Long Term Prospects Remain Bright For VeriSign Despite Low Short Term Visibility

VeriSign (NASDAQ:VRSN) reported a good set of fiscal 2013 results, with double-digit growth in revenues and strong expansion in net income margins. The company’s revenues increased 10.5% to $965 million, driven by a 5% growth in domain registrations and average domain price. Although gross margins for the year declined by about 19 basis points, lower operating expenses provided support to a 2.3 percentage point expansion year-on-year in operating margins. This expansion in operating profit margin, along with a favorable tax benefit of approximately $88 million, lifted the company’s net income margin from 37% in 2012 to 56% in 2013.

In addition to delivering good top line and strong bottom line figures, VeriSign completed approximately $1 billion in share repurchases in 2013. The company’s board approved an additional buyback program of $1 billion without an expiration which should continue to provide earnings accretion for the company. ^[1] We have incorporated key trends discussed below from VeriSign’s latest earnings and have a revised price estimate of $61 for the company.

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.com/.net Domain Share Continues To Decline

VeriSign’s share in the global top level domain (TLD) market decreased from 48.1% in 2012 to approximately 46.7%, according to our estimates. We believe this decline in share for the company’s .com and .net domains is a result of a migration of businesses from generic TLD extensions (gTLDs) such as .com, .net, .info, .org etc. to country code top level domain (ccTLD) names. As of today, there are 141 different gTLDs for registration along with 296 different ccTLDs. ^[2] This huge gap between gTLDs and ccTLDs is a factor contributing to declining interest in choosing gTLDs by businesses. With only 141 gTLDs providing services to millions of domain registrations, of which VeriSign operates three, businesses are migrating to ccTLDs to have a shorter url as opposed to a long and cumbersome .com url.

To balance this gap between gTLDs and ccTLDs, the Internet Corporation of Assigned Names and Numbers (ICANN) allowed organizations to apply for new gTLDs to expand the root zone database. VeriSign was delegated with 12 new gTLDs of the 14 extensions it had applied for with ICANN. ^[1] However, the company has not begun the contracting process associated with delegating new domains into the zone. We expect the company to begin the contracting process with ICANN and begin registrations for its new gTLDs subsequently in fiscal 2014, which lowers to the growing pressure on its .com domain name. It is unclear from the company’s prepared remarks as to when the company would begin contracting and registering new gTLDs. A deferral in new registrations should lead to a continued decline in market share going forward.

Operating Margins Should Inch Higher In FY14

In FY13, VeriSign’s non-GAAP and GAAP operating margins stood at 58.5% and 54.7% respectively, compared to 56.2% and 52.4% respectively from a year prior period . The company’s non-GAAP margins exclude the stock compensation component from its operating expenses, resulting in a higher margin figure. Although operating margins expanded in fiscal 2013, Q4 witnessed a contraction in margins on a sequential basis, with increased sales and marketing, and general and administrative spend from the company.

The quarterly increase in operating expenses was a result of VeriSign’s preparation for a worthless stock deduction claim for tax benefit purposes by liquidating one of its domestic subsidiaries. The liquidation of its subsidiary resulted in a net tax benefit of $375 million, subject to IRS audit and adjustment, and has not been included yet in its prepared FY13 financial results. ^[1] While these potential tax benefit claims are yet to materialize for the company, the company’s tax burden for FY14 would be weighed down by its plans to repatriate approximately $700-$800 million of cash held by foreign subsidiaries. ^[1] For fiscal 2014, the company expects net tax expense between $35-$50 million, which could increase further should the IRS reduce VeriSign’s tax benefit claim substantially.

For FY14, the company guides its non-GAAP operating margin to range between 58%-60%, boosted by a further reduction in operating expenses. We expect FY14 non-GAAP margins to expand by approximately 1.5 percentage points to reach 60%. However, net income for the company could see some downward pressure if its tax claims do not resonate with the IRS. We have a 37.6% forecast for the company’s non-GAAP net income margin in 2014 compared to 38.8% in 2013.

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1. VeriSign Management Discusses Q4 2013 Results – Earnings Call Transcript, Seeking Alpha, February 2014 [↩] [↩] [↩] [↩]
2. Root Zone Database, IANA [↩]