Agilent Technologies Supplement

By: Steve Rubis

Our recent article on Agilent is more pedestrian than we had hoped. Therefore, I would like to add this addendum or supplement to the previous article. While writing the article, the theme and construction did not come together easily. That being said, profiling the company was very important for a few reasons. First, Agilent proved to be one of our first buying opportunities (I found it while doing a valuation analysis of the Scientific Measurement and Technical Equipment Industry). Our original numbers were a bit too lofty causing us to recalculate our target value. It was this recalculation that caused so much angst during the writing process. Nevertheless, upon posting the article it is apparent that our purpose for profiling Agilent should have been more educational as well.

A profile of Agilent Technologies serves both illustrative and educational purposes. First, the profile illustrates a very important investment situation – a restructuring which entails a spin off. The educational aspect revolves around its usefulness for explaining a spin off situation and how such a situation is a potent catalyst to unlocking true company value.

Here at Stock Research it is important to profile companies that are more than just a good investment. Every now and again it is important to highlight more than just a business model, valuation, and prospects for growth. Sometimes a stock presents itself as an educational opportunity much like Agilent does now. Our main investment thesis is that the company’s restructuring plan undertaken in 2005 is about to come to completion through a spin off. The spin off should allow the stock to enjoy modest to strong price appreciation.

In order to understand why Agilent is such a strong investment, an investor must understand the term spin off. A spin off occurs when a company intends to divest or disperse a non-core asset or line of business. Investors receive a special dividend in the form of stock in a new company rather than cash. For instance, all Agilent shareholders as of a specific date will receive a predetermined number of shares of its subsidiary Verigy on a specified date.

This strategy was very popular during the Tech Bubble of the late 1990s. Agilent and Avaya are previous examples of a spin off. In 1999, Hewlett Packard felt that Agilent was a hodge podge of businesses with no real common thread between them or the parent company. Lucent had come to the same conclusion about Avaya when it spun off the subsidiary around the same time.

Understanding spin offs are important if one wishes to be a successful value investor. This begs the question why are they so important to investors? The reason is quite simple; spin offs allow firms to divest from non-core business allowing both the new and old firm to focus on their core lines of business. This new focus on core lines of business offers investors a win-win situation. Shareholders can benefit from both companies new found focus, especially if the new business strategies work. The spin off is the most potent option when management seeks to restructure the business.

It is always easy to find strong investment opportunities. The problem is finding candidates with compelling stories behind a compelling valuation. Investors should always take notice of out of favor companies undertaking a restructuring. Especially, if the parent company intends or has declared that it will spin off a subsidiary in order more closely focus on the core line of business. Such a situation allows investors to benefit twice: once from the parent, and then again when he or she receives shares of the subsidiary.

*the author owns 100 shares in Agilent Technologies at the time or writing. His target price is stated in the previous article on Agilent. The author cannot guarantee that the stock will go up or down in price and cannot be held responsible for any reader’s decision to purchase said stock.

Agilent Technologies (A)

By: Steve Rubis

Ticker: A
Market Cap: 14.10B
Target Value: $44
P/E: 5.03 Forward P/E: 18.55
Revenue: 5.63B
P/S: 2.44
EBITDA: 1.77B
EPS: $6.86
Cash: 2.25B
Debt: 1.50B



Leader in Measuring Equipment Embarks On Spin Off

Unfortunately, it has been some time since we last profiled a stock for investment. Today we wish to analyze Agilent Technologies (A). The stock is rated a strong buy with a target price of $44. We believe that accelerating earnings coupled with the company’s spin off of Verigy (VRGY) will generate considerable share price appreciation. Currently, our outlook for the Scientific and Technical Equipment industry is positive, since we are interested in three firms in this industry: Agilent (A), Hurco Companies (HURC), and Winland Electronics (WEX).

Agilent Technologies is a diversified technology business with a core focus of measurement equipment. The company implemented a major restructuring program in 2005 in order to focus on the measurement business. Their new corporate strategy is to be the number one provider of scientific measurement equipment.

In order to attain this strategy, Agilent felt it should divest itself of all non-core assets. In 2005, the corporation sold its semiconductor test business to Avago for $2.5B. The completion of this divestiture will occur on October 31, 2006. At that time, all remaining shares in the subsidiary Verigy will be given to Agilent shareholders as a special dividend. Each shareholder on record as of October 16, 2006, will receive 0.12 Verigy shares per each Agilent share owned.

It seems that the spin off of Verigy is a potent catalyst for unlocking the true value of Agilent. A non-core asset will be spun off, which will allow the corporation to more closely focus on the core business. A simple breakout of revenues illustrates the value of this move; the electronic measurement business contributes $3.3B, bio-analytical measurement contributes $1.4B, and semiconductors only$0.5B to total revenues.

The company embarked upon a major restructuring plan in 2005. The crux of the restructuring concerned the two spin offs mentioned above. Other initiatives that occurred were: (1) retirement of its convertible debt; and, (2) a $4.466B share repurchase program. At the end of 2005, Agilent had repurchased 92M shares at a price of $3.3B.

Here are some highlights of their third quarter earnings announcement:

1.) Revenues increased by 17%
2.) EPS was $0.55 vs. $0.10 for the quarter
3.) $86M in charges due to the Verigy spin off
4.) Asia and Europe provided the most growth
5.) Orders increased 15% for the year-over-year period

Lastly, the company has a strong balance sheet, giving investors confidence in the business as a going concern. Its Atlman Z score, an equation used to predict bankruptcy with 99% accuracy, is 4.32, well above the threshold score of 3 for financially sound companies. Secondly, it has a net current asset value of $0.69 and current asset value of $5.43. While these values are lackluster, the fact that they are meaningful and not negative further gives us some confidence.
In closing, we believe that Agilent offers investors a compelling value play. The potent catalyst of a spin-off is near completion. We think that once the spin off is completed that share price could appreciate to near the $44 level.

Please review the following documents used to develop our research:
Verigy Spin Off Ratio
Barron’s Price Appreciation Article
Scientific and Technical Instruments Spreadsheet

This item is our relative analysis of the Scientific and Technical Instruments Industry. Please review our calculations and take issue with them if you like!!!