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The Web's Virtual Vault: Veri Sign


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The Web's Virtual Vault: VeriSign

With a near-lock on secure Net transactions, it's building an E-empire

Used to be, he was the warm-up act at day-long investor powwows--the burly pitchman for a geeky little Internet security company in the shadow of rock-star CEOs of such highfliers as Amazon.com Inc. (AMZN) and Netscape Communications Corp. But when VeriSign Inc. (VRSN) CEO Stratton D. Sclavos stepped up to the podium to speak at San Francisco's swank Ritz-Carlton Hotel on Sept. 20, he was the marquee player. It was standing room only, with about 250 people jammed into Banc of America Securities' annual investment conference. After four years of biding his time in the engine room of e-business, Sclavos had arrived. "You've probably heard this story before," Sclavos says sheepishly, "but the story has gotten bigger and better."

With a trio of acquisitions, culminating in the $15.5 billion June stock purchase of Network Solutions, VeriSign is emerging as a toll booth on the Internet. Want to register a new Web address? VeriSign's Network Solutions Div., or NSI, gets a cut. Want bank-vault-style security so your customers' online purchases are protected from prying eyes? VeriSign has a 75% chunk of that business--a hold on the market that it beefed up with the acquisition last December of Thawte Consulting. The company also has jumped into the nascent Internet payment-processing business with the purchase of Signio. "VeriSign could be one of the Top10 technology companies," in terms of overall financial performance, says analyst Bob Lam of Bear, Stearns & Co. He expects revenues to climb to $980 million next year, up from about $500 million this year.

The company already is motoring along quite nicely. Unlike many of its Net compatriots, VeriSign of Mountain View, Calif., has been in the black for more than a year. Analysts expect $12 million in net income, on $154 million in revenue, when the company announces its third-quarter results this month--tripling the $41.1 million it logged in the second quarter before the NSI deal closed. That huge bump comes largely thanks to the acquisitions: 65% of VeriSign's revenues are from NSI, while 5% come from Signio, and 30% from the original security business. In the past year, while other high-tech companies have sputtered, VeriSign's stock has run up more than 400%--though, at 190, it is 25% below its peak before the NSI merger was announced in March.

Now, Sclavos hopes to stitch together his businesses into a Web powerhouse. He has consolidated four sales forces into one--200 strong--and can approach new customers with a suite of services, while cross-selling new services to existing customers. A company that pays $35 per year for a Web domain name with VeriSign, for instance, might later buy encryption services, paying from $40 to $400,000 a year depending on the level of service. And new services are on the way: A database that cross-references Web addresses and their phone numbers will let people make phone calls via the Net. "We intend to be the Internet's first utility," Sclavos says.

Along the way, VeriSign faces a handful of challenges. First, Sclavos must make his pricey mergers pay off. To buy NSI, for instance, VeriSign had to issue 78 million new VeriSign shares, sending the stock tumbling 30% in three weeks. Did Sclavos pay too much? Some analysts thought so. Also, VeriSign faces stiff competition--including giants, such as Microsoft Corp. (MSFT)--in most of its businesses.

So far, though, there doesn't seem to be much to slow down the upstart. "They know their business inside and out," says Guy Fisher, a manager at GE Global Exchange Services, which uses VeriSign security technology. "I have faith in what we are using." Analysts believe the stock will climb again once it's clear that the mergers are paying off. The price paid for NSI "is an awful lot. But consider that NSI gives them access to every company that's on the Web," says analyst Avivah Litan of market researcher Gartner Group Inc.

Sclavos' Internet roots run deep. Formerly a marketer at Taligent Inc., he joined VeriSign just as it was getting started, after a fateful meeting he had in 1995 with Yahoo! Inc. (YHOO) founders Jerry Yang and David Filo. Over beers at a Silicon Valley brew pub called the Tide House, they convinced him that the Internet would be the next big thing in computing, and that e-commerce would be huge. Now, Sclavos has the opportunity to make his company grow as fast as the Net itself. The value of all Web transactions is expected to hit $4 trillion by 2003, up from $657 billion this year, according to Forrester Research Inc.

VeriSign's unusual business model makes its prospects seem especially bright. It enjoys fat gross profit margins--about 63%, or roughly equal to other top Web software companies, such as Vignette Corp. (VIGN) and BroadVision Inc. (BVSN) Unlike those companies, however, it is not prone to the ups and downs of business software sales. Primarily, VeriSign provides services that customers pay for in advance, like a magazine subscription. This gives it the stability of a services company with the richer profit margins of a software company. VeriSign does this by hosting customers' security needs on its own computers in data centers. VeriSign's margins are improving 1% to 2% each quarter, as the data centers near completion. "I think you are actually going to see their profits growing faster than their revenues," says analyst Martin Pyykkonnen of CIBC World Markets.Easy money. Sclavos works hard to minimize risk. The company does sell some software the old-fashioned way, mainly encryption software packages it hawks to customers who opt not to subscribe to its security service. One reason it doesn't push that method: Microsoft's new Windows 2000 software includes basic encryption software. For many companies that handle their own security, that might be enough.

Sclavos is playing it safe with his Web site registration business, too. Until 18 months ago, NSI had a monopoly on the registration of all Web addresses, charging $35 a year for every .com, .net, and .org it doled out. Now, other companies are free to sell so-called domain names, and NSI's market share has slipped to 41%. That's a good thing, though, says Sclavos. He plans on bringing his Web site registration market share down below 25% within three years to satisfy the government. Regulators won't extend NSI's monopoly on the database for all domain names unless it has less clout in the registration market. In the domain database business, VeriSign collects $6 for every Web site that any of its rivals register. It's easy money.First dibs. That business is secure--for now, but VeriSign faces a handful of rivals in its other markets. Entrust Technologies Inc. (ENTU) and Baltimore Technologies (BALT), for example, are putting together security services that will compete directly with VeriSign. Entrust has formed a partnership with payment processing giant First Data Corp. for a digital certificate service, and Baltimore earlier this year bought GTE CyberTrust--the second-largest digital certificate service behind VeriSign. VeriSign can't be complacent, since it is relatively easy for corporations to switch security services if they're offered a better price.

In the payment processing business, VeriSign has a lot of catching up to do. It's in third place behind CyberSource Inc. (CYBS) and CyberCash Inc. (CYCH) With its $733 million purchase of Signio last December, it bought a 20% share of this promising $75 million market--which is expected to grow 100% a year for the next three years. While the market is focused on consumer transactions, VeriSign is branching into the emerging business-to-business market. It has inked deals in the past month with online marketplaces run by Ariba Inc. (ARBA) and Commerce One Inc. (CMRC) Sclavos' reasoning: This way he gets first dibs on managing the back-end payment systems.

Now, with the pieces of an Internet empire in hand, the pressure is on. "We can't screw up," says Chief Financial Officer Dana Hall. If VeriSign's execs make the pieces fit, they'll be sitting in one mighty big toll booth.e.biz online

For a Q & A with Stratton Sclavos go to ebiz.businessweek.com.By Jim KerstetterReturn to top


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