February 11, 2010 - 12:59pm EST by
2010 2011
Price: 9.50 EPS $0.00 $0.00
Shares Out. (in M): 15 P/E 0.0x 0.0x
Market Cap (in $M): 138 P/FCF 0.0x 0.0x
Net Debt (in $M): -56 EBIT 0 0
TEV ($): 82 TEV/EBIT 0.0x 0.0x

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We believe Keynote represents an incredibly cheap and timely investment opportunity in a market-leading, niche business trading for an adjusted EV/EBITDA multiple of 2.9X and a free cash flow yield of 16% on distressed earnings with non-core asset value (net cash + value of headquarters) collateralizing 70% of today's price. Additionally, the Company's closest competitor, Gomez, which was initially slated to go public in 2009, was recently acquired by Compuware for $295 million, or 5.4X revenues (KEYN currently trades for an EV/Sales multiple of 1X). Gomez & Keynote operate nearly identical businesses with similar market share within the internet test & measurement space. With a critical inflection point on the horizon in their core internet T&M business, an emerging mobile T&M segment on pace to grow revenues 20% yoy with no competition, and significant downside protection in the form of cash and real estate, we believe KEYN's risk/reward profile is heavily skewed in our favor.

Scenario Analysis:

($, MM) Bear Case Base Case Bull (Gomez) Case
Net Cash 55.9 55.9 55.9
Corp HQ  22.0 41.0 41.0
   Methodology Book Value 10% Cap, $25/sqft 10% Cap, $25/sqft
Internet T&M 48.6 121.6 262.4
   Methodology* 1X Sales 2.5X Sales 5.4X Sales**
Mobile T&M 32.4 81.1 81.1
   Methodology 1X Sales 2.5X Sales 2.5X Sales
Total Value 158.9 299.6 440.4
Common shares 14.5 14.5 14.5
options 4.8 4.8 4.8
strike 11.65 11.65 11.65
FD Value/share***: $10.96 $18.42 $25.72
Implied Upside: 15.4% 93.9% 170.7%
*SaaS Peer Group mean and median EV/S of 4.2X and 4.0X, respectively.  Group includes OMTR, BBBB, CTCT, N, RNOW, CRM, SFSF
**KEYN's identical comp in the internet t&m segment, Gomez, was recently acquired for 5.4X Sales by CPWR
***Assumes T-stock Method.  Ascribes no value to $87MM in State/Federal NOL's or implied $43 in NOLs' from building

Business Description:
Keynote develops and sells internet and mobile test and measurement solutions, primarily software, to any and all companies with a presence online. Since 1995, Keynote has been providing performance measurement data and testing capabilities that allow companies to better understand and improve their customers online and mobile experience. Keynote has two core target markets: Internet Test & Measurement and Mobile Test & Measurement:

Internet Test & Measurement (60% of TTM Revenue):
Keynote pioneered the internet test & measurement business, having spent in excess of $100 million in software development costs, R&D, and infrastructure over the last decade. In its simplest form, Keynote's software solutions allow companies with a presence online to enhance the end customer's experience and trouble-shoot URL specific performance issues that could result in lost revenues, diminished brand value, waning customer loyalty, and reputational impairment. Examples include a retailer whose website is experiencing slow load speeds or excessive downtime due to increased traffic around the holiday shopping season, or a slow/defective online banking portal for a major financial institution. The impetus for Keynote's services stems from the principle that you can't test or monitor a website from behind your firewall. Web-server locations create a dynamic where users receive different online experiences from different locations.

So how does the process work? Keynote operates as the largest on-demand internet test and measurement company in the world, with market-leading infrastructure of over 3,000 strategically placed measurement computers connected to 240 major internet backbone and last mile locations around the world. This enables Keynote to collect, analyze, diagnose and disseminate web application and transaction response times, data availability, load testing, streaming data, VOIP, and performance problems, among others. They primarily operate a software-as-a-service (SaaS), subscription-based business model, with 88% of sales generated on a subscription basis with contract lengths of anywhere from 1 month to a year. Keynote currently tests over 19,000 distinct URL's for many of the top websites in the world, including American Express, JP Morgan, Disney, eBay, E*trade, Microsoft, Sprint, Verizon, Youtube, Facebook, etc. Keynote's internet test and measurement division's growth is primarily driven by three factors: online page growth, the acceptance of the internet as a mechanism to transact, and the stability of per page pricing (more on this later).

