Business Breakdowns
· Mark de Vos, Matt Reustle
[00:00:00] S1: They're not generally tied to a single pharmaceutical company. They work with all of the main manufacturers of these types of drugs. There is definitely more customization for each specific project. So they generally partner with them quite early during the development phase. Agilent probably won't be making very much money on it while they develop these custom sort of oligonucleotides to support the project. But the payback is if they make it to commercialization and some of them are now moving to commercialization, that the volume really ramps. And that stays with Agilent. There's no other company that has equal capacity or larger capacity than Agilent for producing these specialist oligonucleotides. Most things, it's probably easy to make in really small quantities. But if you want to make production-grade stuff where you can make 100,000 vaccines, then really it's only Agilent you can work with who have that facility. There are definitely differences. I think you're right. But it's similar in that it's not tied to a single all-in-one drug or nothing. [00:00:00] S0: Is it tied to the mRNA more broadly? That theme within pharma broadly. [00:00:00] S1: Correct. The step back of RNA-based drugs is unhelpful and things like changing in the funding environment and things like that. You definitely see that in some of their results where companies focus less on R&D one year and more on commercialization to respond to funding changes.
· Mark de Vos, Matt Reustle
[00:00:00] S1: Correct. The step back of RNA-based drugs is unhelpful and things like changing in the funding environment and things like that. You definitely see that in some of their results where companies focus less on R&D one year and more on commercialization to respond to funding changes. [00:00:00] S0: And you mentioned it's gone from small to it's not huge, but it's a much bigger portion of the business now. What does it represent versus what it was before? [00:00:00] S1: Their core NADS internally developed is a little over $300 million now of revenue. They've also acquired a business for about a billion dollars called Biovectra, which is in a similar space. It does slightly different things, but very similar. So altogether they're about $470 million of revenue, so about 7% of sales or so for huge. [00:00:00] S0: Impressive to come from something so small, especially when the rest of the business is growing alongside you. When you think about that as a shareholder, you mentioned a bit about the margin profile not being great in the early stages, so you're investing with this long cycle return. I'm just curious to get into your head about how that all felt. Maybe years back versus where we are today because it is a bit different with inside the business and they've gone from if we go all the way back to the HP days that being a conglomerate in many things to much more pure play. How do you frame that type of somewhat strategic adaptation to include this with some of those things in mind?
· Mark de Vos, Matt Reustle
[00:00:00] S1: Way back at the start of the conversation in Agilent's history, I went through an example where they gave away or sold for a tiny price a business that went on to be a core part of Broadcom today. Obviously it would have been nice if they kept hold of that one. Agilent engineers have clearly developed something that's unique and seeing demand from customers, it's a healthy sign that the company is willing to back them with the capital that they need. They run a pretty cautious balance sheet. They've got 1 times net debt EBITDA. If it's a choice between giving away the opportunity to someone else, who's going to spend that money backing your own engineers? We were pretty glad to see they had a culture firstly where they could reach the right people to make that kind of decision and then also where they decided to back their team and build out that facilities. We viewed it as a positive. [00:00:00] S0: When it comes to other capital allocation decisions. You have capex there reinvesting in the business and some of the opportunities you tapped into some bolt-on M&A historically and some bigger acquisitions. How core to the overall Agilent thesis is M&A and the willingness to continue to look for bolt-ons other deals that fit the general thesis of what they're doing.
· Mark de Vos
[00:00:00] S1: I think they've got a decent long track record of doing small bolt-ons. We think that's a pretty good thing. I wouldn't say it's a significant driver of growth, at least in the short term. They've generally used them for one of two purposes. One would be to fill in a small technology gap. So for example, they recently acquired a software business that specializes in lab productivity software. So now you can buy your Agilent instrument consumable service and plug it into this Agilent piece of software that will track usage and reorder consumables and call service technicians automatically. If you're a machine, break all of that kind of stuff. Seems pretty logical to acquire a small business that's doing that. So we like that. The other would be to add adjacent products where they're selling to the same customers. So that would be Biovectra recently where they've got this NADS business that was organic Biovectra had some additional capabilities, particularly around filling and packaging some of the products that benefited that NADS business, and that to us felt reasonably sensible. Of course there's always an element of risk and as the deals get larger the risk goes up. So we're keen. There's a sort of upper level on acquisition prices, but so far they seem to be being sensible. And I wouldn't say it's core to the strategy.
· Matt Reustle, Mark de Vos
[00:00:00] S0: There's a history of it. It's not core to the thesis from year to year, but it can be a nice tack on when executed well. When thinking about valuation for Agilent or this type of business in general, how would you say investors generally frame valuation for this type of business? Whether there's a specific methodology—and feel free to group yourself in there with any type of methodology that you think is relevant? [00:00:00] S1: We tend to focus on either free cash flow yields or price to earnings multiples. I think we find them the right mix between simple enough to ensure usability but also comprehensive enough to actually be useful. Agilent, for example, is trading above 4% free cash flow yield in recent months, which is close to the highs it's been over the last 10 years. Basically since the Keysight spin, which we view as pretty reasonable for a business that we think should be growing earnings high single digit. That equates to a just sub-20 times price to earnings multiple. Again, looked reasonable for a business Agilent where cash conversion is pretty stable. The two are largely interchangeable generally. Try not to overcomplicate it. If we really we the business and we're confident about the long-term growth, then as long as the valuation looks reasonable we're likely to invest.
· Matt Reustle
[00:00:00] S0: I admire it. I will not poke any holes in it. Oftentimes I love a simple P/E multiple inverted into a cash flow yield when the earnings conversion is fairly smooth into free cash flow. So bonus points for me on that. Simplicity is often a good thing. You outlined it fairly simply. Even in that response where there's visibility into high single digit earnings growth, you do have this cash flow conversion. Would you say there's any tailwinds that could result in more material outperformance? I rarely have to mention this into an episode because usually we get a very bullish presentation of the different things. I think this has been very balanced and fair in terms of presenting the business and the outlook. Is there anything that you think is missing or not mentioned as a potential upside lever or catalyst?