Description

Tektronix is a high quality test & measurement company that is very cheap on a normalized earnings basis. Trading at $17, the company has a rock-solid balance sheet that has $6.80 of net cash per share. The company is cheap due to the cyclical downturn that has hit the telecom, computer, and electronics markets. Near term trends continue to be bleak, but the strong net cash position and cheap valuation relative to normalized earnings should provide a floor of support at current prices. TEK enjoys a high 30%+ ROIC, good management, and healthy competitive dyanmics in the oligopolistic T&M (test & measurement) industry. Long-term organic growth is in the 8% range.

I believe a conservative assessment of fair value for TEK is $22.50. This is based on my believe that normalized revenues are $1,150, normalized EBIT margins are 12%, and TEK should trade at 10x EV/Normalized EBIT (35% tax rate). There is a good chance that TEK will ultimately trade above $22.50 on the next upcycle as investors become bullish again and overshoot fair value.

One of the key points about TEK is that as the stock gets cheaper, the EV falls even more due to the $7 of net cash on the balance sheet. This makes the stock increasingly more compelling as the stock drops. In fact, I was originally planning to post TEK on Sept. 17. I decided to wait because I thought TEK might fall further and become even more compelling. Unfortunately (for those looking for a great value), it finished the week flat.

Here are the key metrics on TEK:
Price: 17
Shares: 92.1mm
Eq Cap: 1565.7
Net Cash: 626.6
EV: 939.1

Note: FY ends in May
FY Year 1997 1998 1999 2000 2001
Revenues 879 989 880 1051 1235
EBIT 102 126 76 126 175
EBIT Margin 11.6% 12.8% 8.7% 12.0% 14.2%
Current EV/Historic EBIT 9.2 7.5 12.4 7.5 5.5

For those who do not know TEK's business, here is the basic breakout based on FY2001 revenues (a peak year for optical and mobile test):

Pdt Breakout Application Breakout
36% O-scopes 45% R&D
21% Optical Test 30% Mfg equipment
20% Mobile Test 25% Instillation and monitoring
12% Video Test
11% Digital Systems

Looking at a 10-year set of data for o-scopes and TEK's other end markets, it appears that the long-term growth rate is about 8%. I believe that FY2000 represented a "normal" year for TEK and FY 2001 represented an above trend year. TEK is currently seeing its orders plummet due to the current tech wreck. In the morst recently reported quarter, orders dropped 46% to $164mm or an annualized revenue of $660mm.

It is my belief that in cyclical industries, companies that have spent time above trend usually end up spending time below trend. I believe trend sales for TEK are in the $1.1bn range based on my analysis of long-term growth rates and an analysis of company specific pdt cycles. It is not surprising to me, though, that we could spend a year with orders in the $700mm range to correct for the boom for FY2001 (ended May '01).

I think TEK represents a superior bet on a cyclical rebound relative to other names in technology. First, the company has an excellent balance sheet which will be very helpful in this environment for operations and possible stock buybacks at opportunisitc prices (which I am sure mgt will do at current prices). Second, TEK is very well run and has managed expenses in this downturn much better that its competitors (primarily Agilent). In the most recent quarter, TEK made money while Agilent lost money. I expect TEK to be at worst cash flow neutral as the cyclical downturn hits the point of maximum pain. Third, the competitive dynamics between TEK, Agilent, and LeCroy (the 3rd biggest competitor in o-scopes) are healthy and gross margins should stay reasonably healthy in the downturn.

Tektronix has a leading market postion in many of its markets. It is #1 in o-scopes, #1 in Video Test, #2 in Digital Systems, and #3-4 overall in mobile test and optical test (with a much stronger postion in the specific pdt niches where it competes).

Tektronix went though an important transformation last year. After spending years as an unfocused company with various unrelated businesses, TEK spun off and sold a variety of assets to become a focused T&M company. A new management team was put in place that is highly energized and that is going to run TEK in the future in a far superior way than it was run in the past.

By the way, the historic numbers I showed for Sales and EBIT are pro-forma numbers for TEK's T&M business. They do not match what you would see if you looked at TEK's historic consolidated financials which include the other buisnesses that were spun off. I believe that the pro-forma analysis is conservative and probably understates what TEK would actually have earned as a stand alone T&M business.

When I compare TEK to other cyclical plays on the electronics industry like AVX, KEM, VSH, I take comfort in the fact that pricing is not likely to crumble like it probably will for the commodity components companies. I think a further deterioration of pricing could cause those other companeis to fall. I also think TEK is much more attractive than semi-conductor capital equipment companies that are still not a trough valuation.

An important think to remember for TEK is that R&D and instillation and monitoring related spending tends to be less volatile than manfuacturing equipment related spending which will not see any capaicty buys in the near future. Don't get me wrong-- R&D spending will drop, but it will not completley dry up. Thus, TEK has appeal relative to other semi cap equipment names that are not as cheap right now.

One thing that I am a little concerned about is that LeCroy (#3 o-scope company) has recently introduced a series of high end o-scopes that are closing the gap between their pdts and TEK. TEK has been gaining share against LeCroy and Agilent in o-scopes, but this trend might stop or even reverse a bit in the face of this problem. However, I think this risk is more than covered at the current valuation.

Catalyst

Current trends in TEK's business are negative and likely to remain that way for some time. The only catalysts that I see are valuation and the possibility that further Fed easings might cause a rally in telecom and computer related stocks. I also see a possiblity that the market will focus more on the balance sheets and net cash positions. Valuation can be it's own catalyst.