Last summer, I concluded that shares of Keysight Technologies (NYSE:KEYS) were getting into my sight. Shares fell to 52-week lows as results fell short compared to expectations, amidst a decline in the order intake.
Fast forwarding nearly a year in time, Keysight continues to struggle with lackluster order intake, hurting sales and margins as well. Amidst an interesting deal recently announced, I am still upbeat on Keysight over the long haul, although a return of growth would be greatly welcomed.
Keysight – Connect & Secure The World
Keysight is a $5.4 billion business which aims to accelerate innovation to secure and connect the world. The company reports its results across three segments, with commercial communications responsible for pretty much half of sales. This is complemented by a 30% contribution from the electronics industrial business, with the remainder of sales coming from aerospace, defense and aerospace markets.
The company provides a huge and diversified range of products including oscilloscopes, analyzers, meters, software, wireless products, generators, modular instruments, network & test equipment, among others.
In terms of geographic exposure, some 40% of sales are generated in the Americas, as well as Asia Pacific, with Europe being responsible for about a sixth of total sales. The company employs some 15,000 workers, which serve over 30,000 customers across more than 100 countries all over the world.
The company is well positioned and a profitable business. The company posts operating margins close to 30% of sales as the company has seen a very strong ride over the past decade. Over the past 8 years, the company essentially doubled sales while it grew operating margins from high-teens to high-twenties. All this resulted in the company essentially tripling earnings per share to about $7.50 per share.
This has created quite a profitable run for shareholders after the business was spun off from Agilent (A) back in 2014, at the time being a $30 stock. Shares peaked around the $200 mark late in 2021, but ever since, shares have mostly traded in a $125-$175 price range.
Picking Up The Case
In November 2022, the company posted its results for the fiscal year 2022. Revenues rose by 10% to $5.42 billion, with adjusted earnings reported at $7.63 per share. After adjusting for stock-based compensation expenses, earnings came in around $7 per share. The order intake was reported up 10% to $5.98 billion, adding to a non-quantified backlog.
While revenues grew in the first quarter of 2023, the order intake was on the reverse, with book-to-bill ratios coming in below 1 times. The company announced an EUR 913 million purchase of French-based ESI Group early in the summer., acquiring a virtual prototyping solutions provider in automotive and aerospace markets. With a mere EUR 140 million revenue number, sales multiples of 6.5 times were somewhat demanding.
The real shock came in August, with third quarter sales being flat at $1.38 billion, yet the order intake was down 15% to $1.24 billion, weighing on the near term sales outlook. At $129, Keysight commanded a $23 billion equity valuation, as the company operated with a largely flattish net cash position (accounting for the deal for ESI). With ESI adding about 2% to pro forma sales, the balance sheet being net unleveraged, and shares trading at a realistic 17 times earnings multiple, I liked the prospects for Keysight here, aided by a strong track record is as well.
Stagnation
Since last summer, shares actually showed a quick near 25% recovery to $160 per share by year-end as shares still traded at these levels in May. In recent weeks, shares have tumbled to $135 per share, mostly related to softer second quarter results.
In November of last year, Keysight posted 2023 sales at $5.46 billion, up less than a percent on the year before, as the full year order intake was down 13% to $5.19 billion. The company managed to grow adjusted earnings from $7.63 per share to $8.33 per share and after backing out a pre-tax stock-based compensation expenses of $0.76 per share, I peg realistic earnings close to $7.75 per share.
The company reported a net cash position of around three quarters of a billion, but still ahead of the deal with ESI. The company only outlined a first quarter guidance, yet with revenues seen at a midpoint of $1.245 billion, that was not too inspiring.
The tender deal for ESI gave Keysight a greater than 98% equity stake in ESI as announced in January, as some bright news could be welcomed. After all, Keysight posted a near 10% fall in first quarter sales to $1.26 billion, as orders fell further to $1.22 billion. This really impacted the results on the bottom line as well, with adjusted earnings down from $2.02 per share to $1.63 per share. Moreover, Keysight guided for second quarter revenues to come in at just $1.20 billion, as the softness in the order intake continued.
In May, Keysight posted second quarter sales at $1.22 billion, just ahead of the guidance, but still down over 12% year-over-year. The order intake of $1.22 billion was roughly at par compared to the lower revenue base, marking the first time in quite a while that the book-to-bill ratio exceeded 1. With adjusted earnings reported at just $1.41 per share, adjusted earnings trend at just $6 per share.
The company does not expect an imminent recovery, guiding for third quarter sales at a midpoint of $1.19 billion.
Another Deal
With the 175 million shares of Keysight commanding a $23 billion and change market value, and a similar enterprise value amidst a flattish net debt load, the company is engaging in M&A (again) in order to ignite growth.
In March, the company made a 199 pence per share offer for UK-based Spirent in a $1.46 billion deal, in a transaction equal to about 6% of the market value of the firm here. With the deal, Keysight will add automated test and assurance solutions for networks and cybersecurity, among others.
The pro forma $1.5 billion net debt load is perfectly manageable given the still solid earnings power of Keysight. The deal is quite interesting as Spirent is a substantial business which posts nearly half a billion in sales, adding about 10% to pro forma sales, although that sales were down meaningfully in 2023, as the same applied to margins.
What Now?
The truth is that current earnings power will be quite impaired. The company could be lucky if adjusted earnings come in at $6 per share this year, which makes that realistic earnings only trend around $5.50 per share if we strip out stock-based compensation expenses. This pushes up the valuation from a market multiple around 18 times to about 25 times earnings, due to a tougher year.
The reality is that the current weakness is taking a bit long for my taste, as it seems that some execution issues might be at play here as well. The reality is that we see similar trends at more companies here, so we can not be too harsh on Keysight here.
The long-term thesis does not look impaired, as I expect a real profit rebound in 2024. Moreover, the latest Spirent deal looks quite compelling, as the company is able to effectively use the balance sheet to buy a somewhat challenged peer at quite an appealing sales multiple.
Amidst all this, I remain quite constructive on the shares, and after having bought a small stake in the $120s in the summer last year, shares have been trading largely stagnant. It is clear that the recovery will take longer than expected, but shares still look compelling given the long-term promise.
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