September 19, 2013 VeriSign Inc. Current Recommendation Prior Recommendation SUMMARY DATA NEUTRAL Outperform Date of Last Change 06/24/2013 Current Price (09/18/13) $51.30 Target Price $54.00 52-Week High $51.30 52-Week Low $34.15 One-Year Return (%) 8.57 Beta 0.86 Average Daily Volume (sh) 1,145,113 Shares Outstanding (mil) 144 Market Capitalization ($mil) $7,366 Short Interest Ratio (days) 14.45 Institutional Ownership (%) N/A Insider Ownership (%) 1 Annual Cash Dividend $0.00 Dividend Yield (%) 0.00 5-Yr. Historical Growth Rates Sales (%) -7.0 Earnings Per Share (%) 18.6 Dividend (%) N/A using TTM EPS 24.4 using 2013 Estimate 23.6 using 2014 Estimate 21.0 Zacks Rank *: Short Term 1 3 months outlook * Definition / Disclosure on last page 3 - Hold SUMMARY Risk Level * Type of Stock (VRSN-NASDAQ) VeriSign s second quarter results beat the Zacks Consensus Estimate on both lines. Management provided a positive guidance based on higher addition of new names in the registry. We believe that the hike in.net fees will drive the company s topline growth going forward. Additionally, growing generic top-level domain customer base, international expansion through IDNs and strong growth in the Network Intelligence and Availability services will further boost revenues and profitability. However, negative impact of search engine adjustments on domain monetization and increasing marketing expenses related to the introduction of new gtlds and IDNs remain the primary headwinds in the near term. Moreover, the ongoing cash repatriation issue remains a concern with respect to liquidity in the near term. Although the recent debt issue improves liquidity, we believe that higher interest rates will hurt profitability in the near term. Additionally, significant competition in the NIA segment remains a concern. Thus, we remain Neutral and set a price target of $54.00. Low, N/A Industry Internet Softwa Zacks Industry Rank * 19 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2011 182 A 190 A 197 A 204 A 773 A 2012 206 A 214 A 224 A 230 A 874 A 2013 236 A 239 A 241 E 244 E 961 E 2014 250 E 254 E 1,022 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2011 $0.27 A $0.32 A $0.37 A $0.35 A $1.31 A 2012 $0.41 A $0.43 A $0.46 A $0.54 A $1.84 A 2013 $0.55 A $0.55 A $0.53 E $0.54 E $2.17 E 2014 $0.60 E $0.62 E $2.44 E Projected EPS Growth - Next 5 Years % 11 2013 Zacks Investment Research, All Rights reserved. www.zacks.com 111 North Canal Street, Chicago IL 60606
OVERVIEW Based in Reston, Calif., VeriSign Inc. (VRSN) provides Internet infrastructure services that include domain name registry services and infrastructure assurance services. Through its only reportable segment Naming Services, the company provides Registry services and Network Intelligence and Availability (NIA) services. Registry services operate the authoritative directory of.com,.net,.cc,.tv, and.name domain names. With respect to the.com,.net and.name, the company has agreements with the Internet Corporation for Assigned Names and Numbers (ICANN) that makes it the exclusive register of these domain names. With respect to.com the company has an agreement with the U. S. Department of Commerce (DOC). In Jun 2012, ICANN approved the renewal of the company's agreement to serve as the authoritative registry operator for the.com registry. The term period for the agreement started from Dec 1, 2012 through Nov 30, 2018. Subsequently, in Nov 2012, DOC also approved VeriSign s renewal agreement with ICANN. Besides ICANN, the company has agreements that make it the exclusive registry for the.tv and.cc country code top-level domains (cctlds). Additionally, the company provides back-end systems for all.gov,.jobs and.edu domain names based on these agreements. It also provides internationalized domain name (IDN) services that enable web-users to access websites in their local language. VeriSign charges fees for operating different domain names except.edu registry. The.com and.net fees are charged as per agreement terms with ICANN and any price increase is subject to prior approval of the DOC for the.com domain. The.name fees are charged as per terms of agreement with ICAAN, while fees received for operating the.gov registry are based on the terms of agreement with the U.S. General Services Administration ( GSA ). NIA provides infrastructure assurance services to organizations and also offers idefense, Managed Domain Name System and Distributed Denial of Service protection Services. VeriSign reported revenues of $873.6 million in 2012. Active domain names ending with.com and.net were 123.1 million at the end of Mar 31, 2013. US contributed 64.8% of revenues, while Europe, the Middle East and Africa (EMEA), Australia, China, India, and other Asia Pacific countries (APAC) and other countries (that include Canada and Latin American countries) contributed 15.5%, 15.0% and 4.7% respectively. VeriSign faces competition in the domain name registry market from 16 registries for the operation of 18 generic top-level domains (gtlds) who have agreements with ICANN. The company also competes with more than 250 Latin script cctld registries and 38 IDN cctld registries as well as from outsourced domain name service providers such as Neustar, Inc., Afilias Limited, ARI Registry Services and Nominet UK, Inc. The company also competes with search engine providers such as Google, Microsoft and Yahoo! and social networking services provider Facebook. Equity Research VRSN Page 2
