Why Are Hedge Funds Dumping Keysight Technologies (KEYS)?

Keysight Technologies Inc (NYSE:KEYS) shareholders have witnessed a decrease in hedge fund sentiment lately. Nearly one out of 5 hedge funds with KEYS positions dumped their entire stake during the fourth quarter. The level and the change in hedge fund popularity aren’t the only variables you need to analyze to decipher hedge funds’ perspectives. A stock may witness a decline in popularity but it may still be more popular than similarly priced stocks. That’s why at the end of this article we will examine companies such as Manhattan Associates, Inc. (NASDAQ:MANH), Biomed Realty Trust Inc (NYSE:BMR), and StanCorp Financial Group, Inc. (NYSE:SFG) to gather more data points.

Keysight Technologies showed up on our radar about a year ago when Greenlight Capital wrote the following about the stock in its investor letter:

“We established a position in Keysight Technologies (KEYS), a maker of electronic test and measurement equipment. The business was spun out of Agilent (A) in November 2014. We believe Agilent treated KEYS as a cash flow source to fund other businesses. We expect that as an independent company starting with an almost unlevered balance sheet, KEYS will have the flexibility to invest in unexploited growth initiatives and make better R&D and capital allocation decisions. We believe the Street doesn’t fully appreciate KEYS’ prospects. We purchases our position at an average price of $30.54, or about 12x near-term EPS, which doesn’t yet benefit from the investment spend. The shares ended the quarter at $33.77.”

Hedge funds are usually attracted to spin-off stocks because historically they outperformed the market by double digits annually. These stocks outperform the market mainly because their managements are usually incentivized and focused to pursue revenue and profit opportunities that weren’t among their parent companies’ priority list. It seems like that’s the reason why David Einhorn initially invested in the stock. By the way, Greenlight didn’t lose money from this investment as it sold its stake during the second half of 2015. Today Keysight Technologies trade at $27. The company reported declining revenues, profits, and cash flow in its latest earnings announcement.

Let’s first take a glance at the key hedge fund action surrounding Keysight Technologies Inc (NYSE:KEYS) and then we will try to explain why the stock is experiencing negative sentiment.

Hedge fund activity in Keysight Technologies Inc (NYSE:KEYS)

Heading into 2016, a total of 17 of the hedge funds tracked by Insider Monkey held long positions in this stock, a change of -19% from the third quarter. With hedgies’ sentiment swirling, there exists a few key hedge fund managers who were upping their stakes considerably (or already accumulated large positions).

According to Insider Monkey’s hedge fund database, D E Shaw, managed by D. E. Shaw, holds the most valuable position in Keysight Technologies Inc (NYSE:KEYS). D E Shaw has a $69.2 million position in the stock, comprising 0.1% of its 13F portfolio. On D E Shaw’s heels is Renaissance Technologies, managed by Jim Simons, which holds a $21.7 million position; the fund has less than 0.1%% of its 13F portfolio invested in the stock. Remaining members of the smart money that are bullish include Cliff Asness’s AQR Capital Management, Ric Dillon’s Diamond Hill Capital and Israel Englander’s Millennium Management.

Most of these hedge funds are quantitative hedge funds that probably invested in the stock because of its cheap valuation multiples. According to Yahoo Finance the stock has a forward PE ratio of 11. This is actually low enough to attract my attention too. I like investing in stocks that have an earnings yield of around 9% or more especially if their earnings are stable and growing. When I went over KEYS’ latest earnings report I noticed that the management is emphasizing non-GAAP earnings which exclude several valid and usually recurring expense items such as stock based compensation. KEYS’ share count increased from 167 million at the end of 2014 to 172 million at the end of 2015. The value of 5 million shares is nearly $140 million, a big number for a company that generated an operating cash flow of $376 million. If I treat the increase share count as pure expense, KEYS’ operating cash flow declines to about $240 million. Considering that the company has an EV of $5.1 billion, it trades at 20 times more than its adjusted cash flow.

The company announced a $200 million share repurchase program to counter the dilutive effect of stock based compensation. Overall, my conclusion is that KEYS doesn’t seem to be as attractively priced as it seems which is probably why hedge funds like Highbridge or Gotham Asset Management sold out of the stock during the fourth quarter.

Let’s now take a look at hedge fund activity in other stocks similar to Keysight Technologies Inc (NYSE:KEYS). These stocks are Manhattan Associates, Inc. (NASDAQ:MANH), Biomed Realty Trust Inc (NYSE:BMR), StanCorp Financial Group, Inc. (NYSE:SFG), and Lions Gate Entertainment Corp. (USA) (NYSE:LGF). This group of stocks’ market values are similar to KEYS’s market value.

As you can see these stocks had an average of 27 hedge funds with bullish positions and the average amount invested in these stocks was $793 million. That figure was $147 million in KEYS’ case. Lions Gate Entertainment Corp. (USA) (NYSE:LGF) is the most popular stock in this table. On the other hand Manhattan Associates, Inc. (NASDAQ:MANH) is the least popular one with only 23 bullish hedge fund positions. Compared to these stocks Keysight Technologies Inc (NYSE:KEYS) is even less popular than MANH. Considering that hedge funds aren’t fond of this stock in relation to other companies analyzed in this article we don’t think it is a good idea to invest in this stock at the moment.