Keynote Systems KEYN
August 05, 2001 - 8:20pm EST by
2001 2002
Price: 9.00 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 256 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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Keynote Systems (KEYN) is an internet services company trading below cash value ($11-12/share), with significant recurring revenues, positive cash from operations, and minimal cash burn.

Founded in 1995, Keynote provides internet performance measurement, diagnostic and consulting services to companies that operate electronic business web sites. Their services enable customers to measure and improve their e-business quality of service from multiple locations around the world. The foundation of these services is an extensive network of strategically located measurement computers connected to the major internet backbones in dozens of metropolitan areas worldwide, plus a sophisticated operations center for collecting, analyzing and disseminating internet performance and availability data.

Basically, Keynote helps companies monitor the performance of their web sites. About 95% of revenues come from monthly subscription fees and the remaining 5% comes from consulting services. The subscriptions are not based on long-term contracts, but Keynote has historically had a 90%+ retention rate. The company is the leader in this space.

Price $9.00
FD shares 28.4mm
Mkt cap $256mm
Net cash $339mm
EV -$83mm

Recent quarterly revenue trends (Sep FY):

1Q00 $4.8mm
2Q00 $7.2mm
3Q00 $9.8mm
4Q00 $12.1mm
1Q01 $13.0mm
2Q01 $12.0mm
3Q01 $11.1mm
4Q01 $10.0mm (forecast)

Recent revenue declines are attributable to the failure of many of Keynote’s dot-com customers. These customers accounted for 40% of revenues in 1Q01, 32% in 2Q01, and 25% in 3Q01. In the September quarter (4Q01), dot-com customers are expected to account for only 15% of subscription revenues. The remainder of Keynote’s revenues come from real bricks and mortar companies. In fact, just doing the math, it turns out that non-dot-com revenues have actually held steady in the last 2 quarters and is expected to be flat to slightly up in 4Q01. Stable revenues from the non-dot-com customer base is impressive given the current state of the economy and tech spending in particular. Once the decline in dot-com customers stabilizes (probably 4Q01 or 1Q02 since there are not many left), and the economy starts to recover, revenues will start to grow again. Keynote currently has 2,900 customers, each paying an average of $272/month per URL measured (12,500 URLs in June Q).

Keynote is also expanding its business from just web site benchmarking to load-testing, a business in which MERQ is the leading player. The company should hit the market with this new service this quarter and will be selling through partners such as CA, BMC, and HWP. This should also help Keynote return to revenue growth in the coming quarters.

As of June 30, Keynote had $255.5mm in unrestricted cash and equivalents ($9/share on 28.4mm FD shares) plus another $85mm in restricted cash ($3/share). The restricted cash serves as collateral for a synthetic lease that Keynote entered into last year for their new headquarters. This cash should be counted toward Keynote’s valuation since the building could be sold for proceeds approximating the purchase price or the lease could be restructured to free up the cash. To be conservative, let’s assume that real estate prices in the SF area are down 33% and give Keynote credit for only $2/share of restricted cash. Even then, Keynote has $11/share in cash on the balance sheet.

Cash burn has been limited. In 1Q01, Keynote burned about $500k. In 2Q01, the figure was $3mm and in 3Q01, there was no cash burn. The company is expected to burn $3mm in 4Q01. (These figures are, of course, after capex.) Keynote has actually generated positive cash from operations in each of the last six quarters!! And it is expected to do so again in 4Q01.

Keynote authorized a $50mm share repurchase in January 2001. The company repurchased 103,000 shares in 2Q01. It did not repurchase any shares in 3Q01. I would be surprised to see no activity in the current quarter, given where the shares are trading.

The thesis for Keynote is simple. This is a real business, with real customers and significant recurring revenues. Despite some recent deterioration in its dot-com customer base, Keynote has remained profitable and has continued to generate positive cash from operations. Despite this, the stock is trading well below net cash value ($11-12/share). Sometime in the next two or three quarters, revenues will start growing again as the dot-com customer base dwindles, the economy improves, and the load-testing business starts to ramp up. Once this happens, I expect the stock to move up as well. The way I look at it, at current prices, Keynote is a free call option on the eventual resumption of revenue growth.


1) resumption of revenue growth as dot-com customer base dwindles, economy improves, and load testing business ramps up
2) share repurchase
3) attractive acquisition candidate for the likes of CA
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