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  • 1. Please see page 11 for rating definitions, important disclosures and required analyst certifications Wells Fargo Securities, LLC does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of the report and investors should consider this report as only a single factor in making their investment decision. June 6, 2012 Equity Research VeriSign, Inc. VRSN: Initiating Coverage With An Outperform Rating • We are initiating coverage of VRSN with an Outperform rating. We think the company can consistently grow revenue in the low double digits and EPS at about 20%. Additionally, new gTLD’s should enable VRSN to supplement growth by 2.5%/yr starting in late 2013. We also like the optionality in VRSN’s emerging security business, which could grow to $50MM+ in revenue in the next few years. Lastly, we think VRSN could increase leverage and buybacks once the .com renewal is complete. Our 2012 and 2013 EPS estimates are $1.91 and $2.31, respectively, and our valuation range is $45-47 per share. • REVENUE GROWTH + MARGIN EXPANSION + BUYBACKS CREATE ATTRACTIVE TOTAL RETURN PROFILE. With 5% ave annual price increases and domain name growth consistently at 7-8%, VRSN should be able to deliver rev growth in the low double digits. Margin expansion should drive operating and net income growth of 15% and share repurchases should enable the company to realize a ~20% EPS growth rate for the next three years. • DEFENSIVE BUSINESS MODEL. VRSN’s contracts allow the company to push through 7% price increases in .com domain names in 4 out of 6 years and 10% increases in .net names. Given that VRSN usually increases prices on both registries at the same time, price increases have historically averaged 5% per year. In addition, domain name growth has remained stable. Even during the recession of late 2008/2009, domain name growth troughed at 5% (in mid- 2009) and VRSN was able to grow revenue in excess of 10%. • NEW GTLD'S CREATE OPPORTUNITY TO SUPPLEMENT REVENUE GROWTH. ICANN is in the process of accepting bids for new gTLD's. This is expected to result in some 2,000 new domains coming into the marketplace. VRSN has applied for 14 new gTLD's--12 of which are transliterations or foreign language versions of the .com domain. In addition, VRSN has been selected to run the back end for 220 brands. The company expects no significant revs from this initiative in 2013. However, longer term, we think it could add 2.5% to the revenue growth rate for 5 years starting in late '13. This would help VRSN maintain low double digit top line growth even as .com and .net growth matures. • OPPORTUNITY TO INCREASE LEVERAGE AFTER .COM RENEWAL. While VRSN has provided no indication on longer-term target leverage, we think the company could increase leverage after the .com renewal. Should VRSN increase adjusted net leverage to 1.3x from 0.6x current (note: we tax foreign cash) VRSN would have an additional $400MM in liquidity. This and core business FCF would enable VRSN to repurchase $700MM in stock which equates to ~12% of the company’s market capitalization over the next 12 months. Valuation Range: $45.00 to $47.00 from NE to NE Based on 19.5x - 20.5x 2013E EPS. Risks: potential cannibalization of .net due to new gTLD's, noise around the .com renewal, and history of management turnover. Investment Thesis: We believe VRSN can consistently grow revenue in the low double digits and EPS by ~20%. Additionally, we think new gTLD's will supplement growth longer term and that VRSN could become more active on buybacks after the .com contract is renewed. Outperform Sector: Internet Infrastructure Overweight Initiation of Coverage 2011A 2012E 2013E CASH EPS Curr. Prior Curr. Prior Q1 (Mar.) $0.32 $0.42 A NC $0.55 NE Q2 (June) 0.39 0.47 NE 0.57 NE Q3 (Sep.) 0.39 0.50 NE 0.59 NE Q4 (Dec.) 0.40 0.53 NE 0.61 NE FY $1.49 $1.91 NE $2.31 NE CY $1.49 $1.91 $2.31 FY P/E 25.7x 20.1x 16.6x Rev.(MM) $772 $880 $984 Source: Company Data, Wells Fargo Securities, LLC estimates, and Reuters NA = Not Available, NC = No Change, NE = No Estimate, NM = Not Meaningful V = Volatile, = Company is on the Priority Stock List Cash EPS excludes stock comp, amortization expense, and non recurring items. Ticker VRSN Price (06/05/2012) $38.33 52-Week Range: $27-44 Shares Outstanding: (MM) 158.9 Market Cap.: (MM) $6,090.6 S&P 500: 1,285.50 Avg. Daily Vol.: 1,701,950 Dividend/Yield: $0.00/0.0% LT Debt: $1,350.0 LT Debt/Total Cap.: 20.0% ROE: NM 3-5 Yr. Est. Growth Rate: 20.0% CY 2012 Est. P/CASH EPS-to- Growth: 1.0x Last Reporting Date: 04/26/2012 After Close Source: Company Data, Wells Fargo Securities, LLC estimates, and Reuters Gray Powell, CFA, Senior Analyst (212) 214-8048 / gray.powell@wellsfargo.com
  • 2. WELLS FARGO SECURITIES, LLC Communication Technology EQUITY RESEARCH DEPARTMENT 2 Company Description: VeriSign is an Internet infrastructure provider whose primary line of business is managing the authoritative directory for all .com and .net addresses on the web, known as generic top-level domains (gTLD). The company also serves as the manager for the .name gTLD, .cc and .tv country-code top-level domains (ccTLD), and operates the back-end systems for the .gov, .jobs, and .edu top-level domains. VeriSign manages over 115MM total domain names (1 out of every 2 globally) and processes over 30B+ transactions daily. In addition, VeriSign has a small network security business. Headquartered in Reston, VA, VeriSign was founded in 1995 and has more than 1,000 employees. INVESTMENT THESIS We are initiating coverage on VRSN with an Outperform rating. We believe that the company can consistently grow revenue in the low double digit range – driven by average 5% annual price increases and consistent domain name growth in the 7% - 8% range. Additionally, we think new gTLD’s will create a $120MM revenue opportunity longer term and enable VRSN to supplement growth by 2.5%/yr and maintain low double digit revenue growth in 2014 and beyond. We also like the optionality in VRSN’s emerging security business which could grow to generate $50 - $100MM in revenue in the next few years. Lastly, we think VRSN will be able to increase leverage and further repatriate shareholders once the .com renewal is complete. Our valuation range is $45 - $47/share based on 19.5x – 20.5x 2013E EPS. Risks to our range include potential cannibalization of .net due to new gTLD’s, noise around the .com renewal, and history of management turnover (which has been corrected). BUSINESS OVERVIEW Core DNS segment (est 95%+ of revenue): VeriSign acts as a wholesaler for all .com and .net Internet names, and sells these domains to registrars who in turn sell them to end users. Some of the larger and better-known registrars are Go Daddy, Enom, Tucows, Network Solutions / Register.com (owned by Web.com Group), and Schlund and Partners. Exclusive contracts with the Internet Corporation for Assigned Names and Numbers (ICANN)--an oversight body for domain names--grant VeriSign the right to manage the .com and .net domain registries. The contracts with ICANN are typically six years and have non-competitive rebidding provisions as long as VeriSign maintains uptime within state SLA’s. Approximately 87% of VRSN’s domain name base is comprised of .com names, ~13% from .net names, and less than 1% from other names. The company sells both one-year and multi-year naming contracts. The average contract term for a domain has been about 13 months historically. Network Intelligence and Availability (NIA) segment (less than 5% of revenue): VRSN also offers security and network solutions that are designed to take advantage of the shift towards cloud computing. They offer three main products in this segment: Managed DNS services provide faster Domain Name Services (DNS) response times, simplified DNS management and support services that monitor customers’ Web servers to redirect DNS queries in the event of an outage or service disruption. In simple terms, the service enables the internet to find a company’s website faster and makes sure that the website is available even in the event of a network outage. Customers pay a monthly subscription fee that varies depending on the number of queries and the customer’s network requirements. iDefense is a subscription-based service that allows enterprises to identify security threats and filter out only those threats that are most relevant to their applications. This allows enterprises to proactively guard against security threats while easing the burden of research threats not relevant to their line of business or applications. Customers pay a recurring monthly subscription fee for iDefense. DDoS Protection Services provide organizations with scalable Distributed Denial of Service (DDoS) protection services to help websites stay online during attacks. Customers pay a monthly subscription fee that varies depending on the customer’s network requirements. Former CEO, Mark McLaughlin noted in May 2011 that the market for NIA services is $900MM-$1B today, and is growing at a 13-15% CAGR. He also made comments implying that NIA could be a $50MM - $100MM business for VRSN in three to five years. Since that time, VRSN has changed CEO’s and has not formally disclosed revenues from the NIA business or the potential market opportunity. As a very rough exercise – we
  • 3. WELLS FARGO SECURITIES, LLC VeriSign, Inc. EQUITY RESEARCH DEPARTMENT 3 took VRSN’s average .com and .net domain names and an assumed ARPU based on VRSN’s contracted prices with ICANN. We then backed out an estimate for VRSN’s domain name revenue to arrive at a very rough estimate for VRSN’s NIA revenue. As a result, we believe that VRSN’s NIA business is currently running at a $20MM annualized pace (so ~3% of VRSN total revenue) and think that the segment could be growing faster than 25%/yr. Revenue Generation VRSN currently has two significant contracts with ICANN: one for.com domains and the other for .net: .com: VeriSign collects a $7.85 fee for each .com domain name sold to end-users by registrars such as GoDaddy. During the six year duration of the contract, VRSN has the option to increase prices four times, at a rate of up to 7% per increase. The current (and final) price increase for this contact took effect on 1/15/12. The company is actively negotiating with ICANN to renew the .com contract for another six years, and a decision is expected before the current contract expires on 11/30/12. We are highly confident that VRSN will be able to successfully renew this contract. First, we note that the renewal is not subject to an open bidding process as the contract with ICANN provides VRSN with the right of first refusal as long as VRSN meets all mandated service level agreements. Additionally, the proposed renewal agreement has identical terms to VRSN’s existing contract with regards to pricing. So far the renewal process appears to be going smoothly. Once approved by ICANN – the proposal will be submitted to the Commerce Department no later than 90 days prior to November 30, 2012 for final approval. .net: VeriSign collects a $5.11 fee for each .net domain name sold to end-users by registrars such as GoDaddy. The .net contract authorizes a 10% increase in any year over the life of the six year contract. The current fee structure took effect 1/15/12, and VRSN renewed its contract with ICANN last year through 6/30/17. Others: Fees for the .name, .cc, and .tv top-level domains vary in price. However, transaction volumes for these domains are so low that they do not have a material impact on revenue. Historically, VRSN has announced price increases for .com and .net domains simultaneously. While VRSN has pushed through all contractual .com price increases (7% four times in six years), the company has been more reserved on .net increases. Generally speaking, VRSN has increased pricing on both domains in 4 out of 6 years. Given that .com equates to 87% of VRSN’s domain names and .net equates to 13% - the blended average annual price increase nets to roughly 5%. We highlight VRSN’s historical .com and .net price increases in the table below. VRSN: Historical Summary of .com and .net Price Increases Effective Date of .com .net Price Increase Old New % Change Old New % Change 1/15/2012 $7.34 $7.85 7% $4.65 $5.11 10% 7/1/2010 $6.86 $7.34 7% $4.23 $4.65 10% 10/1/2008 $6.42 $6.86 7% $3.85 $4.23 10% late 2007 $6.01 $6.42 7% $3.50 $3.85 10% Source: Company reports The domain business is seasonal in nature, with Q1 generally being the strongest quarter of the year in terms of net adds, as registrars implement a large portion of their annual marketing budgets. Registrars do this in an attempt to start the year off strong and get the benefit throughout the course of the year. Historically, first- time domain names renew at a 55-60% rate; second-time names, in the mid-70% range; and third-time and beyond, in the high-80% range. VeriSign generates 60% of revenue domestically and 40% internationally, and is largely immune from Fx fluctuations on topline results, as revenues paid for .com and .net registrations are in U.S. dollars. Furthermore, with ~12% of employees based offshore, the Fx impact on margins is minimal as well.
