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Morningstar | Continued Execution at VeriSign Leads to Margin Upside; Raising FVE but Valuation Rich. See Updated Analyst Note from 26 Apr 2019

VeriSign’s first-quarter results showed a strong start to 2019, with the top and bottom lines coming above our expectations and consensus. Management provided no details about key future growth levers for their business: the eventual operation of the .web registry and the incorporation of their amended Department of Commerce, or DOC, agreement into their contractual arrangement with ICANN. However, we view these proceedings as formalities, and don’t see existential risk in either scenario. Consequently, the firm’s narrow-moat rating remains intact. We will raise our fair value estimate slightly, to $120 from $118 because the firm's cost controls inspired comfort, with modestly higher medium-term margin assumptions in our model. However, the shares continue to trade at a significant premium in our view. Current levels have the stock at 30 times above our estimate for adjusted 2019 earnings. We remain skeptical that the firm will achieve the kind of growth and/or profitability, implied by such a rich valuation, and recommend that prospective investors remain on the sidelines.

Revenue of $306.4 million equates to 2.4% year-over-year growth. The company ended the quarter with a .com and .net domain name base of 154.8 million, a 4.4% increase from the previous year. Management pointed to the continued growth in registrations across the U.S. and China and we expect this to continue, even as new types of top-level domains, or TLDs, provide different avenues to establish an online identity. VeriSign’s operational execution continued to increase margins, with GAAP gross and operating margins widening by 120 and 340 basis points, to 85.1% and 65.4% respectively. While this performance can be partly attributed to timing mismatches in sales and marketing investments, we think management has done a prudent job controlling costs, investing selectively in their maturing business.

VeriSign remains engaged with ICANN over the operation of the .web TLD registry. Although the timing remains uncertain, management said ongoing litigation was a potential factor delaying confirmation of the deal. One of the losing bidders in the .web auction, Afilias, has filed an arbitration suit against ICANN, alleging that the auction was handled inappropriately. VeriSign is not party to the litigation, but is attempting to help rebut Afilias’ claims. While we believe these proceedings will affect the timing, we don’t see a reversal in the result of the auction. While we cannot comment on the integrity of the auction proceedings, we believe VeriSign’s registry track record and robust infrastructure supporting the Internet’s DNS make the firm best equipped to operate .web.