How many of you have shares of stock in a company that you never intended to purchase? I have a surprisingly large number of equities in companies I never directly purchased, and they vary in their relative makeup of my portfolio from less than 0.1% to more than 6%. So, how did this sloppy investing occur?
One of my earliest investments was a speculative play in Westinghouse. At the time, the company was facing enormous problems with fixed price uranium supply contracts for customers of its nuclear power plants. The nuclear business was eventually sold, and Westinghouse subsequently purchased CBS and changed its name from Westinghouse to CBS. CBS was merged with Viacom relatively recently, and became ViacomCBS (VIAC). I doubt that I would ever have considered picking Viacom or CBS for my portfolio, but it’s now there.
This would happen again with PepsiCo (PEP), a core holding of mine for decades. The company decided it was losing too large a volume of core beverage and snack food sales to thousands of pizzerias, sub shops or luncheonettes because those small businesses viewed PepsiCo as the competition due to Pepsi’s ownership of KFC, Pizza Hut and Taco Bell. It spun the three restaurant groups out to shareholders as Tricon Global. As the shares of Tricon Global spiked, I sold a covered call against the position and almost all of the shares were called away. Tricon Global subsequently changed its name to Yum! Brands (YUM), and Yum decided to separate out its business in China as Yum China (YUMC). I currently hold small positions in both Yum companies, and again, these were stocks I would have been unlikely to select.
The most confusing of all of these situations was my purchase of shares of the original AT&T in the 1980s. A series of court-ordered antitrust mandates separated the company into seven Regional Bell Operating Companies (or RBOCs) for local service, while AT&T held onto the long distance business, along with its manufacturing arm (which later became Lucent Technologies) and Bell Labs. AT&T, as part of these decrees, would subsequently spin out Lucent in return for permission to sell computers, and AT&T would eventually acquire NCR. As a result of these actions and a series of subsequent acquisitions, mergers and divestitures, I eventually wound up with shares in all of these companies, as well as Comcast Class A (CMCSA), my second largest holding, a variety Liberty Media companies and even ADRs in foreign entities after Lucent was acquired by Alcatel, which was later merged into Nokia (where I currently have a small position).
All too often the positions were too small to warrant my attention, which brings us closer to the subject of this article – Keysight Technologies (KEYS). I was employed at AT&T as the company continued to acquire and divest pieces of itself. As a result of one of those divestitures, Hewlett-Packard acquired a piece of AT&T’s UNIX System Laboratories, and I found myself working for HP. Like many of my fellow employees, I participated in HP’s 401-k program and began acquiring HP stock. By 1998, HP would begin the process of splitting itself into two separate companies – Hewlett-Packard and Agilent Technologies (A).
A Quick Historical Perspective
Interestingly, Agilent, the test and measurement business of HP, was much closer to the original company started by Bill Hewlett and David Packard. That business would be the first Silicon Valley technology giant, and the garage where they designed and built their first test and measurement product is now a historical landmark. However, since the computer business was much larger than the test and measurement business by the late 1990s, the computer business kept the name associated with its founders. Agilent eventually had its initial public stock offering (or IPO) at $30 on November 18, 1999, and raised $2.1 billion, then a record IPO for a Silicon Valley company.
Since I had been in the HP 401-k plan, I also ended up owning a small position in Agilent. Both companies became incredibly overvalued during the dot-com bubble of the late 1990s into early 2000. By March of 2000, the shares of Agilent would spike to nearly $116, not long before the dot-com bubble would burst.
I held onto both positions far too long. At some point I sold most of my HP shares, but by late 2016 the few remaining shares would be split into two separate equities – HP, comprised mostly of the printer and personal computer businesses, and Hewlett Packard Enterprise (NYSE:HPE). Agilent would soon follow suit, spinning off part of its business as Keysight Technologies. And, on
Nov. 1, 2014, in a special dividend distribution of all outstanding shares of Keysight’s common stock, Agilent shareholders received one share of Keysight common stock for every two shares of Agilent common stock held as of close of business Oct. 22, 2014.