  • 4. WELLS FARGO SECURITIES, LLC Communication Technology EQUITY RESEARCH DEPARTMENT 4 Divestitures In 2007, VRSN embarked on a four-year effort to divest several businesses that were outside of their core competency. This restructuring saw the company unwind 13 separate business units, culminating in the sale of their Authentication business to Symantec (SYMC) in 2010. VRSN was able to generate $2.3B from the divestitures, leaving the company with its core DNS business and smaller network security business. Below, we highlight VRSN’s key asset sales. VRSN: Key Asset Sales Since 2007 Date Business Unit Price (in MMs) Jan 2007 Jamba (51%) $192 Sept 2007 Jamba Services $13 Dec 2007 Retail Data Solutions $10 Mar 2008 Self-Care & Analytics $14 Apr 2008 CDN $1 Apr 2008 Digital Brand Management $50 Oct 2008 Communications Consulting $1 Oct 2008 Jamba (49%) $199 Dec 2008 Post-Pay Services $28 Dec 2008 EMEA Mobile Media $8 Apr 2009 International Clearing $0 May 2009 Communications Services $228 May 2009 Real-Time Publisher Services $2 July 2009 Managed Security Services $40 Oct 2009 Global Security Consulting $5 Oct 2009 Messaging/Mobile Media $172 Nov 2009 Mobile Delivery Gateway $19 August 2010 Authentication/Security/SSL $1,280 TOTAL: $2,263 Source: Company reports Customer Exposure All Internet providers rely on VRSN’s Internet registry services to route all communications to .com and .net Internet addresses. Domain name registrars, including The Go Daddy Group (which accounts for 32% of worldwide domain name registries), Enom, Tucows, Network Solutions / Register.com (owned by Web.com) group pay VRSN for each .com and .net domain name they register on behalf of their customers. There are approximately 900 registrars in the world. 90% of the business globally is driven by the top 10% of registrars. GoDaddy is the world’s largest domain registrar and VRSN’s top customer, accounting for 30% of revenue in 2011. Source: Company reports GoDaddy as % of Revenue 30% 26% 28% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50% GoDaddy % of Revenue, FY'09 % of Revenue, FY'10 % of Revenue, FY'11
  • 5. WELLS FARGO SECURITIES, LLC VeriSign, Inc. EQUITY RESEARCH DEPARTMENT 5 It is important to note that the loss of any one customer would not have a material adverse effect on VRSN, as end-users would simply transfer their domains to one of VRSN’s other existing customers. Competition While VRSN does not face direct competition for the registry of .com and .net Internet domain names, it competes with other companies that maintain the registries for different domain names. This includes NeuStar Inc. (NSR, $31.37, Market Perform), manager of the .biz, .us, .co, .tel, and .travel top-level domains; Afilias Limited, manager of the .org and .info registries; and managers of country-specific domain registries, such as .uk for domain names in the United Kingdom. With this in mind, VRSN manages roughly 50% of the world’s domain names, which is roughly 5x+ more than its closest peer Afilias. We highlight the largest domain name registries and VRSN’s market share in the table below. VRSN: 50% Market Share In Worldwide Domain Name Registries Domain Market Top 10 Domains Names (MM's) Share Registry Operator .com 102.5 43.6% VRSN .de 15.0 6.4% DENIC eG .net 14.7 6.2% VRSN .uk 10.1 4.3% Nominet UK .org 9.9 4.2% Afilias .info 7.9 3.4% Afilias .nl 4.9 2.1% SIDN (Stichting Internet Domeinregistratie Nederland) .ru 3.8 1.6% Coordination Center for TLD RU .eu 3.6 1.5% EURid vzw/asbl .cn 3.3 1.4% Computer Network Information Center, Chinese Academy of Sciences Total Top 10 Domains 175.7 74.8% Other Notable Domains .biz 2.2 0.9% NSR .us 1.8 0.8% NSR Other (1) 55.3 23.5% Total Domain Name Registrations 235.0 100.0% Note: (1) Other domains primarily consist of ccTLD's Source: Company reports and Hosterstats.com With respect to Network Intelligence and Availability services, VRSN competes with companies such as iSight Partners, Secunia ApS, Dell SecureWorks, McAfee, Inc., Prolexic Technologies, Inc., AT&T Inc., Verizon Communications, Inc., Dyn, Inc.’s Dynect Platform, NeuStar Ultra Services, OpenDNS, BlueCat Networks, Inc., Infoblox Inc., Nominum, Inc. and Afilias Limited. INVESTMENT POSITIVES REVENUE GROWTH + MARGIN EXPANSION + BUYBACKS CREATE ATTRACTIVE TOTAL RETURN PROFILE. VRSN exhibits very consistent and predictable revenue growth that when combined with margin expansion and share buybacks create an attractive total return profile. Starting at the top line, VRSN is experiencing domain name growth in the 6% - 8% range. This combined with average annual 5% price increases is driving revenue growth in the low double digit range. In addition, margins have been expanding by 500 bps+ per year as management has reorganized the company and improved their cost structure. Today VRSN operating margins stand at 52%. Some register operators have noted that a registration business can be profitably run at $2 - $4 per year. Given that VRSN runs .com at $7.85 per year and .net at $5.11 for a blended $7.49/yr implies that VRSN could achieve a 60%+ operating income margin longer term. Out of conservatism - if we simply assume that incremental revenue comes in with a 65% contribution margin - VRSN would be able to continue to expand margins by 140 bps per year. This would enable the company to turn a 12% revenue growth rate into 15% growth in operating income. Lastly, we assume that VRSN will continue to use the bulk of its FCF to buy back stock. This would enable VRSN to buy back $320MM of stock per year, which equates to 5% of the company's market cap. If we net out dilution related to option grants, VRSN's 15% operating income growth rate could be translated into EPS growth of ~20% for the next 3 years. We highlight our rough math in the table below.
