TOP CONTRIBUTORS

1 2

Agilent Technologies (NYSE: A) is the world market leader in the test and measurement (T&M) business with 2006 sales of $5 billion. Its closest but distant competitors are Tektronix (TEK)--2006 sales of $1 billion--and National Instruments (NATI)--2006 sales of $600 million. Similar to other smaller competitors like Lakeshore and Keithley Instruments (KEI), these two competitors have succeeded by focusing on niche markets.

Agilent, on the other hand, is the broadest and most diversified T&M company. Since it was spun off from parent company Hewlett-Packard (HPQ) in 1999, Agilent has undergone a period of significant restructuring during which it divested its assets in semiconductor testing and manufacturing, as well as developed a joint venture in LED lighting technology, in order to rededicate itself back on its core scientific and R&D markets. The advantages of this approach are twofold. First, the R&D market is more stable, as it is usually sheltered from macroeconomic trends. Second, the semiconductor test and manufacturing business is highly cyclical, tied mostly to the ups and downs of the IT hardware industry.

Agilent's near-term strategy is to start putting resources toward increasing market share in areas traditionally held by competitors, such as wireless R&D (this includes mobile phones, computer networks, and other wireless communications), oscilloscopes, and low-cost instruments, as well as emerging markets such as IP network convergence, nanotechnology, and surveillance. In the long term, Agilent plans to grow its business in bioanalytic test as demand grows in the medical, biotech, and pharmaceutical industries.

Company and Industry Overview

Agilent Technologies--spun off from Hewlett-Packard in 1999--develops, manufactures, and sells test and measurement (or T&M) equipment for a variety of research, medical, and industrial applications. Customers include those who want to measure some sort of physical variable quantitatively and electronically.

Typical physical variables that are tested: Pressure, temperature, radiation, current, voltage, inductance, capacitance, frequency, chemical composition, chemical properties, and many other scientific variables.

Customers and industries include: Aerospace, defense, communications, computer/networking hardware, semiconductor, pharmaceutical, oil/petroleum, biotechnology, medical, and general R&D, including universities.

Agilent has tens of thousands of customers, domestically and internationally (66% of Agilent's business is overseas) and no individual customer contributes more than 10% of its total revenue in 2004, 2005, or 2006, making it less dependent on localized trends in any particular country or industry. In 2006, Agilent held 33% of the estimated $15 billion test and measurement market, ranking it the largest test and measurement company.

Today Agilent has 2 main T&M product subdivisions: Electronic and Bioanalytic.

Electronic

2006 revenue breakdown

Agilent's electronic T&M subdivision makes standard and custom T&M instruments and systems; monitoring, management, and optimization tools for communication networks; software and services related to development, manufacture, deployment, and operation of communications networks and electronics equipment. Agilent also provides services such as start-up assistance, instrument calibration and repair, and customization, consulting, and product support services. Electronic measurement makes up $3.4 billion or 69% of Agilent's total revenue in 2006.

Bioanalytic

Agilent's bioanalytic T&M subdivision makes and supports instruments, software, consumables, and services for the analysis of physical, chemical, and biological properties. There are seven main product categories: microarrays, microfluidics, gas chromatography, liquid chromatography, mass spectrometry, software and informatics, and related consumables, reagents, and services. Bioanalytic contributed $1.6 billion or 31% of Agilent's total revenue in 2006.

Bioanalytic product categories can be further broken down into chemical analysis and life sciences:

• In chemical analysis, growth has recently been driven by sales of liquid and gas chromatography, and mass spectroscopy equipment to the food and environmental testing industries.
• In life sciences, contract research organizations and generic drug manufacturers bought the same types of equipment as did customers of chemical analysis, with the addition of microarrays.

The following are photos of some of Agilent's T&M equipment:

Trends and Forces

Recent Restructuring

• In late 2005, Agilent sold its semiconductor products business (renamed Avago) for $1.8 billion.
• In late 2006, Agilent spun off its semiconductor test business (now called Verigy) in an IPO that was partially distributed to current Agilent shareholders.
• In late 2005, Agilent sold a 50/50 joint venture in the light emitting diode company Lumileds for $1 billion to Phillips

The goal of these divestitures was to reduce Agilent's exposure to the highly cyclical semiconductor business. During the post tech bubble period of 2001-2003, many tech companies suffered from negative operating margins, and the semiconductor business significantly exacerbated this problem for Agilent. With the divestment of the semiconductor business, the break-even point for Agilent's revenue has been reduced significantly.

