Spirent-buyer Keysight tries to dominate 5G market

Keysight Technologies (US:KEYS) is attempting to create a dominant player in the telecommunications testing market with last week's surprise bid for competitor Spirent Communications (SPT). The US company is hoping to profit from the upcoming surge in 5G infrastructure investment as telecoms companies compete to get ahead of each other in the emerging market. However, there are concerns amongst analysts that regulators could block the deal given this would give the combined entity up to 80 per cent market share in the high-speed-ethernet (HSE) telecoms testing sector. 

On 28 March, Keysight announced a formal bid of 199p per share for UK software company Spirent, at a 15 per cent premium to its share price. This came in just weeks after Viavi (US:VIAV) had an offer of 175p a share accepted by the Spirent board. Spirent has now backed the higher offer, which it will put to shareholders. 

At the time of the Viavi bid, Numis analyst John Karidis believed the offer materially undervalued Spirent given its technology is already in use by clients whose spending looks set to rebound. Even with the larger offer from Keysight, Karidis still believes Spirent is being undervalued by 19 per cent given the growth in the 5G market expected next year. In particular, he expects T-Mobile to spend heavily as it attempts to disrupt the “AT&T/Verizon duopoly”.

Opportunistic bids

These two bids come at a time when Spirent’s business has been struggling. As its software enables the testing and monitoring of telecoms infrastructure, its revenue is largely dictated by the spending levels of its customers. In the past year its customers have cut back spending to maintain cash flows in the face of rising inflation.

Just over half of Spirent’s revenue comes from the US, with customers such as Verizon (US:VZ), T-Mobile (US:TMUS) and AT&T (US:T), all of whom have cut back significantly on growth spending. In 2023, Verizon’s capex dropped from down to $18.8bn (£15bn) from $23.1bn the previous year and it will spend a forecast $17.5bn in 2024. In the same period at T-Mobile, capex dropped 38 per cent to $10.8bn, while at AT&T it was down 9 per cent to $17.9bn.

Correspondingly, last year Spirent issued multiple warnings about the health of its market. An October profit downgrade came just two months after the company had tried to comfort investors by saying: "we are seeing increasing customer engagement and an improving pipeline”. Its share price fell 55 per cent during 2023. 

This decline wouldn’t have surprised long-term followers of the telecoms industry, where investment is historically driven by the macro-economic cycles. However, there were hopes that the need for a lot of 5G investment in the coming years would create a structural tailwind.

In January 2023, Numis published a note titled “Why Spirent is now a structural growth stock”. The investment bank's analysts explained that 5G was much more complex than previous generations of cellular networks, requiring multiple vendors to set up and many upgrades over the coming years to reach its full potential. Because of increasing competition, Numis argued, telecoms companies would need to continue investing in 5G through any recession, or risk falling behind.

While this theory didn’t prevent Spirent from suffering in the recent downturn, there is still a belief the industry on the brink of new investment cycle. Keysight clearly believes this thesis as it tries to consolidate the testing market through its bid for Spirent.  

Alongside Spirent, Keysight is the leading company in the telecommunications testing market. However, Keysight also operates in a number of other markets, and is a significantly larger business overall. In the year to October, it made $5.4bn in revenue, compared to $483mn at Spirent, meanwhile Keysight’s market cap of $27bn is more than 20 times that of Spirent.

Keysight has also been suffering from the declining telecoms capex but its diversity has insulated it somewhat, at least in comparison to Spirent. In the three months to 31 January, Keysight’s commercial communications (telecoms testing) revenue declined 14 per cent. However, this was diluted by the only 5 per cent drop in its electronic industrial solutions business.

There are signs of green shoots, with Keysight chief executive Satish Dhanasekaran saying that orders are now starting to grow in aerospace, defence and government solutions but that the “overall demand environment remains constrained”. The company is guiding for $1.2bn in revenue in the current quarter, a 13-per-cent from the previous year.

Standalone prospects

There are no guarantees regulators in the US would allow the deal to pass as it would give Keysight a near monopoly in the HSE telecoms testing market. Last year, Spirent chief executive Eric Updyke said that Spirent and Keysight each had around 40 per cent market share, according to Numis analyst John Karidis. "Viavi believes that the proposed combination of Keysight and Spirent would further entrench Keysight's leading position in many product segments, which would limit customer choice," said the previous buyer of the business last week. 

Stifel analyst Ruben Roy, also flagged the “significant overlap” in the product portfolio.  “We believe that a Keysight and Spirent combination would create a single provider of high-speed Ethernet testing equipment,” he said.  

In this scenario, Karidis still sees a promising future for Spirent. “We have reasons to think SPT's standalone prospects will improve materially whilst KEYS labours for regulators to clear its bid,” he wrote.

Even if this deal doesn’t go through, it is an endorsement of the theory that Spirent is about to benefit from an upturn in 5G investment. The only company that knows the 5G testing market as well as Spirent is its largest competitor. 

Run the rule over Keysight Technologies