VeriSign: Downgrading to Underweight on Lack of New Catalysts and .com Being Cannibalized

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VeriSign: Downgrading to Underweight on Lack of New Catalysts and .com Being Cannibalized

January 22, 2015

Underweight

Even though shares underperformed the market in 2014, we believe that there is a lack of near term new catalysts and we are seeing new gTLDs cannibalize the growth in .com and therefore we are downgrading VeriSign to Underweight from Neutral. 

·         .com seeing the drain of new gTLDs. In 2013, the base of .com/.net grew 5.0%, but only grew 2.7% in 2014. But if we add the 3.7M new gTLDs registered in 2014 to the increase in .com/.net, the total grew 5.7%, basically in line with the growth seen in 2013 prior to the launch of any new gTLDs. That suggests to us that demand for new gTLDs is cannibalizing the growth of .com. This is something that even ICANN noted it expected when we hosted a call with them in January of 2014. 

·         Margin expansion and share repurchase catalysts fading. We do not expect a lot of new incremental repurchase activity after the repatriation of $700-800M in offshore cash that we and we believe investors anticipate, and will be used for repurchase. Still, we believe VRSN will be one of the most steady management teams in terms of return of capital. The other major catalyst that we believe has driven the stock in recent years is margin expansion and in 2014E the 180 bps improvement is down from 230 bps in 2013 and 650 bps in 2012. Looking to 2015, we anticipate the expansion will continue to fade. 

·         Valuation has less room to expand. Our estimates for EPS growth for 2015-16 are 6.7/4.8% and if we take the prospect for mid-single digit growth in revenue, more limited margin expansion, and steady share repurchase, we see EPS growth upside being 12% on average. The stock this year has traded at just under 20x forward P/E, a healthy premium to the S&P 500 that we feel reflects much of the positive drivers. 

·         IDNs and gTLD revenue would be areas that could overcome cannibalization. VeriSign has yet to launch its IDN (international domain names) where .com is written in other language characters like Arabic. If after launch this, or any registry services to new gTLD providers, is able to offset the cannibalization then revenue could improve and so would the prospects for the stock, in our view. 

·         December 2015 price target of $57.50. Our price target is based on a 2016E 19x P/E.