohistochemistry, Dako offered a chance to not only repair years of under-investment in R&D, but also leverage the company's strong technology in tools toward diagnostics and augment the largely tools-driven sales mix with a disposable/consumable component. I would not say the job of improving Dako is done yet, but the business did post double-digit organic revenue growth in the last quarter.
Value today, value tomorrow
Evaluating Agilent as is (with Keysight), I would look for long-term revenue growth of around 4% to 5% and 8% FCF growth (based upon FCF margins growing from the mid-teens to the high teens) to support a fair value in the high $50's today. While the split will create some added costs early on for Agilent, the post-split Agilent will be a faster-growing company with substantial opportunities for reinvestment. I look for long-term revenue growth of above 6% and long-term FCF margins in the low 20%'s to drive double-digit free cash flow growth. With a less cyclical business model (relative to T&M) and a lower discount rate, I believe Agilent's stand alone value will exceed $40 per share.
The bottom line
Sometimes "one plus one" can equal more than two, and in this case I believe Agilent's parts will ultimately be worth more independently than together. As Agilent moves forward in areas like sample prep diagnostics, lab automation, and genomics, I expect the company will unlock more value. With that, I think Agilent is worth owning today, whether an investor chooses to sell or keep the Keysight T&M business after the split.