  • 6. WELLS FARGO SECURITIES, LLC Communication Technology EQUITY RESEARCH DEPARTMENT 6 VRSN: Normalized Growth Projections Scale for $'s not meaningful 3 Yr. 3 Yr. Today Target CAGR Comment Revenue $100.0 $139.0 11.6% Current growth rate of 13% slowing on larger revenue base over time. Operating Income $50.0 $75.4 14.6% Assume 65% contribution margins - yields 140 bps / year expansion Net Income $34.0 $51.7 15.0% Assume 30% non GAAP tax rate Shares 100 88 NA Assume 4% shares net of options repurchased per year EPS $0.34 $0.59 20.0% Margin expansion and repos drive EPS growth of 20% Source: Company reports and W ells Fargo Securities, LLC estimates DEFENSIVE BUSINESS MODEL. VRSN's DNS business exhibits very defensive characteristics, which we believe provides a high degree of revenue visibility even in a weak macro environment. As we have discussed, VRSN consistently pushes through 5% average annual price increases. Furthermore, domain name growth has remained positive even during weak economic times. In fact, the only time .net and .com domains experienced a decline in registries was back in 2002 during the tech bubble collapse. More recently, VRSN still experienced domain name growth in the H2 2008 and 2009 recession. Despite the weak macro environment in 2H'08 and 2009 - VRSN added on average 1.6MM new domains per quarter (7% annual growth) and grew revenue 12% in 2009. Assuming similar domain name growth in a downside scenario on today's base - VRSN would grow its customer base by 5% per year. This combined with 5% average annual price increases would translate into 10% revenue growth, which we think is pretty good for a downside scenario. While a $7.85 fee with a 5% annual price increase for a .com registry appears expensive - we note that the fee is by far the smallest component of any company's infrastructure costs. To put the fees to VRSN in perspective - we examine a few offerings from Go Daddy. For a company purchasing only the domain name and no additional services - Go Daddy charges $12.99 per year and makes a 40% gross profit, which is pretty good considering that Go Daddy does little other than create cool Super Bowl commercials for this part of the business. However, Go Daddy also sells additional services on top of domain name registration. For example, a small business can run a very basic 5 page website with a photo album and search engine visibility for $89.25 per year. Thus, VRSN's .com fee equates to just 9% of the cost of even a very basic website for a small local business. We highlight the two Go Daddy offerings in relation to VRSN’s annual registry fee in the chart below. VRSN: Registry Fees - A Very Small Portion of Infrastructure Costs Actual $'s 2 Year Example: Domain Name Plus Site Builder Services 5 Page Economy Website 2 years for $56.88/yr $113.76 .com yr 1 $1.99 .com yr 2 $14.99 Basic Website & Domain Cost - 2 Years $130.74 Average Annual Cost $65.37 Search Engine Visibility $23.88 Total Cost $89.25 VRSN Fee $7.85 % of GoDaddy Revenue 8.8% Simple .com Registry - 1 Year Term GoDady Price 12.99 VRSN Fee 7.85 % of GoDaddy Revenue 60.4% Source: Company reports NEW GTLD'S CREATE OPPORTUNITY TO SUPPLEMENT REVENUE GROWTH. ICANN is in the process of accepting bids for new gTLDs. This is expected to result in some 2,000 new domain names coming into the marketplace. While there is some small potential cannibalization risk - on the .net side - we think the
  • 7. WELLS FARGO SECURITIES, LLC VeriSign, Inc. EQUITY RESEARCH DEPARTMENT 7 gTLD process will create an opportunity for VRSN to supplement revenue growth by almost 2.5% on an annual basis starting in late 2013. Specifically, VRSN has applied for 14 new gTLD's - 12 of which are transliterations or foreign language versions of the .com domain. In addition, VRSN has been selected to run the back end for 220 brands. Examples could include .nike, .cocacola, .paris, etc. The company expects no significant revenue from this initiative in 2013. However, longer term, we think it could be a meaningful positive for the company - adding 2.5% to the revenue growth rate for 5 years starting in late 2013. Specifically, we think the locally translated .com domain penetration could exhibit a similar opportunity to that of country level domain names like .de, .uk, .nl, etc. Along these lines, the top 10 country level domains account for almost 50MM registered sites. The math here is very rough. But assuming that VRSN takes a 50% market share - the company could be managing 25MM domains in 5 years conservatively at a price of $4 per domain - which equates to a $100MM annual revenue opportunity. Assuming it takes 5 years to scale into the opportunity, the new gTLDs would add $20MM per year to VRSN's revenue or 2% to the growth rate each year. In addition, VRSN has been chosen to provide back end systems for 220 brands. There is not a great comp for this structure and most brands would likely have only a small number of registered sites. Anecdotally, we have heard of small domain deals under fixed fee contacts at $50K - $150K per year. For larger contracts in this sub-segment, we think a deal could look similar to the .gov contract that VRSN won with the U.S. In early 2011, this contact had a total value of $3.3MM for 1 year with 4 one year renewal options. We estimate this contract equates to about $600K per year. Again, the math is very rough - but simply assuming a price of $100K/ year for 220 brands would equate to a $22MM per year revenue opportunity for VRSN. We think the full benefit would be realized as early as 2014, but that growth off of the initial $22MM base would be limited due to the fixed fee nature of the contract. All in, we estimate that the gTLD program could add $120MM+ in revenue to VRSN over a 5 year period. While the potential revenue would not start to be realized until late 2013 - we think the new gTLDs could supplement VRSN's revenue growth by 250 bps per year, which would help the company maintain a low double digit top line growth rate even as .com and .net growth matures. OPPORTUNITY TO INCREASE LEVERAGE AFTER .COM RENEWAL. While VRSN management has provided no indication as to the company’s longer term target leverage, we think the company could increase leverage after the .com renewal as VRSN likely would then have a very high degree of visibility on its cash flow profile over the next 6 years. Specifically, we think VRSN could increase leverage to 1.3x adjusted net debt to 2013E EBITDA from roughly 0.6x today. This would be a similar net leverage level to that of NeuStar Inc. (NSR), which runs a similar business. As a result, VRSN would generate an additional ~$400MM in liquidity on top of the $320MM in estimated 2013 FCF. Thus, we think VRSN could repurchase $700MM in stock (net of incremental interest expense), which would equate to about 12% of the company’s market capitalization over the next 12 months. VRSN: Outlining the Ability to Increase Leverage $'s in millions Adjusted Q1'12A Q1'12A Cash - Domestic $245 $245 Cash and Equivalents - Foreign $1,141 $742 Tax foreign cash at 35% Total Cash and Equivalents $1,386 $987 Credit Facility $100 $100 2.0 - 2.5% debt Face Value of Convert $1,250 $1,250 Net Debt ($36) $363 2013E EBITDA $586 $586 Current Net Leverage -0.1x 0.6x Target Leverage Est 1.3x Similar to NSR pro forma net leverage Target Net Debt - 2013E $762 Additional Liquidity $398 2013E FCF $320 Fully taxed Incremental Interest Expense ($14) Assume mix senior debt, 5% - 6% and credit facility at 2.0% - 2.5% Total Potential Liquidity $705 Source: Company reports and Wells Fargo Securities, LLC estimates