REASONS TO BUY We believe that the renewal of the.com contract and price hike for the.com and.net domain name registration will boost VeriSign s top-line growth going forward. In 2012, the company hiked the registry fee for both.com and.net domain. The company hiked.com fees by 7% ($0.51) to $7.85 and.net fees by 10.0% ($0.51) to $5.62. Although the.com price is expected to remain fixed till Nov 30, 2018 (as per its agreement with ICANN), the company has the right to increase.net domain fees by up to 10% each year till Jun 30, 2017. During the second quarter, the company raised.net domain fee by $0.56 to $6.18, effective Feb 1, 2014. We believe that frequent increases in fees provide a significant growth opportunity for the company going forward. VeriSign views the introduction of new gtlds as an adjacent growth opportunity. The company has applied for 14 new gtlds including 12 IDNs (internationalized domain names). In addition, applicants for approximately 220 new gtlds have already selected the company to provide backend registry services. Additionally, international expansion through IDNs will also boost its penetration rate into the growing markets of APAC. We believe that along with price increases this will positively impact results over the long term. We remain particularly optimistic on VeriSign s Network Intelligence and Availability ( NIA ) services business. With the rapid adoption of cloud computing, cyber security has become a major concern for enterprises. Large enterprises are expected to increase their security budgets to efficiently address security concerns and renew confidence in cloud computing. According to market research firm Gartner, the global market for cyber security will reach $86.0 billion by 2016. We believe that the company s NIA business continues to gain traction and this huge spending will provide it a significant growth opportunity going forward. VeriSign has a healthy cash balance ($2.0 billion) and remains committed on increasing shareholder value through share repurchases and dividends. In the first half of 2013, the company repurchased 10.1 million shares for $465.9 million. At the end of Jun 30, 2013, the company had approximately $1.00 billion ($509.7 million under 2012 plan and $519.0 million authorization announced recently) remaining under its current share repurchase program. Moreover, the company continues to generate significant cash flow ($297.5 million in the first half of 2013), which will help it to pursue further growth opportunities including acquisitions going forward. REASONS TO SELL Under the agreement with ICANN, VeriSign is subject to certain restrictions in the operation of.com,.net and.name domains on pricing, bundling and use of registrars. However, these restrictions do not apply to cctlds. The introduction of new IDN TLDs and gtlds by ICANN will further intensify competition. An increase in domain name availability in the marketplace could introduce new choices for end-users as well as create end-user confusion around brand preference, which, in turn, could have an adverse effect on the company s business. Another significant headwind for VeriSign is the sluggish growth in the active domain name business for.com and.net TLDs. Net new name registrations declined from 8.6 million in 2011 to 7.3 million in 2012. The company has cited search algorithm changes from Google and macro-economic headwinds in Europe as the primary factors behind these declines. Google s free public domain name service is also a major competitor in our view. We believe lower first time renewal rates will continue to hurt top-line growth going forward. Equity Research VRSN Page 3
VeriSign s balance sheet is significantly leveraged. As of Jun 30, 2013, the company had a total debt obligation of $2.0 billion, which includes the new $750.0 million debt issuance and $1.25 billion subordinated convertible debenture. Higher interest rate on its debt is also expected to negatively impact profitability going forward. VeriSign holds approximately 85.0% of its cash balance internationally. Currently, the company is in the process of evaluating strategic alternatives related to repatriation of this large cash balance. According to management, the process is significantly complex and it expects to provide an update by the end of this year. Unless the repatriation analysis is complete, we believe that concerns regarding near-term liquidity will linger. Although the recent debt issue improves liquidity, higher interest rate will hurt profitability. We provide a word of caution to investors in this regard. RECENT NEWS Second Quarter Highlights Jul 25 VeriSign reported second-quarter 2013 earnings of $0.55 per share, which beat the Zacks Consensus Estimate by $0.02. Earnings (minus stock-based compensation) increased 22.5% year over year but declined 4.6% sequentially. Revenues surged 11.8% year over year and 1.2% sequentially to $239.3 million, slightly ahead of the Zacks Consensus Estimate of $237.0 million. Approximately 60% of the revenues were from the U.S, while the remaining came from overseas. Both U.S. and international revenues increased 12.0% from the year-ago quarter. VeriSign Registry Services added 1.22 million net new names compared with 1.99 million in the previous quarter. Active domain names in the zone for.com and.net increased 4.9% year over year to $124.3 million (.com 109.2 million and.net 15.1 million) in the quarter. VeriSign processed 8.7 million new domain name registrations for.com and.net, slightly down from 8.9 million