ilent Pays A Hefty Price For A Fixer-Upper Diagnostics Company

By Stephen D. Simpson, CFA | May 22, 2012 AAA

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.

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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

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

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