Much investor attention is lavished on the FANG stocks, and for good reason. These companies all have wide-moat, dominant businesses and benefit from the steady growth of the internet and digital businesses worldwide.
The same can be said of another tech company you might not have heard of: Verisign (NASDAQ: VRSN). Verisign isn't as well known as the big internet FANG platforms; however, there's no disputing the company's stock price performance over the past five years. It's quadrupled, while the Invesco (NYSE: IVZ) QQQ ETF, which tracks the broader tech sector, is up "only" 130% in that time.
So, what's the secret of Verisign's success?
A wonderful business
Verisign is the exclusive registry for the .com and .net top-level domains (TLDs) for the entire internet, as well as the less-used .gov, .jobs, .cc, and .tv TLDs. Verisign also operates 2 of the 13 international root zone servers, which house this authoritative data, forming the backbone of the internet.
You might think this function would be handled by a government agency, but it's not -- well, not entirely. Verisign performs these functions as a private, for-profit company under the authority of the Internet Corporation for Assigned Names and Numbers (ICANN). ICANN itself is a nonprofit, public-private partnership that runs the internet domain name system (DNS) worldwide. ICAAN's participants include a large number of governments, corporations, and individuals, which collectively believe that certain internet functions should be run as a private enterprise. Verisign used to operate under an agreement with the United States government, but ICANN took over those functions in 2016.
Image source: Getty Images.
Verisign's long-term contract with ICANN has presumptive rights of renewal, and the company recently inked an eight-year renewal in 2016 to run the .com name until 2024 and .net until 2023. Thus, Verisign operates almost like a regulated utility, with a kind of global monopoly on the most popular domain names. Verisign's financials have historically been tied to the amount of growth in the .com and .net universe. In 2018, the combined growth of those names was about 4%, with revenue up 4% in lockstep.
Expensive or fair?
Verisign's price-to-earnings ratio sits at nearly 40, which some may find egregiously expensive for a company growing by only 4%. However, there are four very good reasons for Verisign's high multiple.
1. Safety in a low-rate environment: Verisign's monopoly status implies a high degree of stability in revenue and earnings. Since the Federal Reserve paused interest rate hikes in the first quarter, many "safe" stocks such as consumer staples and even restaurants have seen their multiples expand, even if their growth prospects aren't exactly stellar. In addition, the overall trend of the internet is still one of growth, and most businesses will likely still want a .com or .net address.
2. Margin expansion: Verisign has a highly scalable business model that doesn't incur many incremental costs. As the company grows domain name registrants on its stable infrastructure, excess revenue tends to fall to its bottom line. For instance, last year, Verisign's 4% revenue growth enabled 8% operating profit growth, and operating margins expanded from 60.7% to 63.2%.
3. Pricing power: Perhaps most importantly, Verisign amended its contract with ICANN just last October, allowing it to request price increases on the .com domain name up to 7% in each of the last four years of its contract. That means the company could potentially increase prices on domain names 7% in 2021 and each year thereafter until 2024, which Verisign had not been able to do historically. Verisign has been able to raise prices by 10% on the .net domain name in each of the last two years, though .net is far smaller than .com.
You might think an international body would be resistant to allowing Verisign -- a U.S. for-profit company -- to raise prices, but ICANN actually voted to allow a 7% increase on .com back in 2012. It was the U.S. government that vetoed it. Now that ICANN has more powers, the chances of accepted price increases are actually higher.
4. Capital allocation: Verisign's management has done a great job of capital allocation, opportunistically returning cash to shareholders in the form of repurchases. While the company doesn't pay a dividend, management's ample buybacks have allowed it to lower its share count from over 140 million in 2015 to just 122.66 million shares at the end of last year, about a 14% decrease. That's allowed Verisign's stock to increase a bit more than it otherwise would have had those shares been distributed as dividends.
A "tech staple?"
While the main risk surrounding Verisign is its contract renewal in 2024, it doesn't appear as if that is in any great danger. Verisign has operated the .com DNS for 21 years with 100% stability, so unless something drastic happens, I don't see ICANN risking upsetting the apple cart. While Verisign's earnings yield is roughly the same as that of the 10-year Treasury Note, its earnings and cash flows seem almost assured to grow, and in a tax-efficient manner.
Verisign is a rare stock that has outperformed many high-growth stocks while exhibiting the financial stability of a utility or consumer staple. While the multiple is a tad high today, I think it's justified, and the stock could be an appropriate pick for those looking for stability and tech exposure at the same time.
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Billy Duberstein has no position in any of the stocks mentioned. His clients may own shares of the companies mentioned. The Motley Fool is short shares of VeriSign. The Motley Fool has a disclosure policy.