VERISIGN INC VRSN
August 19, 2020 - 12:13pm EST by
MarAzul
2020 2021
Price: 206.79 EPS 5.8 0
Shares Out. (in M): 115 P/E 40 0
Market Cap (in $M): 24,000 P/FCF 30 0
Net Debt (in $M): 600 EBIT 0 0
TEV ($): 24,500 TEV/EBIT 0 0

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  • Pricing Power
  • Still very expensive looking

Description

Verisign is a regulated monopoly. The Company operates the directory for the .com, .net and other less important domain names. To explain it in simple words, they basically charge an annual fee for every site name ending with those words. For example, valueinvestorsclub wants to use .com in their site. They probably go to a distributor like Godaddy that sells them the right to use the valueinvestorsclub.com name (if it is available). Godaddy charges VIC let`s call it $9/year. Out of that payment, Godaddy has to pay Verisign $7.85/year for the .com domain name. Godaddy makes money in other ways, so let's not get into that. But they are important, given that Verisign relies on resellers to distribute the domain names.

It is a great business given that the .com and .net domains are the standard. There is no need for an established company to try other domains in order to save $10/year. Verisign has the monopoly on these domains. They have a contract regulated by ICANN (regulates the internet). The contract renews every 6 years or so. There is a clause that makes a renewal a given if they don`t break any of their service compromises. In its history, Verisign has been very capable managing their services. Given the importance of what they do, there is little incentive for ICANN to take away the contract from a company that has been good at delivering for years now.

The business is a cash cow given the lack of investment needed for growth. The company does have data centers and needs to reinvest close to $50mm a year, but OCF margins have been close to 60% in recent years. Free cash flow is also higher than net income as the company has tax assets and working capital helps as there is constant build in deferred revenue.

Revenue tends to grow with names registrations. In the past few years, these have grown in the low single digts (3-4%). On top of that, there is untapped pricing power. The company is permitted to increase .com prices by 7% a year in the final 4 years of the contract. They said they will not increase prices this year due to COVID, but they expect to increase .com prices before October 2021. Since 2012, .com prices have been frozen at $7.85/year. The beauty of this price increase, is that it should basically fall to the bottom line as there are no additional expenses. Given the relatively low cost, I think thye should not face much pressure from parties involved, at least in the medium term.

As seen, registered names have grown in the single-digits. .Net pricing has increased over the years, but .com has stayed flat since 2012. As expected, .com is more important. Expected increases in pricing for .com next year should help top line expand (name registrations gowth + pricing).

In a world with rates at zero, I see Versign as a bond with growing cash flows starting at a 3.5% free cash flow yield. On top of that 3.5%, you get name registration growth of call it 3%. Then for the first time in years, Verisign is expected to apply some .com pricing increases (call it 5% over next few years). So we are looking at 3.5% cash flow yield, plus 3% name growth, plus 5% pricing. That translates to possible annual returns of 11% or so, not bad for a bond-like investment. If you want to get aggresive, you can throw in some margin leverage given how this revenue growth should, in most part, drop to the bottom line.

This dynamic has been reflected in the financial figures. Margins have expanded significantly with modest revenue growth.

The business does not require additional capital for growth, so they have been returning basically all the cash flow via repurchases. In the past decade, share count has gone down from 180 to 116 diluted shares outstanding.

Charlie Munger on pricing power: "There are actually businesses, that you will find a few times in a lifetime, where any manager could raise the return enormously just by raising prices and yet they haven't done it. So they have huge untapped pricing power that they're not using. That is the ultimate no-brainer."

Risks:

-Interest Rates: As any business with a high multiple, and bond-like cash flows, rising rates would hurt the valuation. Something on the positive side, is that given the toll-road aspect of the business, there is some protection against inflation. So the real worry would be real rates.

-Contract: There is always a risk that they could lose their contract. That would be fatal for the company as they are a regulated monopoly. I think there are little incentives to try something new, when Verisign has been affective at providing a secure and reliable service. These are criticial functions so I would suppose regulators are not interested in trying something new just because. Also, there is not a whole lot of pressure by relvant players to reduce prices for domains. $7.85/year is not a lot for the right to use a name. Verisign does not add a while lot of value, but they are good at what they do, have a track record and there are not many incentives to change the status quo.

-Domain Names: Eventually, the .com and .net names could lose popularity or face competition. It has been happening. Having said that, established companies and sites will probably continue paying for the standard .com, .net. 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

No specific catalyst required, as I am not looking for multiple expansion. Rate increases next year might help as investors realize that price increases fall directly to the bottom line.

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