Verisign (“VRSN”): The quarterly update from VRSN is so enjoyable. It takes so little mental effort to realize that this is a great business. Additionally, each quarter, you realize how much heavy lifting is being done for you by the great business. You can find the earnings release here.
VRSN provides a great example of what you should look for in a business. It’s like sitting down in a “Great Business Class” in your MBA program and opening up to Chapter 1 on the first day: Verisign.
The rarity of this business doesn’t mean that such examples never come along. Instead, the rarity is an indication of the patience required to wait for a business that is both understandable by you and
With VRSN specifically, I want to emphasize a few key points about why I think it is such an exceptional business and what to look for in other businesses.
VRSN’s management is not interested in
Competition: Competition is probably one of the biggest threats to shareholder value for any company. The competitive threat from the current landscape of other businesses in addition to the future competitors that don’t even exist now provides a continual concern for shareholders in any company. VRSN is one of the few examples I have ever found that has virtually no competition. The contractual agreement to be the registry for .com and .net provides VRSN a contractual monopoly for their business. Buffett once talked about owning the “one toll bridge from Michigan to Canada” and how great a business that would be. These businesses are very rare and VRSN is such a business. The financial statements of VRSN would look dramatically different
Operating Margins: Although this point is merely an accounting observation, it is quite instructive to see how great of a business VRSN is by looking at the dramatic increase in operating margins over the past 5 years. Operating margins increase as revenues increase faster than marginal or required fixed costs increase. This is a very common idea in business, but VRSN is a great example of how the fixed costs of operating their business do not increase at the same level as their revenues increase, both because of new customers and through pricing power. Without real pricing power due to contractual provisions, VRSN has still been able to increase operating margins because their fixed costs have not increased in line with their increased revenues. They have very little variable costs with each additional user, and their fixed cost base can most likely support many more customers than they are currently serving.
VRSN provides the rare example of the proper equation for investment success. It should take very little time to understand that a business is both exceptional and within your circle of competence. The larger time requirement is in the patience to wait for such an idea and to wait for such an idea at the right price. Most people focus their efforts solely on the time to understand a business, which is natural because that is generally the only factor that they can control. The problem with this approach is that great businesses typically don’t take a significant amount of time to recognize. Instead, people convince themselves after hours of invested time that they have discovered an “off-the-beaten-path” great investment idea.
Although I believe VRSN is a great business, I do think valuation matters. At its current prices, I no longer believe VRSN will provide significant upside going forward. This could change in the future if something causes the valuation to decline significantly without affecting the actual business. VRSN will remain on my watch list and we will be patient for a better valuation.