Keynote: Low Multiple, Strong Growth Prospects

| About: Keynote Systems, (KEYN)

Keynote (NASDAQ:KEYN) is a performance measurement company that provides E-commerce diagnostic services, a fairly simple business. It is based in California, and is a well established leader in the field. 43% of Fortune 100 companies are customers (Microsoft (NASDAQ:MSFT), HP (NYSE:HPQ), Amex (NYSE:AXP) and Google (NASDAQ:GOOG)) are its largest customers. The company serves about 50% of the top 50 websites and its brand among corporate IT managers is strong, with over 2,800 corporate clients.

The company has 14.3 millions shares outstanding, and is trading at $8, or a market cap of $114 mm (the stock traded at $14 back in September, aka the Good Old Days). It has $51mm in cash (as of March 31, 2009), a building (HQ) worth $35mm and NOL's with NPV of $20mm. So you are really buying the underlying business for $8mm.

For the six months ending March 2009 Keynote generated $40mm in revenue and $2.2mm in cash from operations, net of interest income. Annualize that number and you are buying Keynote’s business for under two times cash from operations.

With secular growth in Internet commerce still going strong, and with the brisk business it is doing in Europe via its German subsidiary, growth should be forthcoming and should translate into more reasonable multiples.

With scant analyst coverage (not unusual for this size company), Keynote is very misunderstood. Specifically, GAAP understates cash flow, because much of the revenue is from software licenses which are deferred and amortized over the life of the contract. Thus, cash is reflected in EPS over time, not when it actually comes in. In addition, capital structure is obviously inefficient.

The main risk is that management might put the cash to foolish use. The Sigos acquisition it completed in Germany last year was a successful one, so its record so far bodes well. Also, the underlying business could deteriorate--although the company is dominant in the industry, innovative solutions from a new competitor are certainly possible. One also has to consider the lack of catalyst, although I believe value happens to be the best catalyst.

Management owns about 14% of the company. Keynote regularly buys back stock, and Founder and CEO Umang Gupta recently bought $800,000 worth of stock in the open market for himself.

I like an orphaned stock of a profitable business that has a dominant brand, decent growth prospects, financial flexibility and management walking in the shoes of owners. Most of all I like it when it can be bought at exceptionally low multiples and a very limited downside.

Disclosure: Wellcap is a KEYN shareholder; do your own work.

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