Keysight Technologies

Keysight Technologies reported upside to its July-quarter guidance on the top and bottom lines, and guided to more strong growth in the October quarter. Guidance now implies 32% revenue growth in fiscal 2026, up from management's prior guide of "high-20%" growth.

Why it matters: Keysight is enjoying strong demand across data center networking, semiconductor manufacturing, and aerospace and defense. We appreciate this confluence of great demand across several end markets, with much of it underpinned by broader artificial intelligence investments. Management keeps AI financial details close to the chest, but acknowledged their expectations have improved since last quarter. After about $550 million in the first half of the year, we expect close to $1.4 billion in AI-related revenue in fiscal 2026, with rapid growth to continue thereafter. Even without AI, Keysight is firing on all cylinders. We believe the firm's broad-based and diverse end-market approach, led by strong technology prowess in test and measurement, is shining. This is a high-quality firm enjoying a multiheaded upswing.

The bottom line: We raise our fair value estimate for wide-moat Keysight to $350 from $250, as we re-rate our medium-term growth forecast. We now expect significantly stronger AI revenue capture over the next two years, augmented by a healthy non-AI business. Shares look fairly valued. We previously expected a quicker deceleration of Keysight's growth from fiscal 2026, but we now model a more gradual taper, with more than 20% growth in fiscal 2027 followed by double-digit growth in fiscal 2028. This brings us in line with the market price. We value Keysight at 22 times fiscal 2027 earnings, aligned with its historical range. Our revenue estimates are bullish versus consensus, however. If we're right about Keysight's growth momentum, there's upside as the market re-rates to a higher multiple.

Our fair value estimate for Keysight Technologies is $350 per share, which implies a fiscal 2026 adjusted price/earnings ratio of 30 times and a fiscal 2026 enterprise value/sales ratio of 8 times.

We expect acquisitions to complement strong organic growth in fiscal 2026, with more than 30% total reported revenue growth. In the medium term, however, we see investments in AI infrastructure and defense modernization driving stronger growth in the double digits through fiscal 2028. Long-term, we see mid- to high-single-digit growth for Keysight, toward or above the high end of its 5%-7% target range.

We anticipate the commercial communications market to continue driving results as Keysight’s largest. Keysight is an integral partner to OEMs and suppliers for wireless network buildouts, as well as data center investments, which we think will drive strong medium-term demand. Keysight has been a strong derivative beneficiary of the AI spending boom. Across chip and networking design, Keysight is a partner to companies advancing to new, cutting-edge technologies. While Keysight doesn’t see volumes rise in line with chip or networking shipments, more rapid technology transitions accelerate the firm’s top line. These rapid transitions and large investments drive our double-digit forecast over the next three years.

We also see rising defense spending, tilting toward new-age technologies like cybersecurity, autonomy, and AI, benefiting Keysight’s defense business. We believe this trend is happening concurrent to strong AI and data center investments, compounding Keysight’s growth opportunity in the medium term. In the short term, we believe geopolitical conflicts are driving increased investment in future defense, with Keysight as a key partner to Western suppliers. Outside of communications, we like the firm’s growth opportunity in its electronic industrial segment, which benefits from chip manufacturing investments (AI driving this piece of the business in the medium term) and automotive investments.

We see non-GAAP gross margins holding steady in the high-60% range over the next five years, which represents a nice balance of high-margin hardware and higher-margin software sales. We think operating margin will expand as the firm exerts operating leverage during a high-growth period. All in, we predict non-GAAP operating margins to expand from a below-normal 26% in fiscal 2025 to management’s long-term goal of 32% in fiscal 2026 (with one quarter to go). Thereafter, we see strong leverage against rapidly rising AI-led volumes, with our fiscal 2030 non-GAAP operating margin forecast coming in at 39%.

In our view, Keysight Technologies possesses a wide economic moat owing to intangible assets in the design of test and measurement equipment and software and switching costs for its portfolio of solutions. We think Keysight is a leader in testing and measurement, helping OEMs and all tiers of suppliers accelerate time to market for new products in the communications, aerospace and defense, automotive, industrial, and semiconductor markets. We don’t expect any competitor to encroach on Keysight’s leadership—especially in communications—and expect the firm to earn economic profits over the next 20 years as a result of its comprehensive portfolio that layers software and services over hardware.