  • 8. WELLS FARGO SECURITIES, LLC Communication Technology EQUITY RESEARCH DEPARTMENT 8 INVESTMENT RISKS NEW GTLD’S COULD CANNIBALIZE .NET DOMAINS. While new gTLD’s should be a net positive for VRSN and help the company supplement revenue growth longer term, we think there is some potential risk of cannibalization on the .net side. Specifically, there will be 200+ new gTLD’s likely introduced in mid to late 2013. Most of these are narrow in focus and many are industry and geographic specific. See below for a partial list of gTLD’s. Sample New gTLD's by Category Generic .shop, .site, .web Music Arts .art, .film, .movie, .music Real Estate .mls Tech .pad, .phone, .app Cities .berlin, .miami, .nyc, .paris People .fam, .health, .social Source: ICANN Most new gTLDs that have been introduced over the last 10 years have seen limited success. While .info – which was introduced in 2001 has grown to over 8.0MM domain names other gTLD’s like .biz only have 2MM names and gTLD’s like .pro, .name, and .travel have less than 150K names. However, we believe that a few names such as .web, .site, .pad, or .social could potentially generate some moderate success and cannibalize .net. On an historical basis – ICANN has expanded gTLDs in 2001 and 2005. • 2001 – New names introduced -- .aero, .biz, .coop, .info, .museum, .name, and .pro. • 2005 – new names introduced -- .asia, .cat, .jobs, .mobi, .tel, and .travel In 2005 and 2006 – there was no discernable impact on .net and.com growth related to the introduction of new gTLDs. In fact, .com domains grew at a 41% annual pace in 2005 / 31% in 2006 vs. 27% in 2004 while .net grew at a 28% pace in 2005 / 29% in 2006 vs. 22% in 2004. Looking at 2001 – it appears that there could have been some impact on .net growth related to the introduction of .info because the growth rate of .net diverged meaningfully from that of .com. We admit that trend is hard to dissect because both .com and .net domains declined in 2002 – likely due to the weak economy and the bursting of the technology bubble. However, we note that .net meaningfully underperformed .com in 2002 – declining 15% from 2001 vs. a 5% decline in .com. VRSN: Deviation in .net Growth After New gTLD's Introduced in 2001 Domain Names in 000's 12/22/00 12/11/01 12/15/02 12/17/03 .net 3,888.1 4,320.4 3,684.7 4,293.7 Yr./Yr. Growth NA 11.1% -14.7% 16.5% .com 20,652.2 23,198.7 21,991.8 25,850.0 Yr./Yr. Growth NA 12.3% -5.2% 17.5% Source: webhosting.info Therefore, in a reasonably bad scenario – we could assume that new gTLD’s cannibalize 10% of .net names. Even under this conservative assumption, we think the impact to VRSN would be minimal as .net accounts for slightly less than 10% of revenue. Thus, a 10% cannibalization rate in .net names would create an impact of under 1% or less than $10MM to VRSN revenue in 2014. Furthermore, we think this risk would be outweighed by the benefits of signing new gTLD’s and running the back end systems for other domains, as we previously discussed.
  • 9. WELLS FARGO SECURITIES, LLC VeriSign, Inc. EQUITY RESEARCH DEPARTMENT 9 HISTORY OF MANAGEMENT CHANGEOVER AND BUSINESS DIVESTITURES. Following several quarters of disappointing results and an ill-fated attempt to diversify VRSN into several businesses outside its core competency, VRSN underwent a significant restructuring starting in 2007. The company began an extensive four-year effort to unwind previous acquisitions, which ultimately saw VRSN divesting 13 separate business units, culminating in the sale of their Authentication business to Symantec in 2010. Furthermore, VRSN has had four different management teams over the past five years. In August 2011, Chairman and Founder Jim Bidzos became CEO on a permanent basis. The changes have had investors questioning the company’s growth expectations and overall business strategy. We believe some of the overhang on the stock has now been removed with the appointment of Bidzos as CEO and VRSN’s newfound focus on its core naming business. In addition, VRSN recently hired a new CFO – George Kilguss – formerly CFO of Internap Network Services (INAP, $6.91, Outperform). We know Mr. Kilguss from our coverage of INAP and have a high degree of respect for his work at the company over the last few years and the level of financial disclosures he provided into INAP’s data center business. As such, we think most concerns around historical management turnover should be relieved. However, with a volatile history – we think investors will likely be cautious should VRSN attempt to diversify away from its core naming business even if the company is moving into tangential sectors. ANTI-TAKEOVER PROVISIONS. VRSN does have some anti-takeover provisions which could limit the potential for the company to be acquired – or at least receive a non-solicited take-over bid. Specifically, VRSN has a shareholders’ rights plan which allows existing shareholders to purchase stock at a 50% discount to the market price if any entity acquires a 20% stake in the company. Thus, in the event of a hostile takeover bid, an existing shareholder would have to increase their stake in the company or risk being diluted. POTENTIAL LEGAL CLAIMS OR CHALLENGES TO .COM AND .NET EXCLUSIVITY. While we do not know of any major challenges to VRSN’s position as the exclusive operator of.com and .net registries, the company has faced legal challenges in the past. Most notably, a lobbying group named CFIT (Coalition for ICANN Transparency) was involved with a lawsuit with VRSN from 2006 to 2011 alleging that VRSN won its ICANN contacts without any competitive bidding. After losing in various courts and going through a lengthy appeals process, CFIT dropped the lawsuit in 2011. As such, we think there is very little risk to VRSN’s status as the exclusive operator of .com and .net registries. VALUATION AND CONCLUSION We believe VRSN can consistently grow revenue in the low double digit range – driven by average 5% annual price increases and consistent domain name growth in the 7% - 8% range. Additionally, we think new gTLDs will create a $120MM revenue opportunity longer term and enable VRSN to supplement growth by 2.5%/yr and maintain low double digit revenue growth in 2014 and beyond. We also like the optionality in VRSN’s emerging security business which could grow to generate $50 - $100MM in revenue in the next few years. Lastly, we think VRSN will be able to increase leverage and further repatriate shareholders once the .com renewal is complete. Our valuation range is $45 - $47/share based on 19.5x – 20.5x 2013E EPS. Risks to our range include potential cannibalization of .net due to new gTLD’s, noise around the .com renewal, and history of management turnover (which has been corrected).
