Boring Monopoly Still a Boring Monopoly: VRSN Update

VRSN Earnings Update: 2/10/17:

No news is good news with most companies and Verisign (VRSN) is no different.  There is no real news this quarter.  As we first discussed, Verisign is a solid single, in baseball parlance, that has potential to turn into a double, without much risk of striking out.  In other words, there is limited downside, modest upside with a potential for a higher than modest upside if VRSN is able to obtain price increases on its .com pricing.  The story has not changed much since we originally wrote it up back in late August 2016 at around $75.  Free cash flow continues to be strong and the company is still focused on managing its registry business without deviating at all from its stated plan to grow .com and .net portfolios (and now .web) and use all free cash flow from operations to buy back stock.  Over the past 3 years, the company has purchased $637m, $643m, and $883m of its own stock.  VRSN has brought its share count down from 155m shares to about 124m shares in the past 3 years (the reduction would have been more, but the convertible debt increases as the share price climbs).

2016 2013
Revenue 1142 965
Operating Margins 60.10% 54.73%
Free Cash Flow 641 513

As you can see, the business continues to chug along, it’s a simple, sleep well at night idea.  Since VRSN is consistently purchasing stock in the market, over $500m this upcoming year, now would be a good time to cite Buffett:

But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have increased for the ‘hamburgers’ they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.

A few things to pay attention to over the next year.  

There are two main risk factors, in my view.  First, the idea that new TLDs will take market share from .com.  Instead of registering your website as dropcam.com, you could theoretically now select dropcam.camera.  I haven’t seen this shift occurring yet, but it is a risk factor to consider.  Second, and this is more long-term, that apps become the primary destination of activity, thus decreasing the need for web address usage.  If our time is focused on mobile apps, there may be less of a need to occupy space in various parts of the web.  This is a long-term risk and something I try to keep in mind.  

The other new risk that was briefly mentioned on the call last night was a new CID (Civil Investigative Demand) from the DOJ.  This CID is related to VRSN’s purchase of the right to be the registry for the .web domain.  My hunch is that this relates to VRSN’s ability to exercise monopoly power in the domain registry business if it controls .web, .com, and .net.  I do not think this is a big concern yet, but it is something to keep an eye on.  

On the other hand, there are a few potential opportunities.  

First, the ability of VRSN to take price increases on .com is a potential, however, I would imagine that this potential is less so if the DOJ is investigating VRSN for monopoly power related to its .web purchase.  In other words, VRSN will probably put this request on the back burner for now.  

Second, VRSN holds a significant amount of its cash overseas.  Approximately $1.43B.  However, in the US, VRSN only holds $368m.  This will eventually become a problem as VRSN continues to buy back stock.  Only 51% of its revenues are generated from the US, but most of its expenses are US-based.  Depending on how much stock VRSN purchases this year, VRSN could potentially need to bring back cash and pay 35% taxes on this money.  There has been some talk about a repatriation holiday and this would very much help VRSN, so that is something to keep in mind.  

Overall, I think VRSN’s business continues to move along with strong free cash flow operations and strong focus on capital allocation.  At $84 per share, the stock is not as attractive as it was at $75, but I am still holding it and see no reason to sell.  

My rough, back of the envelope numbers on VRSN are as follows:

Shares 103,091
Convert Shares 21,379 Avg Price $83
Total Shares 124,470
VRSN 83.14
Equity Value $10,348,436
Cash* $1,655,000
Debt $1,237,189
Enterprise Value $9,930,625
Operating Cash Flow $660,000
Capex $35,000
Free Cash Flow $625,000
Price/FCF 15.68

*Overseas cash taxed at 10% to account for potential tax upon repatriation.

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Matt Brice is the portfolio manager of The Sova Group, LLC, an investment firm that manages separate accounts for clients. Matt can be reached at matt@thesovagroup.com. 

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