Testing equipment is used by OEMs and suppliers during research and development and manufacturing to fine tune chips and devices to exact specifications. For example, Keysight manufactures millimeter wave transceivers and radio frequency emulators to test an RF chipset’s ability to transceive signals amid a variety of interference environments and signal strengths. Oscilloscopes can analyze the amplitude and frequency of a 5G signal in testing out a base station’s effectiveness. Similarly, Ethernet channel testing solutions enable suppliers to test the effectiveness of optical transceivers in data transfer and connectivity in a data center, connected car, or other application.

We believe Keysight is the leading player in the communications testing market, in part from being the only player to service the entire communications ecosystem. Keysight’s portfolio addresses all layers of the communications stack, from the physical layer all the way through to the application software layer. We think having the most comprehensive communications testing portfolio in the marketplace makes Keysight a more efficient solution and gives it a leg up in acquiring new customers. Testing is an integral part of the development process, with engineers iterating designs in simulation software, testing different prototypes, and then implementing quality control in manufacturing. Each step introduces new variables to account for, and using multiple testing vendors across development can require calibrating equipment together and ensuring measurement differences aren’t resulting from different equipment. By using Keysight tools and software at each step, engineers can remove variability between each step, saving critical development time and accelerating time to market. Keysight takes this one step further with its PathWave platform, which aggregates software analysis from each step of the development process into one place, reducing variability and iterations and simplifying the process for engineers. In one case study, NTT Docomo credits using a comprehensive Keysight solution for shortening development time for its 5G deployment at the Tokyo Olympics by at least 20% and going to market a full year faster than the competition. With a portfolio addressing all facets of communications and including software, Keysight stands out among its testing peers as a strategic partner. Rather than selling into a specific portion of a customer’s development, Keysight can offer a complete strategy for reducing time to market that features its tools and software.

We think unmatched portfolio breadth and leading capabilities have led to Keysight holding one of the top market shares overall in testing and measurement, a leading position in communications, and a dominant share of the 5G testing market. Management estimates that Keysight holds 25% of the overall testing and measurement market and estimates that 75% of 5G designs globally—between base stations and devices—have been developed using Keysight solutions.

We posit that Keysight’s advantage in communications testing and measurement stems from hefty investment in research and development and vertically integrated production. While some of its peers invest similar proportions of sales into R&D, Keysight exceeds all of them in size, so its total R&D investment in a given year nearly doubles that of the nearest competitor. We think large R&D investment has allowed Keysight to invest aggressively in software and be first to market with a platform like PathWave. Moreover, Keysight gains efficiency from partial vertical integration, with about 50% of manufacturing taking place in-house. The firm operates its own fab in Santa Rosa, California, which it co-locates with its R&D staff. This allows the firm to quickly take designs into production and troubleshoot, rather than waiting on a foundry partner with myriad other customers to serve. We think this improves R&D efficiency and allows Keysight to maintain its high organic investment while staying profitable. Among its peer group, Keysight is the only one in the top three of both R&D as a percentage of sales and operating margin. In our view, the ability to invest twice as much as competitors while maintaining top-tier operating profits gives us confidence in Keysight’s ability to maintain its innovation lead over the next 20 years.

We also think Keysight’s moat is bolstered by switching costs, stemming from an end-to-end solution set combining hardware, software, and services. Keysight’s solutions service the entire design cycle, from design and simulation all the way through to volume manufacturing and operation. We view Keysight as a one-stop-shop for customers and think this leads to switching costs as entire workflows get designed around Keysight’s solutions. Keysight’s comprehensive portfolio not only improves efficiency at customers but makes ripping its solutions out even harder—a customer would likely have to source from multiple suppliers if it chose to leave Keysight. For example, Keysight is the only testing player to supply electronic design automation (EDA) software for chips, which is typically a stand-alone market. Switching away from Keysight would likely require sourcing from multiple new testing suppliers and a new EDA supplier, too.

