Verisign Needs to Acquire

Verisign (VRSN) provides services for the security of business activity over networks and the Internet. The company consistently relies on its core existing programs of domain registry and SSL certificates to produce results. Is it enough to continue to increase shareholder value?

The company has two divisions: the Internet Services Group (ISG) and the Communications Services Group (CSG).

The ISG is comprised of security services and information services businesses. ISG revenues grew 6% sequentially and 22% year-over-year with revenues of $225 million or 61% of total revenue. Registries jumped to 73 million from 69 million (an annual increase of 27%). Bottom line domain revenues continue revenue support via a renewal rate of 76 percent, consistent with previous quarters. On the other side SSL certificates totaled 883,000 in Q2 compared to 850,000 in Q1. The increase of 221,000 certificates gives a 4 percent growth in its base and 13 percent growth year over year.

The CSG performance is evaluated in three areas: 1) digital content and messaging; 2) communications and commerce; and 3) professional services. The CSG branch produced revenue of $143 million for Q2 or 39% of total company revenue, offering no change from Q1. Regarding digital, strong growth is expected but the pricing environment is challenging without near improvement expected. Verisign also anticipates growth for communications and commerce; however, revenues were diluted by declines in connectivity, database revenues, and continued customer defections in prepaid services business. Professional services consolidated into a single professional services organization in Q1 with Q2 results approximately the same as Q1.

So how did the two program areas translate into recent company performance? Verisign’s Q2 results ended June 30, 2007, with total revenue equaling $368 million versus $373 million in Q1. At the same time, VeriSign’s aggregrate cash on hand totaled $820 million (up $80 million from Q1) and deferred revenue of $691 million (up $29 million).

Aside from ISG performance, the continuing reorganization boosted the Q2 operating margin by 21.6%, and the changes are expected to produce $50 million in annual savings by reducing 350 staff company-wide to a total staffing target of 4,420.

Q2 core operating expenses were $141 million or 38% of revenue. This increased from $130.5 million in Q1. The decline in total operating expenses from $234.5 million to $222.1 million was due to ongoing divestiture and from reorganization benefits. Company GAAP net income for Q2 was a negative $5 million versus $61.7 million in Q1, with a GAAP net loss per share of $0.02. However, non-GAAP net income for the second quarter was $62 million with earnings per share for Q2 at $0.25. The fuzzy math between standards doesn’t do the company any favors, with investors and critics both being wary of reporting differences.

Strategically, Verisign management expects the ISG program to continue producing growth from domain registry and SSL businesses in Q3. However, the CSG forecast is not as optimistic: slight growth due to carrier consolidation may occur but challenging market dynamics have slowed the messaging business inroads.

The concerns for Verisign continue on how to make growth happen in new areas. Already having tried acquisitions, Verisign needs to focus its activities closer to success goals. Verisign signaled it will continue dropping non-mission critical areas such as selling its Jamba services, noted in Q1. The company’s strengths continue to be domain-names and SSL certificates, both aspects of the ISG. With a strong cash position, Verisign has the room to maneuver into new growth areas, but its track record in the CSG departments has been mediocre. True revenue growth is only in the ISG, which investors have already priced into the stock price of $33.88.

Given the stock price is close to its 52-week high, one could argue why fix it if it ain’t broken? Well, I disagree. The company seems to not have a very clear direction beyond ISG, and that is of concern. They have been named a leader by Forrester in the Managed Security Services (MSS) area, which I think is a very good growth market for them to focus the CSG efforts on. In fact, I have covered a company before called Qualys, which is a strong technology leader in the Software-As-A-Services (SaaS) MSS space. Its CEO Philippe Courtot, whom I interviewed earlier this year, sold a company called Signio to Verisign earlier. Verisign has since sold Signio to eBay’s PayPal business unit. May be it is time for Verisign to buy something else from Monsieur Courtot to create a solid, recurring revenue stream in its CSG business unit?