Research has shown that investing in spin-offs is a proven and consistent way of beating the market. Since massively outperforming the S&P 500 following its separation last year, shares of Keysight Technologies (KEYS) have lagged the market and its former parent Agilent Technologies (A) considerably.
Does the pullback represent a buying opportunity for new investors?
The Business
Keysight is a global leader in electronic measurement tools. Electronic measurement tools are used in a variety of fields including the telecom, aerospace, industrial, and semiconductor industries. The company sells in over 100 countries with 75% of sales being direct to customer.
History
Management
The company was able to secure multiple key employees from its former parent. The current management team has considerable experience with both the industry and the company itself.
While insiders currently own only 1% of the company, this may grow as the business matures and gains a longer trading history.
Growth Opportunities
While many of the company’s underlying markets are still growing, rates are typically in the lower single-digits. Low growth rates however have forced out a significant amount of competitors, allowing Keysight to consolidate its market positions in various key segments. Many of its products are used by a majority of the market worldwide.
In total, the company is part of a $12 billion industry with roughly a 3-4% annual growth rate.
While this may not seem like the most attractive business, its stability has allowed Keysight to take on an attractive capital structure to drive high returns. As of last year, the company generated operating margins of nearly 20% and returns on capital in excess of 30%.
There are many reasons to believe Keysight can continue its dominance in both sales and financial results:
- It has a market leading number of service centers in 30 countries to repair and calibrate customer equipment. This allows it to provide consistent support for multi-national customers at 50+ sites worldwide.
- It has the industry’s leading breadth of products, all designed and delivered by its global team of experts. The company is also one of the few that offer a wide selection of trade-in and certified used product sales.
- The company’s R&D capabilities are also unmatched. It has a 75-year history of creating market-transforming products such as 4G LTE simulation tools and UXG signal generators.
Guru Ownership
Already, shares are owned by a variety of Guru’s including David Einhorn (Trades, Portfolio), Joel Greenblatt (Trades, Portfolio), and Paul Tudor Jones (Trades, Portfolio). Recently, Zeke Ashton (Trades, Portfolio) and Robert Olstein (Trades, Portfolio) made sizable purchases.
Valuation
This year, analysts are expecting $2.34 in EPS off of $2.8 billion in revenue. This would imply that shares only trade for 13.9x this year's earnings.
Using GuruFocus’ Reverse DCF Tool, we can estimate that investors are currently only pricing in 3-4% annual EPS growth over the next ten years. This is roughly the growth rate of Keysight’s underlying markets. This implies no share gains by the company, and no ability to drive higher profitability through cost-cutting measures.
In 2016 alone, analysts are expecting the company to grow earnings by roughly 8% over 2015 levels. If this rate of EPS growth is more indicative of the company’s potential, shares would be about 26% undervalued.
Conclusion
While many investors may shirk Keysight’s meager organic growth rates, there aren’t many investment opportunities out there today that offer a reasonable valuation. The recent dip in Keysight shares could present a long-term opportunity for patient investors.
For more ideas like this one, check out GuruFocus’ Spin-Off List or the rest of R. Vanzo’s Articles.
