Agilent Divests Semiconductor Product Group

By Daryl Inniss, Vice President, Ovum-RHK & Jean Atelsek, Analyst

On Monday August 15, Agilent announced its intent to sell its Semiconductor Product Group (SPG) to Kohlberg Kravis Roberts and Silver Lake Partners for $2.66 billion. The Fiber Optics Product Division (FOPD) is part of SPG; it has the second-largest market share in optical components (OC) and contributes about 15 percent to SPG revenues ($275 million in 2004). The Fiber Optics Product Division has been losing market share for the past five quarters and appears to have lost some shine from its star. By transforming the FOPD from a struggling, non-core slice of Agilent's test and measurement juggernaut into a substantial part of a more focused entity, this transaction may give the business a desperately needed shot in the arm, but the deal itself is not sufficient. Expect to see further announcements related to forging into new markets, discontinuation of products, acquisitions, or further divestitures for this optical components supplier to realize its potential.

After months of speculation, Agilent announced on Monday its intent to sell its Semiconductor Product Group (SPG) to Kohlberg Kravis Roberts & Co and Silver Lake Partners for $2.66 billion. The group's Fiber Optics Product Division (FOPD) has been the second-largest supplier to the global optical components (OC) market for over 2 years, but it has been losing market share for the past five quarters on a rolling 4-quarter basis (see Figure 1). While the news is about Agilent and its restructuring to attack the measurement market, an important sidebar to the story is the consequential impact of divestiture on the Fiber Optics Product Division.

Figure 1 Rolling 4-quarter market share for the top 10 optical component suppliers, 1Q05, and Agilent's rolling 4-quarter market share, 1Q03-1Q05

Source: Ovum-RHK and company financials

The new company will be privately held and jointly managed by the two owners. They are challenged with managing a "volatile" business, as the SPG was described by Agilent's management. The Fiber Optics Product Division recorded annual revenues of $275 million in 2004 and represents about 15 percent of SPG's annual revenues. Its products include Ethernet, Fibre Channel, SONET/SDH, and parallel optics transceivers and transponders.

The resultant business, because it will be run as a smaller entity, has numerous advantages for the FOPD. These include:

• Lower overhead because it is funding business-specific activities
• Continued deep pockets to make necessary capital expenditures for the business
• Management focus on the FOPD because it contributes significant revenue to the new company.

The FOPD is burdened however with high visibility in an extremely competitive and volatile market. Furthermore, it will not have ready access to Agilent's test and measurement resources to help prepare for the next generation of products.

Possibilities include dominating 10G Ethernet market

Given the FOPD's declining performance in the OC market, additional attention from management, based on its more significant contribution to the revenues of the new company, will be welcome. Ovum-RHK believes that further actions will be necessary to further unleash the potential of this division.

Figure 2 illustrates Agilent's Fiber Optics Product Division vis-à-vis other leading OC suppliers based on its financial strength (on the y-axis) and its product/market diversity (on the x-axis).

Figure 2 Comparison of the Agilent FOPD financial strength and product/market diversity relative to its competition

Source: Ovum-RHK
Note: "Product/Market Diversity" represents the variety of products for DWDM, datacom, SONET/SDH, access, and other markets, as well as subcomponent, component, module, and subsystem products. "Financial Strength" takes account of cash or strong financial parent position, market share, and current profitability status.

The FOPD's strength is in Ethernet transceivers, but part of the reason for its declining market share has been price erosion and loss of low-speed module business to low-cost suppliers in Asia. The options for growth include dominating the emerging 10 Gbps Ethernet market, expanding into new areas like WAN DWDM, and/or expanding into access:

(1) Dominating the emerging 10 Gbps Ethernet market appears unlikely, as there are many hungry suppliers and already intense price pressures. The FOPD would have to play catch-up to overtake the early leaders as products based on 10GBase-LX4 are already shipping. However, if the FOPD decides that its best chance of success is keeping with the core business, then delivering to both the Ethernet and the storage markets is what it will do. It will remain a niche supplier to datacom market and will likely continue to lose market share as more low-cost suppliers enter the fray.

(2) Moving into the WAN DWDM market could take the form of either an acquisition or sale of the FOPD. Two excellent candidates for partnership are Bookham or Avanex. While SPG's management currently intends to keep and manage the business, joining with either of these companies would create a formidable OC supplier that would be the immediate market leader.

(3) Expanding into access can be a natural evolution. The need for high-volume low-speed transceivers for PON, for example, fits well in an area of FOPD strength. However, as in the 10 Gbps Ethernet scenario, there are many competitors here.

Divestiture: just the beginning for FOPD Agilent's divestiture of its Semiconductor Product Group can unleash the strength of the group's Fiber Optics Product Division, which currently ranks second in global OC market share. The FOPD's strength in R&D and technology leadership can give rise to developing new products, reducing time to market, particularly to serve the emerging 10 Gbps Ethernet market. The separation from Agilent's test and measurement division can hurt long term, but as they are likely to have an ongoing business relationship the impact may be minimal. But this transaction is not the end of the road. More work is needed to get the division in shape to compete in the OC market. New products, forging into new markets, and acquisitions are all options that must be under consideration. Ovum-RHK does not feel that a product pruning exercise is necessary. However, either leadership in 10 Gbps for datacom or a broader product portfolio, such as could be achieved by entering the PON or DWDM market, are needed to continue to compete with the market leaders. The latter would be best accomplished through merger and acquisition activity with candidate companies such as Bookham and Avanex, which would create an OC market powerhouse.

Daryl Inniss has 15 years of optoelectronics experience. He is responsible for worldwide coverage of pump lasers; erbium, Raman and semiconductor optical amplifiers; dispersion compensators; dynamic gain equalizers; reconfigurable and fixed optical add/drop subsystems; and switch matrices.

Jean Atelsek provides analysis of the optical components market by tracking revenues, market share, and financial transactions in the optical components area. She joined Ovum-RHK as a Senior Editor in 2002.