The shares of Keysight began trading at just under $28 per share. Last Friday, the Keysight shares reached an all time high of $118.99, before closing the day at $116.77. In just over six years, the shares of Keysight had risen ~325%, and its market cap at the end of last week had risen to $21.5 billion. And, by the way, the market cap of Agilent closed the week at $34.2 billion. The combined value of these former test and measurement businesses of HP was $55.7 billion, far exceeding the $41.6 billion combined value of HP, Inc. ($13.5 billion) and Hewlett Packard Enterprise ($28.1 billion).
More importantly, from my perspective, the combined market value of my positions in these two test and measurement equities now represents my sixth largest holding. Despite being an inveterate procrastinator, it’s a combined position I can no longer afford to ignore.
Like many senior citizens, dividend income has become an important criterion over the past few years when deciding where to invest. For instance, the recent changes in my portfolio included adding large new positions in the dividend aristocrats 3M (MMM) and Caterpillar (CAT), and the high yielding REIT, Arbor Realty (ABR). Today, it is highly unlikely that I would even consider investing in either Agilent or Keysight.
that its board of directors has increased the company’s quarterly dividend to 19.4 cents per share of common stock. The dividend reflects an 8% increase over the previous quarter.
The 8% increase was certainly nice, but the forward yield is still a meager 0.73% and wouldn’t have been enough to pique my interest. Now that I own it, and can see a steadily increasing dividend, and remembering that I’m a procrastinator, I won’t be in a hurry to make an immediate decision. More complicated is my decision about what to do with Keysight. I now own stock in a company that would not have attracted my attention, having never even paid a dividend. Should I sell my position in Keysight? And why am I even asking the question?
Buy, Sell, or Hold Keysight?
Last week Keysight reported results for its fiscal year ending October 31st. Under normal circumstances, the results and announcement would have been considered good for most companies:
Achieved Record Orders, Revenue, Gross Margin, Operating Margin, Free Cash Flow
Announces $750 Million Share Repurchase Program
(It should be pointed out that the record revenue referenced above was for Q4 only, and that the full-year revenue declined by 2%.)
Despite a small annual revenue decline, when one considers that these results were achieved in a year that saw so many disruptions due to the impact of COVID-19, it’s easy to classify the results as better than simply “good.” After seeing the company’s record results, I was mildly disappointed by the company also highlighting a new share repurchase program of $750 million and the successful completion of its previous share repurchase program. Keysight reported that it had
…acquired approximately 4.3 million shares in the open market at an average share price of $95.90, for a total consideration of $410 million during fiscal year 2020, exhausting the $500 million share repurchase authorization from May 2019.
I suppose that it’s a positive that the company spent less per share than the current share price, but does it really benefit me? Here’s an exchange from the Q4 conference call held last week:
Jim Suva [Citigroup] – And just housekeeping for the stock buyback, is it meant to just keep share count relatively flat and offset dilution, or is it actually meant to bring the share count down?
Neil Dougherty [Senior VP and CFO]
…So first of all, obviously, we’ve made a commitment to at least at a minimum be anti-dilutive with our buyback programs and we will continue to do that. But just as you saw with us in Q4, and frankly, over the course of FY 2020, we will be opportunistic when those approach. And so, we were very pleased to take 4.3 million shares off the market at an average price somewhere around $96 this year bringing the share count down.
…at a bare minimum, you can count on us to keep the share count constant. We did say in our prepared remarks that we expect in FY 2021 our share count to be 188 million shares, which is flat. So that’s our base case we’re modeling. When I think about capital — priorities for capital beyond share repurchase, we continue to have an active M&A funnel development process. We continue to look for ways to put money to work through M&A and assets that are accretive to growth, accretive to gross margin, much like the acquisition that we did of Eggplant at the end of last quarter. So, no real change for our capital allocation priorities at this point in time.
It was disconcerting, although not totally surprising, to realize that the objective was to keep the share count relatively flat. A number of years ago I came across a study of share buybacks by Credit Suisse (NYSE:CS) that noted:
All too often companies repurchase shares at prices that are too high, or subsequently issue new shares as part of executive compensation plans.