in the year-ago quarter and 8.8 million in the previous quarter. VeriSign estimates renewal rate to be approximately 72.4% in the second quarter compared with 72.9% in the year-ago quarter. Exact renewal rate figures will be available post 45 days of the end of the quarter. In the first quarter of 2013, renewal rate was 73.2%. During the quarter, VeriSign hiked fee for.net domain names from $5.62 to $6.18, effective from Feb 1, 2014, as per its agreement with Internet Corporation for Assigned Names and Numbers (ICANN). As a percentage of revenues, operating expenses declined to 44.8% in the second quarter compared with 50.0% in the year-ago quarter but increased from 43.6% in the previous quarter. A sharp decline in sales & marketing (S&M) as well as general & administrative (G&A) expenses, down 260 basis points ( bps ) and 210 bps, respectively, drove the year-over-year decline. Research & development (R&D) expense declined a modest 10 bps from the year-ago quarter. The sequential rise in operating expense as a percentage of revenues was primarily due to a 20 bps expansion in G&A and a 200 bps upside in S&M, which offset a 60 bps decrease in R&D. Operating margin was 55.2% in the quarter, compared with 50.0% in the year-ago quarter and 59.6% in the previous quarter. The year-over-year improvement was primarily due to lower operating expenses. However, sharp rise in operating expenses on a sequential basis negatively impacted operating margin. Equity Research VRSN Page 4
Net income as percentage of revenues was 36.1% compared with 32.9% in the year-ago quarter and 37.9% in the previous quarter. Cash and cash equivalents (including marketable securities) were $2.00 billion (out of which $630.0 million was held in the U.S.) compared with $1.56 billion in the previous quarter. The significant rise in cash balance was primarily due to the issuance of 10-year $750.0 million senior unsecured notes in Apr 2013. Operating cash flow was $147.0 million in the quarter, down from $150.6 million in the first quarter. Free cash flow was $132.0 million compared with $145.0 million in the previous quarter. VeriSign repurchased approximately 7.1 million shares for $334.0 million in the quarter. The company s board of directors approved an additional $519.0 million to buy back shares, which brings the total authorization to $1.0 billion. Positive Guidance VeriSign intends to focus more on developing new revenue streams in 2013. The company expects to add 1.0 to 1.4 million net new names in the.com and.net registry for the third quarter of 2013. For full year 2013, VeriSign forecasts revenues in the range of $952.0 to $962.0 million (up from prior outlook of $945.0 to $960.0 million), which represents an annual growth rate of 9.0% to 10% (up from 8%). Non-GAAP gross margin is expected to be at least 80%, while operating margin is forecast to be between 58.0% and 59.0% (up from at least 57%). Interest expense and non-operating income, net is expected to be within the range of $60.0 $62.0 million for fiscal 2013. Capital expenditure is expected in the range of $60.0 million to $80.0 million for fiscal 2013. Equity Research VRSN Page 5
VALUATION VeriSign shares are trading at 24.4X TTM earnings, a discount to the peer group average of 65.9X and S&P 500 average of 17.3X. Given that the 24.4X TTM is significantly lower than the midpoint of the historical range of 18.0X to 38.9X TTM earnings, we believe that the shares have upside potential over the next 3-6 months. The stock is trading at 23.6X our 2013 earnings estimate, 78.5% discount to the peer group average of 109.7X, much greater than the average discount of 30.5% historically, indicating the possibility of further upward movement. However, VerSign is expected to generate earnings growth of just 11.0% over the next 5 years, significantly lower than the peer group average of 22.6%, which is expected to limit the upside. Additionally higher interest rate due to the recent debt offering will hurt profitability going forward. Therefore, we believe that the discount attributed to the shares is justified. We maintain our Neutral recommendation and set a target price of $54.00 (24.9X 2013 EPS). Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF (TTM) (TTM) 5-Yr High (TTM) VeriSign Inc (VRSN) 23.6 21.0 11.0 22.8 24.4 38.9 18.0 5-Yr Low (TTM) Industry Average 109.7 91.1 22.6 34.3 65.9 84.2 16.8 S&P 500 15.7 14.8 10.7 13.4 17.3 27.7 12.0 NetEase Inc (NTES) 13.5 12.2 14.1 15.5 15.1 22.9 9.7 Smart Technologies Inc. (SMT) 25.0 25.6 25.0 7.9 32.8 36.0 2.8 QIHOO 360 TECH (QIHU) 99.4 53.7 57.0 97.3 165.7 152.8 36.8 TTM is trailing 12 months; F1 is 2013 and F2 is 2014, CF is operating cash flow P/B P/B P/B ROE D/E Div Yield EV/EBITDA Last 5-Yr High 5-Yr Low (TTM) Last Qtr. Last Qtr. (TTM) Qtr. VeriSign Inc (VRSN) 10.9 25.3 4.4 304.8-2.7 0.0 11.6 Industry Average 7.8 7.8 7.8 2.5-0.6 0.0-36.9 S&P 500 4.2 9.8 2.9 24.3 N/A 2.1 N/A Equity Research VRSN Page 6
Earnings Surprise and Estimate Revision History Equity Research VRSN Page 7
StockResearchWiki.com The Online Stock Research Community Discover what other investors are saying about VeriSign Inc (VRSN) at StockResearchWiki.com: http://www.stockresearchwiki.com/tiki-index.php?page=vrsn/ticker DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of VRSN. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1031 companies covered: Outperform - 14.8%, Neutral - 78.5%, Underperform 5.9%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research VRSN Page 8