• Additionally, these divestments have created large cash flows for Agilent, which have been partly channeled into a 2 year share repurchase program of $4.5 billion. There is a high probability that they may lead to more share repurchasing programs in the near future.

With no more major restructuring on horizon in the near future, Agilent hopes to achieve higher sustainable and profitable growth by leveraging the new operating model.

Growth Areas

Bioanalytic

• Between 2004-2005 chemical analysis sales grew 5%, driven by increased environmental and food testing in Asia. Much of the demand for chemical analysis test equipment is largely driven by government regulations (of any country). New regulations in Asia, particularly in China and India, led to increased demand for gas chromatography, liquid chromatography and mass spectrometry equipment that are used for food and environmental testing. Environmental and Food policy is already quite extensive in the US - Sales could grow if policy became more stringent. Chemical analysis represents 57% of the bioanalytic business.

• Between 2004-2005 life sciences grew 9 percent, driven by increased demand from generic drug manufacturers. The health of life sciences is linked to R&D budgets of pharmaceutical companies, spending on health care (also generally increasing), as well as organic growth in the biotech and medical industries. Life sciences represents 43% of the bioanalytic business.

From http://www.marakon.com/ideas_pdf/id_041104_mckinnon.pdf

Electronic

In the near-term, significant growth is expected in the electronic measurement industry.

• Between 2005-2006, net revenue increased 5% driven primarily by aerospace, defense, and semiconductor design and manufacturing.
• Agilent currently aims at increasing its revenue in the Electronic T&M segment by $1 billion over the next three years, based on estimates that the core business will continue to grow at a rate of about 5% per year, and that its main initiatives in Electronic T&M will grow at 20-30% per year. These initiatives include low cost instruments, surveillance, wireless (i.e., voice, data, audio, and video), R&D (e.g., mobile phones, computer networks, and other wireless communications), IP network convergence, nanotechnology, and oscilloscopes. See Competition Section.
• Growth in the electronic business benefits from the current war on terror and its subsequent increases in defense, aerospace, surveillance, and electronics spending worldwide - which are all industries that Agilent supplies with T&M equipment.

Industry Maturation and Macroeconomic Slowdowns

Overall, this diversified business model is expected to net gains, and is expected act as a buffer against economic slowdowns or changes in customer industries. However, the T&M industry is relatively mature, with greater than 90% penetration in many of its market segments. Its growth will probably derive mainly from the growth of its end markets, estimated to be 6.5% per year in the long term. While Agilent's diversified model will help the company weather any moderate economic slowdowns, it, like many other companies in any industry, would feel the effects of a significant economic slowdown similar to the one from 2001-2003.

Competition

Source: Company Data

Both Tektronix and NI owe a significant portion of their success to their domination of specific niche markets: Tektronix has traditionally led the markets for oscilloscopes and wireless R&D, while NI has led the market for T&M virtual instrumentation software (specifically, LabView) and low-cost instruments. Agilent is currently moving to increase market share in these areas by refocusing its resources.

• Gaining more customers for oscilloscopes and wireless R&D is good because R&D investments typically exhibit much less volatility during economic down cycles, and Tektronix's narrower market model could lose share to a refocused Agilent.

• The overwhelming success of National Instruments LabView software has proved--especially with recent advances in accuracy, precision, and functionality--that virtual instrumentation is the wave of the future. Agilent and Keithley even bundle NI's software with many of their instruments. Most T&M manufacturers/designers, including Agilent, work together to insure compatibility and functionality. Now that NI has proved such a market is viable and large, rivals including Agilent are putting resources into competing in this field. Agilent already leads many other markets, and is likely to have excellent credibility in low-cost instrumentation, a market it has historically ignored.

Sources

Marakon Associates article "Crisis? What Crisis?"

References