Business Breakdowns
· Matt Reustle, Mark de Vos
[00:00:00] S0: One of the main things you will hear in these niche markets that represent a very small percentage of the overall product, but are mission critical is it's a very good spot to be in if you've captured market share in those industries. I'm curious how that impacts the revenue model broadly. We can break it down if possible. You gave us some sense just in terms of volume trends over time. How do they decide on price? And it might be different obviously for new equipment versus service and everything else, but is there a general framework for how you think about pricing as it revolves around the business? [00:00:00] S1: They don't give a sort of full disclosure on price volume, but from our conversations it seems like they've been reasonably cautious on price. So low single digits in recent years per year kind of number price rises. Certainly not the 10, 15% we've seen in the food companies for example. I think generally they're aware that often they've got relationships with these businesses that have been going on for 30, 40, 50 years and they're much more focused around maintaining that business and that strong relationship. And actually they take a little bit less on price. But maybe the customer takes a service contract or something like that that more than pays for any loss. Pricing generally I'd expect low single digit price growth number with the balance driven by volume.
· Mark de Vos, Matt Reustle
[00:00:00] S1: They don't give a sort of full disclosure on price volume, but from our conversations it seems like they've been reasonably cautious on price. So low single digits in recent years per year kind of number price rises. Certainly not the 10, 15% we've seen in the food companies for example. I think generally they're aware that often they've got relationships with these businesses that have been going on for 30, 40, 50 years and they're much more focused around maintaining that business and that strong relationship. And actually they take a little bit less on price. But maybe the customer takes a service contract or something like that that more than pays for any loss. Pricing generally I'd expect low single digit price growth number with the balance driven by volume. [00:00:00] S0: How has revenue trended? Whatever periods you want to pick, whether it's 3, 5, 10. I know you have various things that impact those. But where does this business tend to grow and industry tend to grow at? [00:00:00] S1: I'll pick nine if that's okay. Not because I'm being selective with my date range. It's the longest that I can go post the Keysight spin. It all gets a bit noisy around that time. Since 2015 or so, sales growth at the business has averaged about 5% organically, about 6% reported. So they've done a little bit of bolt-on M&A. They've had decent margin growth over that period. EPS has grown a fair bit faster, about 13% CAGR over that nine year period.
· Mark de Vos, Matt Reustle
[00:00:00] S1: I'll pick nine if that's okay. Not because I'm being selective with my date range. It's the longest that I can go post the Keysight spin. It all gets a bit noisy around that time. Since 2015 or so, sales growth at the business has averaged about 5% organically, about 6% reported. So they've done a little bit of bolt-on M&A. They've had decent margin growth over that period. EPS has grown a fair bit faster, about 13% CAGR over that nine year period. [00:00:00] S0: We could get into margins a bit. Is there a drastic variance to the extent that they split it between the various segments? Is there a massive variance between equipment sales versus the service and consumables in terms of margin profile? [00:00:00] S1: Yes. Unsurprisingly. Consumables and servicing is a fantastic business. I think the instrument sales is definitely more competitive than the servicing. I think consumables is probably the most competitive. So the instrument sale business depends a bit where they're selling to. Selling to life sciences, they're making around a 20% operating margin. But selling to the applied markets I spoke about a little bit higher sort of 24% or so operating margins. If we think about that consumable and servicing business, that's the 34% margin business. It's grown pretty steadily over time. It's also been amongst the fastest growing divisions.
· Mark de Vos, Matt Reustle
[00:00:00] S1: Yes. Unsurprisingly. Consumables and servicing is a fantastic business. I think the instrument sales is definitely more competitive than the servicing. I think consumables is probably the most competitive. So the instrument sale business depends a bit where they're selling to. Selling to life sciences, they're making around a 20% operating margin. But selling to the applied markets I spoke about a little bit higher sort of 24% or so operating margins. If we think about that consumable and servicing business, that's the 34% margin business. It's grown pretty steadily over time. It's also been amongst the fastest growing divisions. [00:00:00] S0: At 50% of revenue, obviously it's a higher percentage of profit. Where does that go over time and where did it come from in terms of it being a business that's split 50, 50 between those two? What do you expect that trend line to be? And maybe some context and the history would be useful as well.
· Mark de Vos
[00:00:00] S1: I think rolling back 10 years, if talk to the very smiley former CEO, he would say they didn't do an amazing job perhaps at selling services at the same time they were making instrument sales. So typically it was two different teams. One team would go yes, we sold an instrument. And then maybe six months later someone from Agilent, they call it CrossLab, it's their servicing division, would walk in and try and sell their services. By which point maybe a local technician group, maybe a competitor, had already gone in there and signed a deal. One of their core strategic focuses in recent years has been increasing that attach rate that I talked about, the percentage of instruments that have an active service subscription and they've been pretty successful at that. So they're in the low 30s percent of active instruments out there. New instruments sold is obviously a fair bit higher. And if we were to look at some of their peers, Waters, who's been much better for much longer at selling those servicing contracts with instruments there in the 50s percent, there's definitely a pretty long runway I think on that. And then when you think about the economics of that service business, it's a classic density business whereby you're in a city, you've got five technicians that operate in that city. To take on 5% more business, you don't need an extra person, they're just filling out their calendar. You've got a fixed cost for the office, you've got an admin team there. It really scales quite nicely as you build up density in a local area.
· Matt Reustle, Mark de Vos
[00:00:00] S0: In terms of the conversion, you mentioned earnings growth and that being quite a bit higher than revenue growth driven by that margin expansion. How has the cash flow profile evolved? Whether it's cash conversion, anything around free cash flow for the business over time. [00:00:00] S1: The company generates around $1.4 billion or so free cash flow a year. It's about 90% of adjusted net income. It's been pretty stable in recent years, that 90% number. The primary difference has been an increase in capex spend in recent years. They're basically building out a facility for a new business segment that they're working on. [00:00:00] S0: I would love to hear more about a new business segment that always adds something interesting to what feels like a pretty straight and narrow business story thus far.