Note: All new or revised material since the last update is highlighted.
Reason for Report: TEK to be acquired by Danaher Previous Update: September 26, 2007; 1Q08 Earnings Update
Brokers’ Recommendations: Neutral: 60.0% (6 firms); Positive: 20.0% (2); Negative: 20.0% (2) Prev. Ed.: 6, 4, 1
Brokers’ Target Price: $36.38 (Up ↑ $2.32 from last edition; 8 firms) Brokers’ Avg. Expected Return: 4.5%
Recent Events
On November 16, 2007, TEK and Danaher Corporation (DHR) jointly announced Raven Acquisition Corp., an indirect wholly owned subsidiary of DHR, has successfully purchased all of the shares tendered and not withdrawn pursuant to its tender offer for all of the outstanding shares of Tektronix, Inc. common stock at $38.00 per share, net to the seller in cash without interest. DHR now owns approximately 83% share of TEK.
On September 20, 2007, TEK announced its 1Q08 financial results. Highlights of the results (as reported by the Company) are as follows:
· 1Q08 total revenue was $291.5 million versus $268.1 million in 1Q07, up 9.0% y/y.
· Pro forma EPS (excluding stock based compensation) in 1Q08 was $0.40 versus $0.35 in 1Q07, up 1.9% y/y.
Overview
Key investment considerations as identified by analysts, are as follows:
Key Positive Arguments / Key Negative Arguments· Brand Image – TEK has a strong brand, and is the most recognized name in the T&M industry. Its brand equity is strengthened by its No. 1 ranking in the oscilloscopes and video test markets.
· Ultimate Leader – The convergence of voice/video/data capabilities with higher processing speeds will be the driver of next generation technologies in wireless markets, where TEK is uniquely qualified as a leader.
· Product Portfolio - TEK has a broad product portfolio and a large installed base of equipment that provide a firm foundation of growth, thereby bringing in new products and upgrades. / · High Operating Leverage - The combination of higher expenses, new product launches and integration related expenses is likely to have a negative impact on the bottomline.
· Cyclical End Markets - Approximately 45%-50% of sales are connected with end markets where demand cycles can be volatile and abrupt.
· Margin Pressure-TEK’s margins could come under pressure from rising R&D, and pricing pressure due to intense competition.
Oregon based Tektronix Inc. (TEK or the Company) is a leading test and measurement equipment maker whose products enable technology based companies to develop global communications networks and other electronic technologies. The Company is the acknowledged leader in the market for oscilloscopes, but also offers an array of other test, measurement, and monitoring tools aimed at the telecom, semiconductor, computing and other electronics markets. TEK has operations in 19 countries worldwide. The Company’s web address is www.tek.com.
Note: TEK’s fiscal year ends on May 31; fiscal year references differ from the calendar year.
Revenue
Provided below is a summary of revenue as compiled by Zacks Research Digest:
Revenue (in $,M) / 1Q07A / 4Q07A / 1Q08A / 2Q08E / 3Q08E / 4Q08E / 2008E / 2009E / 2010ETotal Revenue / $268.1 / $298.6 / $291.5 / $276.8↓ / $284.1↑ / $307.5↓ / $1,159.8↓ / $1,227.1↑ / $1,315.7↑
Digest High / $268.1 / $299.0 / $291.5 / $278.8 / $291.0 / $320.0 / $1,178.5 / $1,270.0 / $1,320.0
Digest Low / $268.0 / $298.5 / $291.0 / $274.0 / $272.2 / $293.6 / $1,145.1 / $1,175.1 / $1,311.5
YoY Growth / 8.7% / 1.5% / 6.9% / 3.0% / 4.9% / 5.8% / 7.2%
Sequential Growth / 12.3% / -2.4% / -5.0% / 2.6% / 8.3%
Zacks Consensus / $277.0 / $285.0 / $1,161.0 / $1,226.0
Zacks Digest revenue in 1Q08 was $291.5 million versus $298.6 million in 4Q07, down 2.4% q/q, and $268.1 million in 1Q07, up 8.7% y/y. 1Q08 revenue exceeded the consensus estimate of $285.1 million by 2.2%, and was slightly above management’s guidance range of $280.0 million to $290.0 million due to better sales in both the Instruments and the Communications businesses.
Provided below is a summary of Segmental Revenue as compiled by Zacks Research Digest:
Revenue (in $,M) / 1Q07A / 4Q07A / 1Q08A / 2Q08E / 3Q08E / 4Q08E / 2008E / 2009E / 2010EInstruments / $198.2 / $238.9 / $225.3 / $213.0↑ / $222.0↑ / $235.0↓ / $895.3 ↓ / $940.0↑
Communications / $69.9 / $59.6 / $66.2 / $64.0↓ / $68.0↑ / $70.0↑ / $268.2↑ / $300.0↑
Total Revenue / $268.1 / $298.6 / $291.5 / $276.8↓ / $284.1↑ / $307.5↓ / $1,159.8↓ / $1,227.1↑ / $1,315.7↑
Provided below is the Pie Chart representation of Segmental revenue:
Instruments Business
1Q08 Instruments revenue grew approximately 13.7% y/y to $225.3 million. The upside was due to backlog reduction of advanced products.