  • 10. WELLS FARGO SECURITIES, LLC Communication Technology EQUITY RESEARCH DEPARTMENT 10 VeriSign,Inc.(VRSN) GAAPIncomeStatement($'sinmillions)FY'09FY'10Q1'11Q2'11Q3'11Q4'11FY'11Q1'12AQ2'12EQ3'12EQ4'12EFY'12EFY'13E TotalRevenue615.9680.6181.5189.8197.0203.6772.0205.7215.3224.9234.5880.4983.9 Yr./Yr.Growth12.2%10.5%12.3%13.1%14.3%13.9%13.4%13.3%13.4%14.2%15.1%14.0%11.8% TotalCostofRevenue166.7156.740.940.741.742.0165.241.343.145.046.4175.7190.6 Asa%ofRevenue27.1%23.0%22.5%21.4%21.2%20.6%21.4%20.1%20.0%20.0%19.8%20.0%19.4% GrossProfit449.2523.9140.7149.2155.3161.6606.7164.5172.3179.9188.1704.7793.3 Margin72.9%77.0%77.5%78.6%78.8%79.4%78.6%79.9%80.0%80.0%80.2%80.0%80.6% OperatingExpenses: SalesandMarketing75.383.422.422.225.127.897.427.828.629.530.5116.4127.9 Asa%ofRevenue12.2%12.3%12.3%11.7%12.7%13.6%12.6%13.5%13.3%13.1%13.0%13.2%13.0% ResearchandDevelopment52.453.713.613.113.513.153.314.815.516.216.963.370.8 Asa%ofRevenue8.5%7.9%7.5%6.9%6.8%6.4%6.9%7.2%7.2%7.2%7.2%7.2%7.2% GeneralandAdministrative146.5137.733.628.224.824.5111.123.524.325.225.898.8108.2 Asa%ofRevenue23.8%20.2%18.5%14.9%12.6%12.0%14.4%11.4%11.3%11.2%11.0%11.2%11.0% RestructuringCharges15.016.95.53.73.03.415.5(0.5)0.00.00.0(0.5)0.0 Asa%ofRevenue2.4%2.5%3.0%1.9%1.5%1.6%2.0%-0.3%0.0%0.0%0.0%-0.1%0.0% TotalOperaratingExpenses289.3291.675.167.166.368.8277.365.568.570.873.2278.0307.0 Asa%ofRevenue47.0%42.8%41.4%35.4%33.7%33.8%35.9%31.9%31.8%31.5%31.2%31.6%31.2% IncomefromOperations160.0232.365.582.188.992.9329.498.9103.8109.1114.9426.7486.4 Asa%ofRevenue26.0%34.1%36.1%43.2%45.2%45.6%42.7%48.1%48.2%48.5%49.0%48.5%49.4% Yr./Yr.Growth45.2%21.1%61.5%48.6%37.6%41.8%51.0%26.5%22.6%23.7%29.5%14.0% InterestExpense(35.4)(157.7)(11.8)(111.9)(11.8)(11.9)(147.3)(12.3)(12.3)(12.3)(12.3)(49.2)(49.2) InterestandOtherIncome0.020.75.56.13.6(3.7)11.50.81.01.01.03.84.0 Income(loss)beforeincometaxes124.695.459.2(23.6)80.777.3193.687.492.597.8103.6381.2441.2 Provision(benefit)forincometaxes32.925.316.9(16.0)22.132.055.021.327.729.331.1109.4132.3 EffectiveRate26.4%26.6%28.5%67.5%27.4%41.4%28.4%24.4%30.0%30.0%30.0%28.7%30.0% IncomefromContinuingOperations91.670.042.3(7.7)58.645.3138.666.164.768.472.5271.8308.8 (Loss)incomefromdiscontinuedoperations157.6763.8(1.5)(2.9)0.38.54.31.90.00.00.01.90.0 NetIncome249.2833.940.8(10.6)58.953.8142.968.064.768.472.5273.7308.8 MinorityInterest(3.7)(2.9)0.00.00.00.00.0(0.0)0.00.00.0(0.0)0.0 NetIncomeattributabletoshareholders245.6831.040.8(10.6)58.953.8142.968.064.768.472.5273.7308.8 EarningsPerShare Diluted$1.28$4.64$0.24($0.06)$0.36$0.34$0.86$0.42$0.40$0.43$0.46$1.71$2.00 SharesOutstanding Diluted192.6179.0172.0167.5163.9160.1166.9162.9161.2159.5157.8160.3154.0 NonGAAPMetrics NonGAAPOperatingIncome(ExclStockComp)205.2284.583.398.198.6103.7383.8106.8112.6118.1124.2461.7527.6 Margin33.3%41.8%45.9%51.7%50.1%50.9%49.7%51.9%52.3%52.5%53.0%52.4%53.6% Yr./Yr.Growth38.7%32.3%44.3%32.8%31.0%34.9%28.2%14.7%19.8%19.8%20.3%14.3% NetIncomeReconciliation NetIncome-GAAP245.6831.040.8(10.6)58.953.8142.968.064.768.472.5273.7308.8 AdjustmentstoNetIncome(122.0)(645.4)14.376.05.310.1105.70.410.410.610.832.246.9 NonGAAPNetIncome123.5185.555.165.464.363.9248.668.475.179.083.3305.9355.7 Yr./Yr.Growth50.2%37.5%54.6%32.3%17.0%34.0%24.3%14.9%22.9%30.3%23.0%16.3% NonGAAPEPS$0.64$1.04$0.32$0.39$0.39$0.40$1.49$0.42$0.47$0.50$0.53$1.91$2.31 Yr./Yr.Growth61.6%47.3%68.7%41.3%27.2%43.7%31.2%19.4%26.3%32.2%28.0%21.1% Note:(1)NonGAAPNetIncomeexludesstockcomp,amortizationestpense,noncashinterest,restructuringchargesandothernoncash/1xitems Source:CompanyreportsandWellsFargoSecurities,LLCestimates
