Business Breakdowns
· Mark de Vos, Matt Reustle
[00:00:00] S1: I think they inherited a lot of people. So Agilent is still based in Santa Clara. I think they're about 20 minute drive their current HQ from the original HP garage where it all started. There's obviously this sort of HP way culture as well, which we obviously own the shares. We've been impressed with the way that they run the business for the long term, the way they look after their people. You kind of get a sense for it. But we experienced that in COVID-19 where right off the bat they were first out the doors saying no one in this company is losing their jobs or anything like that. I think that builds up loyalty and it's not unusual. When we meet managers, they're generally Agilent lifers that started as engineers. [00:00:00] S0: It's interesting where you might have a separation, but there still exists some type of relation to the original family tree and some of the talent that comes along with it. You mentioned when we were talking before, a bit of a razor, razor blade approach with their business. How would you categorize what they're doing beyond selling just equipment outright?
· Mark de Vos
[00:00:00] S1: In terms of how I think about the business, about a third of it is selling instruments, the largest category of which is chromatography instruments. These are large sort of initial sales. And then two thirds of the business is selling consumables, servicing or software which are mostly related to the instruments they're selling. So it's that roughly one third, two thirds split. I've mentioned chromatography a few times. What this actually is is a machine that forces a sample. It could be a liquid or a gas at pressure through something called a column. You can think of a column as a metal tube that's stuffed with material that slows down the molecules in that sample at different rates. This means that the liquid or gas separates into different molecule groups as it passes through that column. And then on the output of the machine, you've got a sensor that detects the molecules now that they're separated. And depending on the type of sensor, it could also quantify how much of those different molecules coming out. So it's a powerful tool. Typically when they're selling one of those instruments, a chromatography instrument, it will cost around $100,000. Obviously there's a huge range, but let's go with that for now. And it's got a useful life of about six to 10 years. Over that useful life, the customer will typically spend another hundred thousand dollars on ongoing consumable and servicing spend. That spend is split roughly equally between physical consumables and service costs. So just talking about the consumables for a second, the bulk of that expense is those columns that we just described. They've got a limited period of use, perhaps maybe 2,000 samples, something like that, and you need to replace them as the columns responsible for separating out that material and it's degraded by high temperature or extreme pH levels, things like that, and that impacts the resolution of the instrument. These are used for pretty critical applications. You basically have to replace it often. It wouldn't be unusual to hear a customer replace every month or so. Servicing is a bit different. It's more focused on repairs, recalibration, cleaning, or a service called qualification where they will be validating the machine is operating correctly.
· Mark de Vos, Matt Reustle
So we're saying Agilent is one of only two companies that has the ability to service other companies equipment in the same lab as well. So it's a pretty big benefit if you're dealing with a large customer. And increasingly Agilent services are sold as part of a broader service contract that's agreed. When they sell the new instruments, one of the ways to judge it would be they publish a number. That's the percentage of instruments out there that have active service contracts. It's called the attach rate and it's been steadily increasing over time. So it's gone over the last five years from a sort of high 20s number to a low 30s percent. And we expect it to continue to grow about a percentage point a year. This is a great business. It sounds boring, but the bulk of Agilent's customers are operating in regulated industries where they need to spend on consumable servicing if they're using the instrument. The example I gave earlier, quite often the quality control process will be written into the FDA approval for a drug and they might even mention the exact instruments and consumables being used. Once that happens and it's approved, it's expensive for the customer to move to a different instrument. And also there's some risks attached with that. So it gives a really nice recurring revenue on that consumable service spend. [00:00:00] S0: Is it right to think about the Agilent equipment being used in the assembly line? Essentially once a drug has already passed the approval, rather than in the original testing or drug development stage.
· Matt Reustle, Mark de Vos
[00:00:00] S0: Is it right to think about the Agilent equipment being used in the assembly line? Essentially once a drug has already passed the approval, rather than in the original testing or drug development stage. [00:00:00] S1: They straddle both. I think probably you're right though in that the sales split would skew towards production. They definitely make those cutting edge instruments which you use for your research and development. There's just a lot more production out there. When you look at the innovations, there's definitely innovations around making the machines higher resolution, more accurate, but actually a lot of the innovations are focused on throughput, where this is a lab that's testing 10,000 samples a day, and if you can do it with one less instrument, then that's a big saving. [00:00:00] S0: My next natural question was going to be what governs the decision for a lab to buy another piece of equipment, another Agilent system? Do you see labs with multiple on their assembly line or is there typically just one associated with each drug? I'm trying to understand whether it's capacity constraints or what drives that.
· Matt Reustle, Mark de Vos
[00:00:00] S0: My next natural question was going to be what governs the decision for a lab to buy another piece of equipment, another Agilent system? Do you see labs with multiple on their assembly line or is there typically just one associated with each drug? I'm trying to understand whether it's capacity constraints or what drives that. [00:00:00] S1: Typically in a production center you'd have a lab attached to it and they would have several instruments as part of that. And generally they will choose a single primary supplier. They may have a sort of secondary supplier there as well, but just for simplicity in terms of having spare parts on site, ongoing service and support, it's generally just easier to have one instrument. When they're considering going from that fourth to that fifth machine, they're considering the service they've received. I think most customers would probably highlight service as the primary driver of their decision. It's worth saying the machines are complex, there is a technical capability, so it's not like there's 500 options out there. It's a reasonably small group that you've got to choose from. But Agilent's this one stop shop where you can get your instrument, you can get your consumables, you can get your servicing all in one, one package. [00:00:00] S0: Talk a little bit about the competition you mentioned. There's one other competitor that can actually service third party machines as well. What does the competition look like? Maybe we can start just in the equipment segment and branch out from there.
· Matt Reustle, Mark de Vos
[00:00:00] S0: Talk a little bit about the competition you mentioned. There's one other competitor that can actually service third party machines as well. What does the competition look like? Maybe we can start just in the equipment segment and branch out from there. [00:00:00] S1: Generally they're competing, I'd say, against two main businesses. There are others, but two main ones. One being a company called Waters and another called Thermo Fisher Scientific. Waters is a strong competitor in liquid chromatography but it's more narrowly focused on the pharmaceutical markets. So around 60% of their sales are from pharmaceutical customers. They're also smaller business. So revenue for Waters is about half that of Agilent's, around $3 billion. Agilent's just above 6. Thermo Fisher is almost the opposite. It's a huge business, $43 billion of revenue built largely through acquisitions. And if you open a Thermo Fisher Scientific catalog, you would see there's a much broader array of products. So they sell everything: lab fridges, test tubes, hot plates, centrifuges, lab shakers, water baths, etc. As well as the chromatography instruments that actually compete with Agilent. So maybe a bit less of a specialist in that sense. What drew us to Agilent was its diversified exposure by end market, but also its focus on niches where it has high market share. [00:00:00] S0: Can you talk a little bit about those niches? If you take a Waters who's entirely focused on pharma, what would be the other categories or niches within those categories that would be highlights for an Agilent?