1Q08 Instruments orders of $184.8 million were down 6.8% q/q and 18.2% y/y, with modest growth in all regions except Japan. Book to bill was 0.82. According to one analyst (McAdams), the low orders were due to economic weakness in Japan and changes implemented in the distribution policy in the last quarter.
Communications Business
1Q08 Communications revenue of $66.2 million declined 5.3% y/y. Order recognition policy changes in Japan initiated in 4Q07 combined with economic weakness in Japan and declining trends in the Network Diagnostics business negatively influenced revenue.
Communications orders declined 25.9% q/q and 0.3% y/y to $57.0 million with strong growth in network products offset by a decline in network diagnostic products. Communications backlog stood at $139.0 million, down $11.0 million sequentially. For 2Q08, the Company expects book-to-bill of about 1.0x, implying improving order expectations.
Outlook
The Company expects 2Q08 revenue in the range of $270.0-$280.0 million. Looking forward, in Instruments business, management believes orders improvement will be driven by strong new products already introduced and that are expected to be introduced in the next several quarters. In Communications business, management believes orders improvement will be driven by growing strength in demand for network management products. In addition, TEK expects to complete the changes implemented in the distribution policy in the last quarter, which had a negative impact in 1Q08.
One analyst (R W. Baird) expects the near term order patterns to improve sequentially, but thinks increasingly difficult y/y Instrument comparisons are likely to mute a near term improvement in order growth patterns. According to another analyst (Goldman), 2H08 outlook for network management is more positive.
According to one analyst (Zacks Investment Research), Communications infrastructure market has been generally weak, as prolonged consolidations led to uncertainties. However, the market seems to be recovering, as network equipment manufacturers focus on bringing 3G infrastructure online.
For more details on individual analyst opinions, please see the Consensus tab of the TEK spreadsheet.
Margin
Provided below is a summary of margins as compiled by Zacks Research Digest:
Margins / 1Q07A / 4Q07A / 1Q08A / 2Q08E / 3Q08E / 4Q08E / 2008E / 2009E / 2010EGross Margin / 63.1% / 62.7% / 59.6% / 60.5% / 60.5% / 61.4%↓ / 60.6%↓ / 61.5%
Operating Margin / 15.7% / 16.2% / 14.6% / 13.5%↑ / 14.8%↑ / 16.6%↑ / 15.1%↑ / 16.5%↑ / 17.1%↑
Pre-Tax Margin / 16.9% / 16.9% / 15.5% / 14.8%↑ / 16.1%↑ / 17.7%↑ / 16.1%↑ / 17.6%↑
Net Margin / 10.9% / 11.6% / 10.0% / 10.8%↑ / 11.2%↑ / 12.4%↑ / 11.3%↑ / 12.3%↑ / 12.5%↑
Zacks Digest gross profit in 1Q08 was $173.9 million, a 7.1% decline from $187.2 million in 4Q07. Gross margin in 1Q08 was 59.6%, reflecting a 3.1% q/q and 3.5 y/y decline. According to analysts, the decline in margin was due to unfavorable sales mix and higher new product warranty/manufacturing costs.
Operating expenses of $129.5 million were lower than the previous quarter’s $138.0 million. SG&A in 1Q08 was $82.8 million, up 7.2% y/y but down 7.6% q/q. R&D in 1Q08 was $47.6 million, down 4.4% y/y and 2.9 % q/q.
Operating profit in 1Q08 was $42.7 million, 11.8% decline from $48.3 million in 4Q07. Operating margin in 1Q08 was 14.6%, down 10.9% q/q and 7.5% y/y.
Outlook
Management indicated that gross margins should improve sequentially. Management expects gross margin to be higher as the sales mix shifts to more higher-margin follow-on Network Management product and software sales. The Company also said it would re-institutionalize its gross margin expansion effort as it believes there will be further room for cost reduction.
One analyst (R W. Baird) expects the gross margin to remain down y/y, reflecting the relatively unfavorable sales mix expected during FY08.
Another analyst (J.P. Morgan) believes TEK’s margin could come under pressure due to high competition, slower wireless networking spending and contraction in general purpose related R&D spending.
Another analyst (B. of America) expects the gross margin to be slightly up on a sequential basis.
Another analyst (Citigroup) expects the gross margin to increase slightly in the coming quarters from 1Q08’s 59.6% based on improving communications mix and lower new product ramp costs.
For more details on individual analyst opinions, please see the Consensus tab of the TEK spreadsheet.