  • 11. WELLS FARGO SECURITIES, LLC VeriSign, Inc. EQUITY RESEARCH DEPARTMENT 11 Required Disclosures $16.00 $18.00 $20.00 $22.00 $24.00 $26.00 $28.00 $30.00 $32.00 $34.00 $36.00 $38.00 $40.00 $42.00 $44.00 $46.00 $48.00 6/4/09 7/2/09 7/30/09 8/27/09 9/24/09 10/22/09 11/19/09 12/17/09 1/14/10 2/11/10 3/11/10 4/8/10 5/6/10 6/3/10 7/1/10 7/29/10 8/26/10 9/23/10 10/21/10 11/18/10 12/16/10 1/13/11 2/10/11 3/10/11 4/7/11 5/5/11 6/2/11 6/30/11 7/28/11 8/25/11 9/22/11 10/20/11 11/17/11 12/15/11 1/12/12 2/9/12 3/8/12 4/5/12 5/3/12 5/31/12 SecurityPrice VeriSign,Inc.(VRSN)3-yr.PricePerformanceVeriSign,Inc.(VRSN)3-yr.PricePerformance Date Date PublicationPrice($) RatingCode Val.Rng.Low Val.Rng.High ClosePrice($) Source: WellsFargoSecurities,LLCestimatesandReutersdata SymbolKey RatingCodeKey RatingDowngrade Initiation,Resumption,DroporSuspend 1 Outperform/Buy SR Suspended RatingUpgrade AnalystChange 2 MarketPerform/Hold NR NotRated ValuationRangeChange SplitAdjustment 3 Underperform/Sell NE NoEstimate
  • 12. WELLS FARGO SECURITIES, LLC Communication Technology EQUITY RESEARCH DEPARTMENT 12 $18.00 $20.00 $22.00 $24.00 $26.00 $28.00 $30.00 $32.00 $34.00 $36.00 $38.00 $40.00 $42.00 5/27/09 6/24/09 7/22/09 8/19/09 9/16/09 10/14/09 11/11/09 12/9/09 1/6/10 2/3/10 3/3/10 3/31/10 4/28/10 5/26/10 6/23/10 7/21/10 8/18/10 9/15/10 10/13/10 11/10/10 12/8/10 1/5/11 2/2/11 3/2/11 3/30/11 4/27/11 5/25/11 6/22/11 7/20/11 8/17/11 9/14/11 10/12/11 11/9/11 12/7/11 1/4/12 2/1/12 2/29/12 3/28/12 4/25/12 5/23/12 SecurityPrice NeuStarInc.(NSR)3-yr.PricePerformanceNeuStarInc.(NSR)3-yr.PricePerformance Date Date PublicationPrice($) RatingCode Val.Rng. Low Val. Rng. High ClosePrice($) 3/5/2012 Powell 3/5/2012 34.71 2 37.00 38.00 34.71 Source: WellsFargoSecurities,LLCestimatesandReutersdata Symbol Key RatingCodeKey RatingDowngrade Initiation,Resumption,DroporSuspend 1 Outperform/Buy SR Suspended RatingUpgrade Analyst Change 2 MarketPerform/Hold NR Not Rated ValuationRangeChange SplitAdjustment 3 Underperform/Sell NE NoEstimate
  • 13. WELLS FARGO SECURITIES, LLC VeriSign, Inc. EQUITY RESEARCH DEPARTMENT 13 $2.00 $3.00 $4.00 $5.00 $6.00 $7.00 $8.00 $9.00 6/2/09 6/30/09 7/28/09 8/25/09 9/22/09 10/20/09 11/17/09 12/15/09 1/12/10 2/9/10 3/9/10 4/6/10 5/4/10 6/1/10 6/29/10 7/27/10 8/24/10 9/21/10 10/19/10 11/16/10 12/14/10 1/11/11 2/8/11 3/8/11 4/5/11 5/3/11 5/31/11 6/28/11 7/26/11 8/23/11 9/20/11 10/18/11 11/15/11 12/13/11 1/10/12 2/7/12 3/6/12 4/3/12 5/1/12 5/29/12 SecurityPrice InterNap Network Services Corp. (INAP) 3-yr. Price PerformanceInterNap Network Services Corp. (INAP) 3-yr. Price Performance Date Date Publication Price ($) Rating Code Val. Rng. Low Val. Rng. High Close Price ($) 6/2/2009 NA SR NE NE 3.05 9/22/2010 Powell 9/23/2010 4.65 1 5.80 6.20 4.85 11/5/2010 5.18 1 6.00 6.40 5.29 2/3/2011 7.67 1 9.70 10.30 7.67 2/24/2011 6.63 1 9.60 10.70 6.63 4/28/2011 8.22 1 9.30 10.40 8.22 7/28/2011 6.31 1 8.40 9.50 6.31 9/16/2011 Hausner 9/16/2011 5.23 SR NE NE 5.72 11/21/2011 Powell 11/21/2011 4.80 1 6.60 7.20 4.80 1/4/2012 5.83 1 7.00 7.50 5.83 2/24/2012 7.46 1 9.30 9.90 7.77 Source: Wells Fargo Securities, LLC estimates and Reuters data Symbol Key Rating Code Key Rating Downgrade Initiation, Resumption, Drop or Suspend 1 Outperform/Buy SR Suspended Rating Upgrade Analyst Change 2 Market Perform/Hold NR Not Rated Valuation Range Change Split Adjustment 3 Underperform/Sell NE No Estimate Additional Information Available Upon Request I certify that: 1) All views expressed in this research report accurately reflect my personal views about any and all of the subject securities or issuers discussed; and 2) No part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by me in this research report. Wells Fargo Securities, LLC maintains a market in the common stock of VeriSign, Inc., InterNap Network Services Corp., NeuStar Inc. Wells Fargo Securities, LLC or its affiliates intends to seek or expects to receive compensation for investment banking services in the next three months from NeuStar Inc., InterNap Network Services Corp. Wells Fargo Securities, LLC or its affiliates may have a significant financial interest in InterNap Network Services Corp., VeriSign, Inc., NeuStar Inc. Wells Fargo Securities, LLC or its affiliates intends to seek or expects to receive compensation for investment banking services in the next three months from an affiliate of NeuStar Inc. Wells Fargo Securities, LLC or its affiliates received compensation for investment banking services from an affiliate of NeuStar Inc. in the past 12 months.
