Verisign – A Predictable Cash Cow
|April 23, 2017||Posted by Oddmund Grøtte under Stock Analysis|
Verisign (VRSN) has a very simple business model, has a strong competitive advantage and very light capital requirement. This is the kind of company I like. Unfortunately, it is not cheap.
Verisign acts almost like a “toll road” for the internet. The services provided by the company are necessary for the internet to function properly. The company is the main provider in domain names ending with .com and .net. Since 2007 it has divested all other business to focus solely on the core business: domain registry and security of those domains. It has basically a monopoly and very little competition. In 2016 it collected fees from 144 million domain names (about 8 USD per domain). ICANN (Internet Corporation of Assigned Names and Numbers) is the “oversight body” of VRSN, and has an exclusive agreement with VRSN until December 2024 (and will most likely get extended beyond that). The margin is very high, around 50%, and there is minimal need for capital. Hence, all capital can be reinvested or given back to shareholders. In other words, the cashflow is extremely predictable. The only drawback is that VRSN can’t increase prices, they need approval from government. They need to focus on effective cost management to increase earnings. This is not a compounder, but a very steady cash-cow.
The management has no plan to reinvest the cash it generates (which is good – there can’t be any ill-advised acquisitions). They are probably correct in their view of returning it all back to shareholders. VRSN does not pay a dividend, but instead focus on buying back shares. Over the last 10 years shares outstanding has shrunk from 238 million to 129 million per December 2016. At today’s price we can expect a 5% yearly reduction in outstanding shares.
Here you can see some key numbers over the last 10 years:
Of course the biggest risk is that the agreement with ICANN does not get prolonged. But I believe that the chances for that happening is quite slim. As far as I understand the agreement is automatically renewed unless VRSN fails on the job.
There have been concerns about VRSN near monopoly and thus they must seek approval from Department of Justice prior to raising prices. Currently prices are capped at 7.85 for .com and 8.2 for .net. Obviously this is a limit on the upside.
Another risk is government interference into ICANN. In 2016 the Obama administration agreed to accept oversight of the internet from the US Government to the international community.
Based on 2016 numbers and today’s share price of 88 USD P/E is 25 but somewhat cheaper using free cashflow (18). So it is not cheap by any standard.
Now, below you find a table indicating following: free cashflow will grow 3% per year, 100% of cashflow are used for buybacks, and ratio for price/CF are stable at 18.
CAGR is about 8% with a share price of 192 in 2025. Bear in mind that this is very conservative calculation. Even if multiple goes down to 15 over the whole period, the share price in 2025 is 160, which equals CAGR of 6%.
You also have to consider that is a very recession proof company.
Book value is negative, but this is due to its incredible light capital requirements.
Perhaps also worth noting is that Berkshire Hathaway owns about 12% of VRSN.
Currently I have no position in VRSN, but I will either issue out of the money puts or buy on a pullback.
The Site has been prepared solely for informational purposes, and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security, product, service or investment. I am not a financial professional and accept no responsibility for any investment decision a reader makes. This article is for informational purposes only. The opinions expressed in this Site do not constitute investment advice and independent advice should be sought where appropriate. Neither the information, nor any opinion contained in this site constitutes a solicitation or offer to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. Information on this site is provided “as is” and “as available”. All information and opinions expressed herein are current as of publication and are subject to change without notice. This website will not be responsible for any loss or damage that could result from interception by third parties of any information made available to you via this site. Although the information provided to you on this site is obtained or compiled from sources we believe to be reliable, The Site cannot and does not guarantee the accuracy, validity, timeliness or completeness of any information or data made available to you for any particular purpose.