Earnings per Share
Provided below is a summary of EPS as provided by Zacks Research Digest:
EPS / 1Q07A / 4Q07A / 1Q08A / 2Q08E / 3Q08E / 4Q08E / 2008E / 2009E / 2010EZacks Consensus / $0.34 / $0.37 / $1.52 / $1.82
Digest High / $0.36 / $0.46 / $0.40 / $0.43 / $0.47 / $0.57 / $1.82 / $2.09 / $2.39
Digest Low / $0.32 / $0.39 / $0.33 / $0.32 / $0.38 / $0.43 / $1.48 / $1.81 / $1.98
Digest Average / $0.34 / $0.44 / $0.38 / $0.39 / $0.42 / $0.52↑ / $1.71↑ / $2.02↑ / $2.19↑
YoY Growth Rate / 11.4% / 17.7% / 17.9% / 17.4% / 14.8% / 17.7% / 8.3%
Sequential Growth / 22.6% / -13.2% / 3.6% / 7.0% / 22.1%
EPS BEFORE FAS 123 (ESOE) / $0.38-$0.42
Zacks Digest pro forma EPS in 1Q08 was $0.38, up 11.4% y/y, but down 13.2% q/q. The pro forma EPS was below the consensus estimate of $0.39.
Outlook
The Company expects 2Q08 pro forma EPS to be between $0.38 and $0.42, on a diluted basis, excluding non-cash acquisition related costs, business realignment costs, one-time items and share based compensation expenses.
Zacks Digest average model projects EPS of $1.71 for 2008, $2.02 for 2009 and $2.19 for 2010, representing y/y increases of 14.8%, 17.7% and 8.3% in 2008, 2009 and 2010, respectively. Estimated 3-year compounded annual growth rate (CAGR) based on 2006 EPS is 15.2%.
Highlights from the chart are as follows:
• 2008 forecasts (9 analysts) range from $1.48 (J.P. Morgan) to $1.82 (Thomas Weisel); the average is $1.71.
• 2009 forecasts (9 analysts) range from $1.81 (J.P. Morgan) to $2.09 (Citigroup); the average is $2.02.
• 2010 forecasts (2 analysts) range from $1.98 (Goldman) to $2.39 (Citigroup); the average is $2.19.
Following 1Q08 earnings release, all the analysts decreased their EPS estimates for FY08 and FY09 based on reduced revenue expectations after TEK provided weak 2Q08 outlook.
For more details on individual analyst opinions, please see the EPS tab of the TEK spreadsheet.
Target Price/Valuation
Of the 11 analysts covering the stock, 2 analysts have given positive ratings, 6 analysts have given neutral ratings and 2 analysts have given a negative rating on the stock. One analyst (Merrill) has not provide any rating on the stock. The Zacks Digest target prices for TEK range from $29.00 (23.9% upside from the current price) (Zacks Investment Research) to $39.00 (2.4% upside from the current price) (Thomas Weisel), with an average of $36.38 (↑ from the last Zacks Digest report, 4.5% upside from the current price). The analyst at the low end of the target price has rated the stock Hold. The analyst at the high end of the target price has rated the stock Overweight, and incorporated a 19x FY09 pro forma EPS estimate to justify the price objective. Following 1Q08 earnings release, two analysts (B. of America, R W. Baird) have reduced the target price due to weak communications cap-ex spending expectation in CY07 and CY08. Additionally, one analyst (Needham) upgraded the stock while another analyst (Wall Street Strategies) downgraded the stock. In the recent update, most of the analysts have raised the target price based on the recent acquisition announcement. However, two analysts (Needham and J.P. Morgan) have downgraded the stock from Buy to Hold and from Overweight to Neutral, respectively.
Provided below is a summary of Valuation and Ratings as compiled by the Zacks Research Digest:
Rating DistributionPositive / 20.0%
Neutral / 60.0%
Negative / 20.0%
Avg. Target Price / $36.38↑
Digest High / $39.00
Digest Low / $29.00
No. of Analysts with Target Price/Total / 8/11
Risks, which may impede the target price and ratings, according to analysts, include a domestic and international economic slowdown, delay in capital spending by telecom carriers and telecom infrastructure providers, increased competition, technological obsolescence, departure of key executives, delay in customer program implementations, integration of future acquisitions, loss of large customers, and negative resolution of outstanding legal issues.
Metrics detailing current management effectiveness are as follows:
Metric (TTM) / Value / Industry / S&P 500Return on Assets (ROA) / 5.39% / 6.65% / 8.60%
Return on Investments (ROI) / 6.43% / 8.88% / 12.61%
Return on Equity (ROE) / 8.49% / 17.84% / 21.47%
ROA, ROI and ROE of the Company are below the overall market averages (as measured by S&P 500) of 8.60%, 12.61% and 21.47%, respectively.
For more details on individual analyst opinions, please see the Valuation tab of the TEK spreadsheet.