  • 14. WELLS FARGO SECURITIES, LLC Communication Technology EQUITY RESEARCH DEPARTMENT 14 INAP: Risks include pricing pressure in the IP business, data center competition, and lack of ownership of hard assets. NSR: Risks to our range include the NPAC renewal in 2015, acquisition integration risk, and economic headwinds to non NPAC business lines. VRSN: Risks: potential cannibalization of .net due to new gTLD's, noise around the .com renewal, and history of management turnover. Wells Fargo Securities, LLC does not compensate its research analysts based on specific investment banking transactions. Wells Fargo Securities, LLC’s research analysts receive compensation that is based upon and impacted by the overall profitability and revenue of the firm, which includes, but is not limited to investment banking revenue. STOCK RATING 1=Outperform: The stock appears attractively valued, and we believe the stock's total return will exceed that of the market over the next 12 months. BUY 2=Market Perform: The stock appears appropriately valued, and we believe the stock's total return will be in line with the market over the next 12 months. HOLD 3=Underperform: The stock appears overvalued, and we believe the stock's total return will be below the market over the next 12 months. SELL SECTOR RATING O=Overweight: Industry expected to outperform the relevant broad market benchmark over the next 12 months. M=Market Weight: Industry expected to perform in-line with the relevant broad market benchmark over the next 12 months. U=Underweight: Industry expected to underperform the relevant broad market benchmark over the next 12 months. VOLATILITY RATING V = A stock is defined as volatile if the stock price has fluctuated by +/-20% or greater in at least 8 of the past 24 months or if the analyst expects significant volatility. All IPO stocks are automatically rated volatile within the first 24 months of trading. As of: June 6, 2012 48% of companies covered by Wells Fargo Securities, LLC Equity Research are rated Outperform. Wells Fargo Securities, LLC has provided investment banking services for 41% of its Equity Research Outperform-rated companies. 50% of companies covered by Wells Fargo Securities, LLC Equity Research are rated Market Perform. Wells Fargo Securities, LLC has provided investment banking services for 31% of its Equity Research Market Perform-rated companies. 2% of companies covered by Wells Fargo Securities, LLC Equity Research are rated Underperform. Wells Fargo Securities, LLC has provided investment banking services for 21% of its Equity Research Underperform-rated companies. Important Disclosure for International Clients EEA – The securities and related financial instruments described herein may not be eligible for sale in all jurisdictions or to certain categories of investors. For recipients in the EEA, this report is distributed by Wells Fargo Securities International Limited (“WFSIL”). WFSIL is a U.K. incorporated investment firm authorized and regulated by the Financial Services Authority. For the purposes of Section 21 of the UK Financial Services and Markets Act 2000 (“the Act”), the content of this report has been approved by WFSIL a regulated person under the Act. WFSIL does not deal with retail clients as defined in the Markets in Financial Instruments Directive 2007. The FSA rules made under the Financial Services and Markets Act 2000 for the protection of retail clients will therefore not apply, nor will the Financial Services Compensation Scheme be available. This report is not intended for, and should not be relied upon by, retail clients. Australia – Wells Fargo Securities, LLC is exempt from the requirements to hold an Australian financial services license in respect of the financial services it provides to wholesale clients in Australia. Wells Fargo Securities, LLC is regulated under U.S. laws which differ from Australian laws. Any offer or documentation provided to Australian recipients by Wells Fargo Securities, LLC in the course of providing the financial services will be prepared in accordance with the laws of the United States and not Australian laws. Hong Kong – This report is issued and distributed in Hong Kong by Wells Fargo Securities Asia Limited (“WFSAL”), a Hong Kong incorporated investment firm licensed and regulated by the Securities and Futures Commission to carry on types 1, 4, 6 and 9 regulated activities (as defined in the Securities and Futures Ordinance, “the SFO”). This report is not intended for, and should not be relied on by, any person other than professional investors (as defined in the SFO). Any securities and related financial instruments described herein are not intended for sale, nor will be sold, to any person other than professional investors (as defined in the SFO).
  • 15. WELLS FARGO SECURITIES, LLC VeriSign, Inc. EQUITY RESEARCH DEPARTMENT 15 Japan – This report is distributed in Japan by Wells Fargo Securities (Japan) Co., Ltd, registered with the Kanto Local Finance Bureau to conduct broking and dealing of type 1 and type 2 financial instruments and agency or intermediary service for entry into investment advisory or discretionary investment contracts. This report is intended for distribution only to professional investors (Tokutei Toushika) and is not intended for, and should not be relied upon by, ordinary customers (Ippan Toushika). The ratings stated on the document are not provided by rating agencies registered with the Financial Services Agency of Japan (JFSA) but by group companies of JFSA-registered rating agencies. These group companies may include Moody’s Investors Services Inc, Standard & Poor’s Rating Services and/or Fitch Ratings. Any decisions to invest in securities or transactions should be made after reviewing policies and methodologies used for assigning credit ratings and assumptions, significance and limitations of the credit ratings stated on the respective rating agencies’ websites. About Wells Fargo Securities, LLC Wells Fargo Securities, LLC is a U.S. broker-dealer registered with the U.S. Securities and Exchange Commission and a member of the New York Stock Exchange, the Financial Industry Regulatory Authority and the Securities Investor Protection Corp. This report is for your information only and is not an offer to sell, or a solicitation of an offer to buy, the securities or instruments named or described in this report. Interested parties are advised to contact the entity with which they deal, or the entity that provided this report to them, if they desire further information. The information in this report has been obtained or derived from sources believed by Wells Fargo Securities, LLC, to be reliable, but Wells Fargo Securities, LLC, does not represent that this information is accurate or complete. Any opinions or estimates contained in this report represent the judgment of Wells Fargo Securities, LLC, at this time, and are subject to change without notice. For the purposes of the U.K. Financial Services Authority's rules, this report constitutes impartial investment research. Each of Wells Fargo Securities, LLC, and Wells Fargo Securities International Limited is a separate legal entity and distinct from affiliated banks. Copyright © 2012 Wells Fargo Securities, LLC. SECURITIES: NOT FDIC-INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE