Verisign

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Verisign operates the infrastructure for the internet’s Domain Name System (DNS), providing critical registry services for .com, .net, .tv, .cc, and others. It also provides security services, including DDoS mitigation and managed DNS.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: Verisign is an internet infrastructure company, primarily known for its critical role in the Domain Name System (DNS). Their core business involves operating the registry for .com, .net, .tv, and .cc top-level domains, which requires complex and high-availability services. Additionally, they offer cybersecurity solutions and other services.

  • Revenues: Primarily from domain name registration fees, renewal fees, and security services subscriptions, the company’s revenues are recurring in nature and high margin.
    • Domain name registrations for .com and .net are by far the largest contributors to the company’s revenues.
    • Security services contribute to about 15% of revenue in 2022.
  • Industry Trends: There is growth in global domain registrations and increasing emphasis on internet security, which leads to greater demand for its cybersecurity services.
    • The DNS industry has proven to be very stable over time.
    • The company’s expansion into the digital identification space appears to be promising.
  • Margins: Operating margins for the company are incredibly high—around 65% to 70%, due to its oligopolistic nature, that results in very strong free cash flow generation.
    • They are also able to extract significant cash flow as they aren’t as capital-intensive as a lot of other businesses.
    • For example, net income margin was about 40% for full year 2022.
  • Competitive Landscape: The landscape is characterized by high barriers to entry, mostly due to a complex regulatory framework, network effect, economies of scale, and the established position of incumbents.
    • The DNS registry business has limited players due to its specialized technical expertise and the requirement to maintain an extremely reliable infrastructure.
    • While the broader tech landscape is intensely competitive, the market they serve has very low competition.
    • Verisign has been the sole registry operator for .com and .net domains for decades.
  • What Makes the Company Different: What sets Verisign apart is the incredibly critical and complex role it plays in the internet’s DNS infrastructure. This makes the company virtually impossible to replace due to high switching costs.
    • It has a very long-term track record of expertise and stability.
    • Their established relationship with ICANN and the global community of registrars makes a transition to another company extremely difficult.
    • The scale of their infrastructure is also very difficult to replicate.

Financial Analysis:

  • Revenue & Profitability: The business is very profitable with high recurring revenues and net income, which proves they have a robust business model. The latest reports show consistent growth, strong margins, and healthy cash flow generation, but this is tied to the number of .com and .net registrations, where the market is approaching saturation.
    • In the three months ended December 31, 2023, revenue rose by almost 4% compared to last year to 370.9 million.
    • Net income also rose almost 21% compared to last year to 176.1 million in the same period.
    • Operating expenses stayed virtually the same.
  • Cash flow from operations was $337.5 million, an increase from $272 million from last year in the same period. * In the year ended December 31, 2022, the company’s revenues were $1.41 billion, and net income was $570.8 million, and cash flow was $1.06 billion.
  • Capital Structure: Their balance sheets show they are capable of maintaining their cash pile, even while continuing their buyback program. There is minimal debt and a ton of cash and investments.
    • As of Dec. 2023, their assets totaled $3.27 billion, with $1.34 billion in cash and marketable securities and $1.9 billion in property, equipment and other assets.
    • Total debt at the same time was $2.14 billion.
    • As of March 31, 2022, their long-term debt was only at $1.11 billion.

The company’s balance sheet is very strong and it is highly profitable with growing recurring revenues. They should be able to navigate almost any downturn and they will continue to do buybacks and possibly initiate dividends as their cash reserves continue to swell.

Moat Assessment:

  • Moat Rating: 3 / 5.
    • Economic Moat Sources: Verisign has a strong network effect, as the more websites there are, the more valuable their registry becomes. It also benefits from very high switching costs because it is very difficult and highly complex to move to another domain name provider. They also have many regulatory approvals (which aren’t as strong as before). Finally, they enjoy a cost advantage as they have been maintaining their infrastructure for over two decades.
  • Justification: While the business’s core service has strong moats, the lack of innovation in their business model and their lack of opportunities for strong future growth that will benefit from a larger TAM means it isn’t the strongest, and they do have some risks that need to be addressed.
  • Their core business is a duopoly that still has some external pressure from government agencies.
  • Their ability to grow their top line isn’t great outside of their core business, and that means that although they are highly profitable they are not likely to exponentially increase in value.

Risks to the Moat and Business Resilience:

  • Regulatory Risk: Their biggest risk is regulatory oversight. They operate under a contract with ICANN, which is subject to renewal, potential changes, and even restrictions. Changes in their contract might affect their income stream, however, this is not likely to happen given the company’s importance to the internet ecosystem.
    • Their contract with ICANN has been renewed for the next 10 years, in which the revenue per domain will not increase.
    • While their core .com and .net domain operations may be safe, a strong case can be made against their expansion into other registries.
  • Technological Disruption: Though unlikely, any future technological changes, new technologies, and shifts in the way domain names operate could present a threat.
    • This may affect their ability to sustain long-term high returns on capital.
  • Lack of Organic Growth: As most of the world has access to the internet, the domain name market isn’t growing that fast. If that is their only business, the company may not be able to grow at their historical rate.
  • Competition in Security Services: Their cybersecurity services are very promising, however, the landscape in cybersecurity is extremely competitive.
    • While Morningstar gives them a wide economic moat, they operate in different segments with different risks, hence their overall moat can’t be considered very wide.
  • Pricing Power: Due to their long contract with ICANN, they have very little control over their pricing.
    • Their average revenue per domain has only grown by 1.5% over the last 10 years.

Business Resilience: Despite these risks, they show very high resilience due to their recurring revenues and critical position in internet operations. Any technological change, if it occurs, will take time, and they will also have plenty of time to adapt. They also enjoy a lot of customer lock-in, as their product is very complex and not easy to duplicate, making switching extremely difficult.

Understandability:

  • Rating: 2 / 5.
  • Justification: While it is relatively easy to comprehend their business and the type of services they provide, the complexity behind the internet’s DNS system, the inner workings of its contracts, and the regulatory environment might be difficult for a lot of people to grasp.
    • There are also many moving parts which all connect into this complex system which makes the entire system more difficult to understand.
    • They also rely on the internet landscape which is continually evolving and is complex to predict.

Balance Sheet Health:

  • Rating: 4 / 5.
  • Justification: The balance sheet is incredibly strong with little debt, no financial concerns, and has a lot of liquid cash and marketable securities. With its high profit margins and free cash flow generation, the company is likely to have very low risk to its capital structure.
    • Their large amount of cash should provide ample protection against any financial surprises.

Recent Concerns and Controversies

  • The company has been under scrutiny and legal action, due to their domain registry agreements.
  • They have also faced backlash for price increases in their fees.
  • The company had issues with Verisign’s domain registrations due to a technical issue in September 2023.
  • During the last earnings call, the management acknowledged concerns about slow revenue growth, partly due to price increases having run their course. This resulted in share prices coming down from the highs.
  • However, the company has said they are focused on increasing their high-margin security business.

Conclusion Verisign is a business with a wide economic moat that is also very stable and highly profitable, however, their ability to grow faster into the future remains a question mark.