Takeaway: We are open to believing in the 5G story, meanwhile almost everything else at KEYS organically declines. KEYS remains a bench Short.

KEYS reported F1Q18 earnings yesterday. We have no directional call on the undulation of revenue due to forest fires and we are waiting to get past this unusual period.

We do think F2Q18 revenue guidance will be tough to beat, and maybe a high water mark for the year. Certainly growth rates will come way down post April-Q as we anniversary the Ixia transaction.

Overview:

Generally speaking, a lot of P+L realities are laid bare when M&A comps lapse, kind of like the tide going out. Despite management talking about Ixia as a grower, for example, the truth is that Ixia revenue was flat y/y at $127m of revenue in F1Q18 (Ixia reported $128m in Dec-Q 2016). At some point the truth becomes hard to avoid.

The net is while we are much more open to believing in 5G growth in F18-F19 than we were in F17, we continue to see that most everything else at KEYS organically declines, leaving 5G as a Pyrrhic victory, with revenue growth mainly supported by 5G plus tuck-in acquisitions. And more acquisitions mean that it may be a long time before management can fulfill the promise of cash return.

Despite all the bluster from management about de-levering, the biggest net debt paydown came post acquisition using Ixia’s cash to retire some of the newly borrowed debt. Since then, net debt has only improved by $86m. Why doesn’t anyone else notice that? Seriously, I feel like I am taking crazy pills. Why does management shout from rooftops about their awesome debt de-levering when it amounts to net $86m over three full quarters?

Summing it up:

The bull case for investors in KEYS is 5G growth + Cash Return. The former is nice but total company growth rates will be dragged down by everything else that declines. And the latter can't happen because the cash is needed to keep the growth funnel going. 

Our view:

We like the idea of investing in companies with exposure to the 5G investment cycle. A lot. We think it is time to take a serious look at Ericsson and other companies in the food chain. But in this case, the rest of the KEYS pile of revenue struggles, management made a mess with Ixia, and is boasting about their cash return potential prematurely as they will need balance sheet cash to keep growth going.