Company Overview: Keysight Technologies Inc. (NYSE: KEYS) is involved in the manufacturing of electronics test and measurement equipment and software. The company was incorporated on December 6, 2013, in Delaware and aids enterprises, governments and service providers accelerate innovation to connect and secure the world by delivering electronic design and test solutions. These solutions are used in the simulation, design, validation, manufacture, optimization, installation, and secure operation of electronics systems in the communications, networking, and electronics industries.

KEYS Details

Increased Investment & Strength in Software-Centric Solutions to Support the Growth: Keysight Technologies Inc. (NYSE: KEYS) is engaged in providing electronic design and test instrumentation systems. In FY19, the company generated non-GAAP revenues of $4.312 billion. Commencing from 1QFY20, the company’s financial reporting comprises two segments namely Electronic Industrial Solutions Group (EISG) and Communications Solutions Group (CSG).  Under CSG segment, KEYS offers radio frequency (RF) and microwave test instruments and allied software, and electronic design automation (EDA) software instruments, and other software solutions. EISG accounts for design verification devices; general purpose test and measurement equipment, and material analysis devices.

Robust demand for the company’s solutions in process node technology testing, considering semiconductor vertical and increase in investments in next-generation energy technologies and impetus in first-to-market solutions, is likely to be a tailwind, going forward. Markedly, impetus in semiconductor sphere and deal wins from NVIDIA, QUALCOMM Incorporated, Viomi Technology, DEKRA, CETECOM, Audix remain noteworthy.

Moreover, incremental adoption of the company’s latest LoadCore offering, a 5G core network testing solution, that simulates complicated real-world subscriber models, is likely to aid revenues in the coming quarters. Furthermore, the growing usage of electronics-based testing equipment across medical devices and pharmaceutical markets may benefit the performance of the company, going forward. Additionally, as employees are being compelled to work from home due to the COVID-19 pandemic, there is an expanding demand for high-speed connectivity, which is likely to bolster the adoption of the company’s 5G testing solutions.

Over the last five years, the company remained on track to execute several strategic initiatives that resulted in strong, long-term value creation for shareholders, customers, and employees. The company also transformed its business model from hardware-centric products to software-centric solutions, which is a key positive. It also focused to make higher strategic acquisitions and increased investment in R&D, with a vision to attain its long-term market growth trends. The Keysight Leadership Model, and its operating framework for continued value creation has focused the organization on enabling the success of its customers. This customer-centric approach has aligned KEYS with key long-term secular growth trends in 5G, next-generation automotive, networking, IoT, and defense modernization.

KEYS is set to gain from the strength of its software-centric solutions, across multiple dimensions of the business. Over a period of FY17-FY19, the company saw a CAGR of 15.2% in revenue. Moreover, the company’s non-GAAP EPS stood at $4.72 in FY19, up from $2.53 per share reported in FY17. The company remains focused on enhancing its overall cost structure and raising the mix of high-value solutions in its portfolio. This, in turn, can lead to high margins in the long term.

Past Performance (Source: Company Reports)

3QFY20 Key financial Highlights: During the quarter, the company reported non-GAAP earnings of $1.19 per share, down 4.8% from the year-ago quarter. Non-GAAP revenues stood at $1.011 billion, down 7% on pcp. Non-GAAP core revenues (excluding the impact of currency and revenues from acquisitions in a year’s time) stood at $1.007 billion, which was also down 7% year over year. The coronavirus crisis-stimulated weakness in automotive and general electronics sectors, along with slow spending across Europe, which mainly led to the year-over-year drop. However, KEYS rides on improving supply chain management, accelerated 5G deployment, and demand recovery across Asia Pacific. Non-GAAP gross margin for 3QFY20 stood at 64.5%, which expanded 110 basis points (bps) year over year. During the quarter, the company’s non-GAAP operating expenses were down 6.5% to $388 million. Non-GAAP operating margin stood at 26.1%, up 90 bps on year over year basis.

Segmental Highlights: During the quarter, CSG revenues declined 4% year over year and came in at $760 million. CSG contributed 75% to total non-GAAP revenues in 3QFY20. However, CC revenues went up 2% year over year due to robust 5G order. Further, higher government spending and impetus in investments targeted at technology development across the United States were few positives. Revenues from EISG went down 15% year over year, primarily due to coronavirus led crisis. However, management observed momentum in first-to-market solutions, and robust demand for its solutions in process node technology testing, in semiconductor end-market. During the reported quarter, the company finalized the acquisition of Eggplant from The Carlyle Group with an objective to improve software test automation capabilities. 

