Here’s Why Verisign’s Stock Is Worth $44

Verisign (NASDAQ:VRSN) provides registry services for all .com, .net, .cc, .tv, and .name domain names. It also provides back-end systems for all .gov , .jobs and .edu domain names, as well as a host of Internet infrastructure assurance services.

We have a near $45 price estimate for Verisign’s stock, which is approximately in line with the current market price. Our valuation is based on a number of forecasts. We expect the share of .com and .net domain names as a percentage of all Internet domain names to decline in the future, on account of increased popularity of country code domain names and expansion in the gTLD universe. Owing to the restriction on .com domain fee hikes, we estimate the combined fee for .com/.net domain name purchases and renewals to increase at a slow rate of 2% over our forecast horizon. Further, we believe the gross margin could decrease over the long-term, owing to Verisign’s limited ability to hike fees and ongoing investments to ensure reliability in infrastructure.

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Market share of .com and .net domain names in total Internet domain names could come down

The share of .com and .net domain names as a percentage of all domain names has come down from 50.4% in 2009 to around 48.1% in 2012. The decline in market share has been due to the rising popularity of country code domain names such as .uk, .in, .cn and .de. Going forward, we estimate this market share to further decrease to around 42% over the long-run, on account of continued pressure from country code domain names and Internet Corporation for Assigned Names and Numbers’ (ICANN) plan to oversee the expansion of the gTLD universe, with an aim of adding 300-1000 new gTLDs every year. While Verisign has applied for 14 of these new TLDs, there is no surety that Verisign will be able to become the registry for these gTLD’s.

Revenue growth is expected to slow down in the future

The .com domains represent around ~88% of the current .com/.net domain name mix, managed by Verisign, and the .com registry fee along with the permitted fee hikes had previously been the primary revenue growth driver for the company. However, under the new agreement with ICAAN, a restriction on .com domain fee hikes has been placed and the .com domain price is expected to stay steady at $7.85 until November 2018. However, the agreement for .net domain registry allows its price to be raised by up to 10% per year.

On account of the same, we estimate the combined fee for .com/.net domain name purchases and renewals to rise at a slow rate of 2% over our forecast period and reach about $8.30 over the long-run. Hence, the growth in the number of .com and .net domains names will the primary factor influencing revenue growth in the future. However, slower growth forecast in registrations/renewals of .com/.net domain names due to competition from country code domain names and the pending launch of new gTLD’s support our lower revenue outlook. The pending launch of new gTLDs may result in businesses deferring their new registrations/renewals, to register with one of the new ones.

On a positive note, new revenue opportunities could open up in 2014 and afterwards if Verisign is able to gain registry for the new top level domains (it has applied for). In addition, applicants for around 220 new gTLDs have chosen Verisign to provide their back-end systems. Since the success of these applications cannot be predicted, it is difficult to estimate this revenue stream.

Gross margin is expected to decline over the long-run

Increase in Verisign’s gross margin over the last few years was supported by application of price hikes permissible under the previous contract and due to the benefits from restructuring initiatives which started back in 2008. However, we expect the gross margin to decline over the long-term on account of the now fixed .com domain name registration fee and the company’s investments in infrastructure to ensure its reliability. The change in fee that Verisign pays to ICANN for each registered .com domain name will further weigh on the company’s profitability. Under the old agreement, the company had to pay $4.5 million as a quarterly lump sum fee, irrespective of the number of domain names registered. However, with the new agreement, Verisign will have to pay $0.25 per year for any .com registered, renewed or transferred domain. We believe that this change could result in an additional annual expense of $10 million from the .com domains alone.

However, if the margins stay at the current levels till the end of our forecast period, on account of restructuring and other cost cutting efforts, it would represent more than 10% upside to our price estimate for Verisign’s stock.

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