Buried within Keysight Technologies' recent earnings calls lies a subtle but potentially seismic shift. While analysts dissected the company's near-term performance, scrutinizing AI data center growth and fretting over semiconductor delays, a more profound story is unfolding. Keysight, a stalwart of hardware testing, is quietly amassing a software empire, one with the potential to reshape its valuation and deliver outsized returns.

The signs are there for those willing to look. In both the Q1 and Q2 2024 earnings calls, Keysight executives repeatedly emphasized the resilience of their software and services revenue. Software and services now constitute approximately 40% of Keysight's total revenue, a figure that excludes the recent acquisition of ESI, a software simulation powerhouse. Organic annual recurring revenue (ARR) is growing at double-digit rates.

This isn't just a defensive play in a volatile market. Keysight is actively expanding its software portfolio, targeting high-growth areas like AI/ML training, system simulation and emulation, and network analytics. The acquisition of ESI complements Keysight's existing Electronic Design Automation (EDA) business, positioning the company to capitalize on the increasing virtualization of design and prototyping.

"The implications are far-reaching. Software businesses, with their recurring revenue streams and higher margins, typically command premium valuations compared to their hardware counterparts. As Keysight's software revenue continues to grow, both organically and through acquisitions like ESI and the pending Spirent deal, its overall valuation could experience a significant re-rating."

Let's put some numbers to this hypothesis. Keysight's current P/S ratio hovers around 5. A generous multiple for a traditional hardware company, but potentially undervalued if the market begins to recognize Keysight's burgeoning software segment. For comparison, other established EDA players like Synopsys and Cadence trade at P/S ratios exceeding 10.

If Keysight's software revenue reaches 50% of total revenue by fiscal year 2025, a reasonable target given current trends, and the market applies a more software-centric multiple, let's say 7 times sales, we're looking at a potential stock price exceeding $200. That's a significant upside from today's levels.

Software and Services Revenue Growth

The following chart shows hypothetical growth of Keysight's software and services revenue based on current trends.

Furthermore, Keysight's software-centric approach positions it at the heart of the technology value chain. As innovation accelerates across diverse industries – from aerospace and defense to automotive and semiconductors – Keysight's software will play a crucial role in design, validation, and optimization. This deep integration into customer workflows makes Keysight not just a supplier, but a strategic partner, further cementing its long-term growth prospects.

40% Revenue

Software and Services currently account for 40% of Keysight's total revenue.

Double-Digit ARR Growth

Keysight's organic annual recurring revenue from Software and Services is growing at double-digit rates.

Strategic Acquisitions

Acquisitions of ESI and Spirent expand Keysight's Software Solutions portfolio.

The silent revolution at Keysight is gathering momentum. While the market may still view the company through a hardware lens, the numbers tell a different story. As Keysight's software tsunami continues to build, Wall Street may soon be forced to acknowledge the emergence of a new industry titan. The question isn't if this re-rating will occur, but when.

"Fun Fact: Keysight's origins trace back to Hewlett-Packard, the iconic Silicon Valley company founded by Bill Hewlett and Dave Packard. In 1999, Agilent Technologies was spun off from HP, encompassing its measurement business. Keysight was then spun off from Agilent in 2014, inheriting the rich legacy of innovation and customer focus that defined those legendary companies."