We also think that Keysight’s focus on selling into research and development versus manufacturing leads to stickier customer relationships. R&D relationships tend to be quite close—sales usually involve one engineer at a time. In our view, individual engineers exhibit stronger personal preference and stickiness than a company as a whole—once an engineer adopts Keysight into their workflow (and so long as it satisfies their needs), we think they’d be loath to learn an entirely new solution. Furthermore, selling early in development to R&D makes Keysight more likely to win manufacturing placements later in development. Manufacturing testing (quality control) is typically dual-sourced, but if a given supplier is used in R&D, it’s likely to be used predominantly in manufacturing, further reducing variability between measurements. A second testing supplier would then be used as a check, ending in roughly a 70%/30% split for Keysight and the competitor, respectively.

We think Keysight entrenches customers even further by layering software on top of its solutions. It is our view that layering software on top of enterprise hardware creates an overall stickier combined solution that engrains itself deeper in customer workflows. Although all oscilloscopes, signal analyzers, and other testing hardware run on embedded software, Keysight has been pivoting to proprietary analytical software to optimize testing and measurement with its hardware. Keysight’s applications save engineers time by automatically analyzing massive quantities of data—an oscilloscope can make 256 billion measurements per second—and Keysight’s customers can aggregate all their data and subsequent analysis in its PathWave platform. Moreover, Keysight’s applications are modifiable. A Keysight application engineer will help customize a program to fit an engineer’s specific requirements at installation. We think an integral software approach with customization embeds Keysight’s tools into customer workflows and makes cobbling together a replacement difficult. Customers would have to replace more than physical tools, and adapt entire workflows to new software—or face the prospect of not finding similar functionality from a new vendor.

Finally, we think the inclusion of services into customer contracts further augments Keysight’s stickiness. We think services both elongate the average duration of contracts and further embed customers in the Keysight ecosystem. Keysight has 68 regional services centers globally and locates them near hubs of customers. Keysight’s services vary in intensity. At a base level, Keysight customers utilize repair and calibration services annually or biannually—equipment needs to be calibrated for accurate measurements, similar to tuning a guitar or violin. Additionally, Keysight application engineers can work with customers to offer troubleshooting, usage guidance, and tweaking of software. For large customers, application engineers will even work on-site at a customer, integrating into the design team. In our view, services allow a customer to use their solutions for longer and create a stickier overall solution as software and workflows become customized to having Keysight as an on-demand partner. We think deep partnership and services has led to long customer relationships—sometimes lasting decades.

We think Keysight’s sticky portfolio has led to a strong base of high-margin recurring revenue that we think will enable it to continue earning excess returns on invested capital. According to management, adding services to a contract can double the gross margin of a deal—and come at little additional cost to the firm. We credit growing software and services sales for helping to expand gross margins since Keysight’s spinoff in 2014. Software and services now make up more than one third of Keysight’s top line, and we expect this number to expand. In 5G applications, which we expect to become a significant portion of sales, software alone can make up 40% of a contract. Additionally, over two thirds of Keysight’s engineers are now focused on software, and many of the firm’s recent acquisitions have been software-centric—exhibiting a companywide pivot toward software. In our view, strong recurring revenue gives us confidence in Keysight’s ability to retain customers in its ecosystem and in turn earn economic profits over a 20-year horizon.

We think Keysight’s large research and development budget has created a competitively advantaged portfolio for communications testing that we don’t expect other firms would be able to easily replicate.

Keysight benefits from AI investments, which are driving rapid development of more powerful and faster chips and networking equipment. Keysight’s wired communications testing leadership positions it well to enable this acceler

We expect Keysight to convert over 100% of net income into free cash flow, and predict it to generate over $1 billion in free cash flow annually over our forecast.

We think Keysight faces an uphill battle to disrupt an automotive testing market which we think is more fragmented and competitive.

In our view, Keysight’s reliance on M&A to build out its portfolio creates risk of stagnating growth if its target pipeline dries up, or of destroying value if it overpays for bolt-ons.

Keysight’s transition to a recurring revenue model for its software and services is still nascent, and we think the firm has a long way to go to increase the stickiness of its solutions.