It was just a day ago that I wrote, in reference to Agilent's (NYSE:A) probable M&A strategy, "I would be surprised if the company targeted sequencing or diagnostics." Well, color me surprised, as Agilent announced on the morning of May 17 that it will be acquiring Danish oncology diagnostic company Dako for $2.2 billion in cash.

Not only is this the company's largest deal to date, but it represents an entry into a new market - the multi-billion dollar world of diagnostics. While the growth potential in diagnostics explains Agilent's interest (to say nothing of the high-margin consumables sales that go with it), Agilent is paying a hefty price for a company that badly needs to refresh its product line-up and lags some very large competitors.

Investopedia Broker Guides: Enhance your trading with the tools from today's top online brokers.

What Agilent Is Buying
For $2.2 billion, Agilent is buying a mid-sized diagnostics company that has spent the last five years as part of EQT. At close to six times Agilent's estimate for Dako's revenue in 2013, this is by no means a cheap deal for the company. That said, looking at the multiples for diagnostics M&A transactions ((including the recent Hologic (Nasdaq:HOLX) - Gen-Probe (Nasdaq:GPRO) deal)), Agilent didn't exactly get fleeced.

There are some definite positives to Dako from the perspective of a company like Agilent. Roughly 90% of Dako's sales are consumables, and that will serve to make Agilent's life science business considerably less cyclical and vulnerable to budget and grant cycles. Moreover, this is an entry into the fast-growing molecular diagnostics market and a well-positioned player in the growing cancer diagnostics market.

SEE: Understanding The Income Statement

Companion Diagnostics a Real Growth Opportunity
As drug companies like Pfizer (NYSE:PFE) and Merck (NYSE:MRK) increasingly try to develop drugs that target particular genetic profiles, it will be increasingly important to have companion diagnostic tests to identify those patients. If a particular drug works well in "triple negative" breast cancer, for instance, but does little in other types, it is critical to have a test available to identify those patients.

Dako has already signed up major drug companies like Amgen (Nasdaq:AMGN) to develop such tests, and I believe this is a real growth opportunity for the diagnostics industry.

Real Risks
Perhaps not surprisingly for a company owned by a private equity, it doesn't look as though Dako has seen the necessary reinvestment over the past five years. In my opinion, Dako's product portfolio is frankly not the most competitive or state-of-the-art today, and I worry that the announced purchase price doesn't include the accelerated R&D that Agilent is going to have to pay for to really make this deal work out.

It's also worth noting that Agilent is buying its way into competing with some heavy hitters. Dako has about 20 to 25% of the immunohistochemistry market, with a giant Swiss competitor holding about half of the market and Danaher's (NYSE:DHR) Leica holding a meaningful share as well. It gets no easier in in situ hybridization, where Abbott (NYSE:ABT) is a real force.

SEE: How To Invest In Private Equity

The Bottom Line
All in all, Agilent's acquisition of Dako is a bold move, and a good use of foreign cash that was otherwise "stuck" overseas unless the Congress passed another repatriation tax amnesty bill. While I do understand the growth potential of molecular diagnostics, cancer diagnostics and companion diagnostics, I am a little concerned that this was a "me too" move by a company that may find it has a lot more work to do once the Dako deal closes.

Although I think a deal for another scientific research equipment company would have been easier, such a deal wouldn't have brought in the potentially lucrative consumables stream, nor the decoupling from capital equipment budget cycles, that Dako should. I'm not wild about the price Agilent is paying, but I still think Agilent is a fine stock that is undervalued today.

SEE: Analyzing An Acquisition Announcement

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Investing News

    What You Can Learn from Carl Icahn's Mistakes

    Carl Icahn has been a stellar performer in the investment world for decades, but following his lead these days could be dangerous.
  2. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  3. Investing

    What Investors Need to Know About Returns in 2016

    Last year wasn’t a great one for investors seeking solid returns, so here are three things we believe all investors need to know about returns in 2016.
  4. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  5. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  6. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  7. Stock Analysis

    The Top 5 Micro Cap Biotechnology Stocks for 2016 (BSTC, OSIR)

    Discover some of the most promising micro-cap biotechnology stocks that investors can consider for their 2016 investment portfolio.
  8. Investing News

    Chipotle Served with Criminal Probe

    Chipotle's beat muted expectations and got a clear bill from the CDC, but it now appears that an investigation into its E.coli breakout has expanded.
  9. Stock Analysis

    Analyzing Sprint Corp's Return on Equity (ROE) (S)

    Learn about Sprint's return on equity. Find out why its ROE is negative and how asset turnover and financial leverage impact ROE relative to Sprint's peers.
  10. Stock Analysis

    Why Alphabet is the Best of the 'FANGs' for 2016

    Alphabet just impressed the street, but is it the best FANG stock?
RELATED FAQS
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center