Mobile Test & Measurement (40% of TTM Revenues):
Keynote's mobile segment is the industry standard for network and on-device testing and monitoring of mobile voice and data content. Keynote's mobile software and services solutions are primarily sold to telecommunications carriers or major mobile providers via subscription or perpetual license. Keynote's software, which is supported by hardware probes and tracking devices along cell towers, enables telecom companies to test the quality of mobile content (think smartphones) through various coverage regions around the world. Keynote has a suite of products that can test and trouble-shoot response times and availability of wireless data services and mobile applications, including web browsing, text messaging, picture messaging, and streaming video, among others. Keynote has the ability to test over 1500 real or emulated mobile handsets (including the iphone and blackberry family) on over 200 mobile networks in 70 countries around the world. After entering this market in '06, Keynote has been able to grow revenues by over 75%, with expectations of 15-20% growth per annum for the foreseeable future. Keynote enjoys no meaningful competition in this market. The company is well positioned to benefit should smart phones evolve into mediums where consumers transact and download data/web pages on a regular basis.

Internet T&M Inflection Point Approaching:
While the mobile segment of KEYN's business continues to growth at a healthy double digit clip, the Internet T&M business has been somewhat of a disappointment over the last half decade. Keynote has been facing significant pricing pressure driven by their chief competitor, Gomez. The average monthly revenue per page charged by Keynote has dropped from near $280/page in early 2004 to $110/page today. While volume (as measured by the number of pages tested) has risen by approximately 25% per year, this is being more than offset by pricing declines of nearly 30%/yr. However, after several years of pricing battles, it finally appears as though pricing is stabilizing, leading to a critical inflection point in the internet segment. On their F1Q10 conference call (1/27/10), CEO Umang Gupta stated the following as it relates to Keynote's internet test & measurement division:
• Having said everything, I can tell you I expect in this remaining-the remaining quarters of the fiscal 2010- to start to grow that line too. So while [core internet t&m revenues] went down for about four quarters, this quarter I believe was pretty much the last.
• But in the next quarter, the quarter ended March, I expect [core internet t&m revenues] to be going back least all our early indications are they should as long as the economy cooperates. And if they do, there is only two things that matter in determining how fast they go up. How many URL's you sold, and what is the price per URL.

If the Company's predictions are accurate, assuming historical volume increases, we should begin to see revenue growth in their core internet t&m business within the next few quarters, with future expectations of at least mid-teens revenue growth on the horizon. We believe that a return to growth in this segment will put Keynote back on the map.

Gomez Acquisition by Compuware (ticker: CPWR):
After many of the smaller players in the internet T&M space were either acquired (i.e. HP's acquisition of Mercury) or dissolved due to competitive pressures over the past decade, the market share battle came down to a two horse race: Keynote & Gomez. Gomez's scaled down, self-service, commoditized internet t&m software platform offered customers a more economical internet testing platform. Both Gomez and Keynote have similar SaaS based, tiered pricing models. However, Gomez's cheaper offering and unified marketing effort helped the company steal market share from Keynote. After several discussions with web analytics consultants and former Gomez employees, all parties agreed that Keynote's internet test and measurement platform is the most technologically advanced, accurate, and feature-rich in the industry. Gomez's ability to outgrow Keynote over the past five years was more a function of aggressive pricing and a more successful marketing campaign. Gomez's five-year revenue CAGR of 32% attracted the likes Compuware, who decided to spend all of the cash on their balance to buy Gomez on 11/9/09 for $295MM, or 5.4X sales. This compares to Keynote's EV/Sales multiple of 1x, or more accurately 0.6x adjusted for non-core asset value. We find it hard to believe that Gomez's platform is worth in excess of 5X that of Keynote's given the following:
• The two have identical market share in the industry
• Both have identical pricing models with similar adjusted gross margins (ex-KEYN consulting drag on margins)
• Based on our review, as well as the impression of several outside web analytical consultants and former Gomez employees, Keynote' suite of services/solutions is far more robust and feature rich than Gomez
• Keynote's new marketing strategy and renewed focus on smaller enterprise clients that they have historically ceded to Gomez
• Keynote's recent success in stealing clients from Gomez. In the hallway of their corporate headquarters there are two walls filled with recent customer adds that were formerly Gomez clients.
• KEYN's net cash and non-core asset value worth approximately $100MM