Geography Highlights: During the quarter, non-GAAP revenues from Americas went down 18% and stood at $365 million, on sluggishness in CC and EISG domains, due to COVID-19 led disruptions. Non-GAAP revenues from Europe also declined 13% year over year and came in at $159 million. However, non-GAAP revenues from the Asia Pacific improved 5% on a year-over-year basis, due to robust strength in order demand across CC and EISG, which more than offset the weakness in ADG domain.

Segment and Region Highlights (Source: Company Reports)

Balance Sheet & Cash Flow Highlights: The company exited the quarter with a cash balance of $1.697 billion, which indicates the impact of $319 million of expenses pertaining to the acquisition of Eggplant. At the end of the quarter, KEYS also had $450 million of additional liquidity available for use under an unused revolving credit facility. Long-term debt at the end of the period amounted to $1.789 billion. Cash flow from operations stood at $183 million, whereas free cash flow amounted to $151 million. 

Latest Key Updates:

• On 26 August 2020, the company announced that the company’s 5G device test solutions have been chosen by Jabilto address the demand for 5G product validation in design and manufacturing.

• On 19 August 2020, the company’s connected car test solutions have been implemented by China FAW Group Co, Ltd (or FAW) to test cases for performance and dependability of devices, applications and entire vehicle-to-vehicle (V2V) along with in-vehicle communications networks.

• On 18 August 2020, the company stated that Korea-based Telecommunications Technology Association (TTA) has selected KEYS’ 5G device test solutions to offer radio resource management and 5G new radio frequency conformance validation services. 

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together forms around 40.35% of the total shareholding. The Vanguard Group, Inc., and T. Rowe Price Associates, Inc. hold the maximum interests in the company at 11.52% and 7.13%, respectively.

Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)

Key Ratio Metrics: KEYS reported Apr’ 2020 quarter’s gross margin at 57.7%, higher than the industry median of 34%. The EBITDA margin, during Apr’ FY20, stood at 20.4%, higher than the industry median of 10.3%. Net margin, in the same time span, stood at 7.9%, higher than the industry median of 1.8%.

Key Metrics (Source: Refinitiv, Thomson Reuters)

Key Risks: The coronavirus outbreak led global supply chain disruptions and macroeconomic challenges are expected to negatively impact the company’s near-term prospects. Also, lower international spending due to the ongoing COVID-19 scenario is likely to hurt the company’s prospects in the aerospace, defense & government end-markets. This, in turn, might dampen growth in Electronic Industrial Solutions Group (EISG) segmental revenues. Further, stiff competition from its peer group adds to the woes.

Outlook: Keysight Technologies Inc. is enhancing its production and services operations and expects returning to 100% capacity by the end of 4QFY20, even though persistent supply chain disputes. For the coming quarter, the company expects revenues to be in the rage of $1.17-$1.19 billion. Non-GAAP EPS (Earnings Per Share) is projected to be in the ambit of $1.42-$1.48. Robust adoption of the company’s advanced PathWave Test 2021 software holds potential. Also, the adoption of the latest support solutions, including Keysight Care, is likely to lead to gross margin expansion, going forward.

Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)

Valuation Methodology: EV/EBITDA Multiple Based Relative Valuation (Illustrative)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

Stock Recommendation: The stock of KEYS closed at $98.07 with a market capitalization of ~$18.4 billion. The stock made a 52-week low and high of $77.93 and $110, respectively, and is currently trading above the average of its 52-week trading range. The stock gave a negative return of ~4.39% in the past three months. The company is well placed to capitalize on the rising demand for its semiconductor measurement solutions driven by the commitment of semiconductor companies to build chips on next-generation process technologies. Considering the above factors, we have valued the stock using an EV/EBITDA multiple based illustrative relative valuation method and arrived at a target price of an upside of lower double-digit (in % terms). For the purpose, we have taken peers like National Instruments Corp (NASDAQ: NATI), Teradyne Inc (NASDAQ: TER), and Viavi Solutions Inc (NASDAQ: VIAV), to name few. Considering the above factors, we recommend a “Buy” rating on the stock at the closing price of $98.07, up 0.5% on 26 August 2020.

KEYS Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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