The above-referenced study, while somewhat dated, is worth a read. I haven’t gone into the details of the Keysight executive compensation plans, nor have I calculated how many shares may have been used for acquisitions over the years. Regardless, the above exchange between Suva and Dougherty would seem to indicate the only so-called benefit from buybacks to shareholders is that their percentage of equity in the company won’t be reduced. For the executives, it is likely to be far more beneficial.
But here’s something else for investors to consider – if the company had used the $500 million to pay a special dividend, the less than 200 million shares outstanding would have resulted in a dividend of more than $2.50. And what about the proposed $750 million buyback? How much of a dividend could that fund? As someone that is currently more interested in dividend income, I would have preferred an announcement that a regular quarterly dividend was being started.
For those that are more focused on potential capital appreciation, Keysight appears to be well placed to benefit from many of the highly publicized technology growth areas. A partial list of their offerings include “solutions” for 5G, Cloud, Internet of Things, Connected Car, Network Security and Data Center Infrastructure. For those concerned about debt or the balance sheet, just over a year ago the company announced
the pricing of an underwritten, registered public offering of its senior unsecured notes in an aggregate principal amount of $500 million. The notes will mature in October 2029 and will bear interest at an annual rate of 3.000 percent.
The rate was certainly attractive, and Keysight used the net proceeds of that offering to repay its $500 million of 3.30% senior notes due October 30, 2019. Perhaps even more important was finding that Keysight had $1.8 billion in cash on the Balance Sheet as of the end of October 2020. With all of these positives, should I be bullish? What about the future? Well, last March the company announced it was increasing its long-term targets, and on the recent call Ron Nersesian, Keysight’s Chairman, President & Chief Executive Officer, reiterated that:
our long-term outlook for revenue and earnings growth is strong, and we haven’t wavered from our pre-COVID long-term financial commitments and growth expectations announced in March of this year.
Those financial commitments delivered last March were:
Based on the Company’s strategic execution to date and strong momentum, Keysight increased its long-term operating model expectations.
- Organic revenue growth is now expected to be sustainable at a 4 to 6 percent CAGR, compared with the prior model of a 4 to 5 percent CAGR.
- Non-GAAP operating margin is now expected to be in the range of 26 to 27 percent by no later than 2023, compared with the prior model of 21 to 22 percent.
- Non-GAAP earnings per share is expected to grow greater than or equal to 10%, in line with the prior model.
The power of Keysight’s leadership model and our execution this year underscore our ability to deliver on these commitments which includes 46% long-term core revenue growth and achieving 26% to 27% sustainable annual operating margin by no later than fiscal year 2023.
All of these positives, and I am only slightly closer to a decision. Do I buy more, should I simply hold or should I sell? I won’t be adding to my position because there is no dividend. Hold? Even if there were a small and growing dividend, I might be tempted, but I don’t believe that’s a realistic alternative at this time. Or, I could sell the entire position, or a portion thereof, and invest the proceeds in dividend-paying stocks.
Or I could opt for some sort of middle ground with “substitute dividend” income. How? I would create my own “dividend” income by selling an out of the money covered call. The January 15th calls with a $125 strike price could be sold for close to $2 per share. If I could do that a few times per year, I would have a reasonable “substitute dividend” yield. While I could also “lose” the 100 shares (each option contract is for 100 shares) at any time for the $125 strike price, it seems a risk worth taking. If the shares were to rise to that $125 price, I would have already seen an increase of more than 6% in just two months and would have pocketed the $200 of call premiums as a substitute dividend. I could then invest the $12,500 in a true dividend stock.
I haven’t made a decision yet, but am currently leaning towards a middle ground – holding the position while selling a call on half of it. And, if I do decide to go with this middle ground, I’m guaranteed to be at least half wrong.
Seeking Alpha requires authors to issue one of five ratings on the equity we examine – very bullish, bullish, neutral, bearish or very bearish. Despite my view that the shares are somewhat overvalued, I will be choosing bullish. It’s the only way I can justify executing the strategy I have laid out.
Disclosure: I am/we are long A, ABR, CAT, MMM, PEP, YUM, YUMC, HPE, T, KEYS, CMCSA, VIAC, NOK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am currently long almost every stock mentioned in this article, and in most cases, if the stock pays a dividend, I will reinvest it. I may be writing a call option against my KEYS shares at any time