Non-core Asset Value:
Keynote's headquarters are located in a stand-alone, 181,000 sq/ft office building in San Mateo, CA. Keynote acquired the building from Franklin Templeton (former headquarters) for $85 million in 2000, and had subsequently written the building down to $25 million a few years back (current book value of $22 million). Keynote occupies approximately 25% of the building, leasing out the remaining 75% to a host of major tenants including the Healthcare Foundation of San Mateo, the San Mateo County Medical Association, and CSC Consulting Group, among others. Current rents are in the $25.00/sq ft range. Using current occupancy assumptions of 90% (from company) and applying a conservative 10% discount rate, we believe the building is worth $41MM. The building includes a hosted data center at the ground level that cost the Company roughly $7 million to build two years ago, which we ascribe no value to in our model. Should the Company decide to monetize the building, they will be able to use the tax loss against future taxable income generated at the operating level. The building is unencumbered and worth approximately $2.81/share under the assumptions listed above.

Additionally, the Company has $55.9 million in net cash on the balance sheet, currently amounting to $3.87/share. There are no major capex projects on the horizon. Keynote also has $87 million in NOL's through a combination of state and federal, and expects to pay no more than $400k per year in cash taxes for the next several years. We ascribe no value for the present value of these NOL's in our model. Collectively, the Company's owed headquarters and net cash amount to nearly $97 million, or $6.68/share. Adjusted for the building, the Company's enterprise value is a mere $40.7 million. Note that Gomez had a negligible amount of cash on the balance sheet and no owned real estate, yet sold for $295 million to Compuware on 11/9/09.

Attractive FCF Yield on Depressed Earnings Power:
Assuming no growth in the internet t&m segment, KEYN should be able to generate approximately $3 million in operating income during 2010. After subtracting expected cash taxes of $400k and adding back $2 million of depreciation expense and $4.8 million of amortization, total cash flow for KEYN is expected to be $9.4 million (without adding back $4 million of annual stock based comp expense). Maintenance capex is $3 million per year. So free cash flow is $6.4 million in a no-growth internet t&m environment, which equates to a 16% free cash flow yield against our adjusted enterprise value. The company is paying out 45% of their free cash flow in the form of a recently initiated dividend. There is enormous leverage in their business model if KEYN is successful in stabilizing (or growing) pricing per page, driven by the rather small commensurate opex and capex needed to support growth in SaaS based models.

Using our reasonably conservative base case assumptions, we believe KEYN is worth at least $18/share (>90% upside). We derive this fair value estimate by adding the company's non-core asset value of $97MM held in cash and unencumbered real estate to our 2.5X sales target for the combined internet and mobile t&m segments. To put this into perspective, Keynote's SaaS peers currently trade for mean and median EV/Sales multiples of 4.2X and 4.0X, respectively. Our peer group includes OMTR, BBBB, CTCT, N, RNOW, CRM and SFSF. Additionally, our 2.5X EV/S fair value assumption for KEYN is less than half of what Gomez was acquired for by Compuware.

Looking at KEYN's valuation from the perspective of Compuware's acquisition price for Gomez (which we agree was overly generous), if we take the 60% of KEYN's consolidated revenues that are a direct comparison to Gomez's business and apply the same multiple of 5.4X sales, KEYN's internet test and measurement business alone would be worth $16.50 per share ($81MM total sales x 60% internet t&m = $48.6MM x 5.4 = $262MM/15.9 MM FD SO) without ascribing any value to their cash, the building, or the mobile t&m business. Inclusive of these additional components, we believe KEYN would be worth more than $25/share in Gomez terms. This represents our bull case fair value estimate. Given KEYN's ample downside protection and substantial upside potential, we recommend taking a look.

• Continued pricing pressure within KEYN's core internet t&m business
• Market share erosion from combined Compuware/Gomez
• Insider control, as CEO Umang Gupta controls 2.67MM shares, or 17.5% of the Company




  • Return to growth within KEYN's core internet t&m segment
  • Potential take out candidate
  • Market realization of KEYN's heavily discounted valuation
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