Agilent (A) reported a few months ago a strong Q4, with revenues accelerating to 8% in the core Life Sciences & Diagnostics business (vs. low to mid-single digit growth in previous quarters) and slightly improving on a sequential basis in the Electronic Measurement business (-12% vs -16% in Q3). This suggests in our view that the company is at an early stage of a beat-and-raise cycle: consensus expectations have been reset in 2012 and early 2013, financial discipline has been rising and the revenue outlook is now improving. In our view, Agilent is a core holding in the Life Sciences Tools sector along with Illumina (ILMN) on which we published an article in January.
2014 is all about the academic spending recovery and the Electronic Measurement bottoming-out
Our level of confidence is pretty high heading into the Q1 release (Thursday after the close) as two large Life Sciences Tools peers, Illumina and Thermo Fisher (TMO), recently reported impressive top-line performances: respectively +25% (4% above consensus) and +6% (3% above the Street, and TMO's highest performance in 13 quarters), suggesting some year-end budget flush by pharma and biotech customers. Even assuming continued tough trading conditions for the Electronic Measurement business in the quarter due to a rather weak telecom equipment market (see the recent uninspiring figures from Ericsson (ERIC) and Nokia (NOK)), Agilent should be able to surprise on the upside in Q1 in our view.
But more importantly, the group's revenue momentum should gradually accelerate in coming quarters. While spending from private customers is likely to remain healthy, academic research spending is expected to recover in 2014 and to give a boost to Agilent. Indeed, Sequestration looks like an old story for Life Sciences Tools companies: the US congress recently released the 2014 budget in which the National Institutes of Health (NIH), the nation's medical research agency which provides research grants, would receive a +3.5% budget increase from FY 2013 levels.
As for the Electronic Measurement business, we expect a gradual improvement and a return to (slightly) positive revenue growth during the year driven by macro, positive industry capex and easy comps after a tough FY13.
Electronic Measurement spin-off a catalyst for increased corporate action
The announced spin-off of the Electronic Measurement business (deal to be completed by November) has been well received by investors as it will enable to unlock value (see below). But we see two additional positive consequences:
1/ Agilent's M&A power is likely to increase as the new Agilent will soon have the opportunity to use its whole balance sheet to strengthen its position in Life Sciences & Diagnostics (M&A in sight) at a time when competition increases. Giant groups have indeed emerged in the industry (such as Thermo Fisher + Life) with a clear scale advantage.
2/ But the hunter could become the hunted: Agilent's more focused profile and strong cash generation and rising consolidation in the industry could attract rivals or private equity investors.
Higher valuation levels in sight for both Electronic Measurement and Life Sciences
In our view, the upcoming spin-off of Electronic Measurement could be completed under favorable conditions for Agilent's shareholders, as the division's improving momentum suggests a higher valuation than initially expected.
The core Life Sciences & Diagnostics business is likely to benefit from higher valuation multiples as well, thanks to accelerating performances and to Agilent's more focused profile. The stock has been trading well below peers until now (Agilent is currently trading at an EV/sales of 2.9x vs. a Tools average around 3.2x) as Agilent was not a pure player in Life Sciences Tools. But the stock should rerate once the spin-off of Electronic Measurement is completed.
Agilent could also command a speculative premium given the scarcity of players in the Life Sciences Tools space. The upside here would be significant: Life Technologies (LIFE) was acquired last year at an EV/sales of 4x and Illumina, widely perceived as a takeover target, is currently trading at a 11.7x ratio…