Mixed Signals at VeriSign


By Alex Salkever On Mar. 7, VeriSign (VRSN) CEO Stratton Sclavos grabbed the brass ring by also assuming the duties of chairman. The 40-year-old Sclavos -- whose spiffy dressing makes him an anomaly in geeky Silicon Valley -- now sits alone atop a diversified company that provides a broad swath of Web services.

While Sclavos declined to talk to BusinessWeek Online, he issued a statement on Mar. 6 that "first-quarter revenues were on track to meet Wall Street expectations." He probably shouldn't break out the Veuve Clicquot just yet, however. The company's shares closed at $32.39 on Mar. 11, much closer to its 52-week low of $21.47 than its 52-week high of $67.94. VeriSign is smarting from the Street beating that started on Jan. 25, when it lowered its 2002 earnings guidance at the same time it announced its annual results, which included a net loss of $13.4 billion.

"ROUND-TRIPPING"? Then Enronitis struck. In early February, VeriSign was forced to vehemently deny unsourced rumors that its revenue numbers were misleading because it had invested in affiliates that then turned around and bought VeriSign products -- a tactic called "round-tripping." (VeriSign spokespeople also declined requests for any interviews with the company's top execs.)

The stock has since recovered, but it's still not back to pre-rumor levels. As recently as mid-December, it was trading at around $45. In fact, shares, which soared to around $258 two years ago, look cheap right now. But investors who are tempted by its low price still may want to watch from the sidelines a bit longer. While VeriSign is one of the world's premier online services companies, it has much to prove this year.

First, the validity of Sclavos' acquisition-heavy strategy has to be borne out. He made a string of buys to build a one-stop-shopping entity for companies that do business on the Internet. Need someone to issue and manage digital certificates (the bits of encrypted code that allow companies to identify and authenticate themselves to online customers)? VeriSign is No. 1. Want to get a new domain name or re-up an old one? VeriSign's Network Solutions unit is the biggest domain-name registrar in the world, competing against the likes of Register.com.

WILD OVERPAYMENT. Through its purchase of Signio, VeriSign is now a player in online-payment processing. And its consultants can help you build and secure a Web site. More important, VeriSign has a monopoly on maintaining the root database for the U.S. government that keeps track of all dot-com names. VeriSign gets $6 per year for every dot-com, making that business a cash cow.

This mix of services came at a high price. VeriSign anted up $21 billion in stock for Network Solutions in March, 2000, right before the dot-com collapse. VeriSign soon realized it had overpaid wildly. Last summer, the company had to write down $9.9 billion in losses, largely as a result of this miscalculation. As of Mar. 11, VeriSign had a market capitalization of $7.4 billion.

Many investors have doubts about its new push into telecom services. In December, VeriSign finalized a $1.2 billion deal to acquire Illuminet, a telecom software and services company with an independent network of signaling stations that can help wireless and land-line carriers exchange billing information on the fly. On Feb. 8, VeriSign completed the $350 million cash acquisition of H.O. Systems, which provides billing and customer-care software for cell-phone carriers. Sclavos' strategy is to bridge the voice and data services that enable business transactions.

"FLAILING AROUND." Critics question why a company whose core business saw revenue increases of 50% annually would buy a company whose revenues are estimated to grow only half as much. "It appears...that VeriSign has been flailing around, looking to acquire companies in whatever area appears hot at the time of the deal," says Peter Cohan, principal of management consultancy Peter S. Cohan & Associates. "Unfortunately for VeriSign shareholders, the wireless strategy is based on overinflated growth expectations in a...sector whose revenues and profits have not kept pace with its debts."

Many of the new businesses have yet to be fully integrated

It isn't just the financial aspects of acquisitions that trouble onlookers, however. VeriSign has yet to fully integrate the half-dozen purchases it made in 2001. "With any company that makes this many acquisitions, there is an integration risk," says Mike Trigg, an analyst with Morningstar. Creating synergy between areas as diverse as telecom, digital certificates, and domain names is a demanding task, and there's the risk that even if the attempt is successful, it will prove to be a distraction from running the businesses.

Other troubling signs are appearing. During the fourth quarter of 2001, the number of customers in VeriSign's mass-market domain-name registrar dropped to 6.2 million, from 6.5 million. Competition is heating up in its key digital-certificate market. Geotrust has come seemingly from nowhere to grab 9% of the business, according to consultancy E-Soft, putting VeriSign under price pressure. VeriSign holds an overwhelming 70% share of the market, but it says its digital-certificate sales increased by just 5% from the third to fourth quarters of last year.

The company hasn't made much of a splash selling its site-building and -management services to business customers. VeriSign is also wading into competitive areas such as security consulting, going head-to-head with formidable rivals like IBM and Internet Security Systems.

LONGER-TERM DEALS. That's not to say VeriSign doesn't have significant strengths. From the third to fourth quarters of 2001, the company boosted its business-customer base to 4,465 units, from 3,775, a robust 18.3% jump. Despite the sluggish economy, VeriSign grabbed 5,000 new customers for its merchant-payment services, bringing the tally to 61,000 at the end of the fourth quarter, an 8.9% increase from the third quarter.

VeriSign spokespeople point out that even though the number of active customers in the mass-market domain-name registry has declined, customers are signing longer registration agreements, which run at about $49 per year. The average agreement is now for two years, up from 18 months last year, says company spokesman Brian O'Shaugnessy. That means long-term revenues are looking stronger, which could smooth out financial gyrations and make earnings more predictable.

Meanwhile, gross revenues soared to $983 million last year, a jump of 107.2%. Some analysts are saying that key measures for VeriSign, such as deferred revenue, are increasing and that the company looks fairly priced. "Their fundamentals had been deteriorating, but they have shown some definite signs of improvement," says Trigg.

KEY QUARTER. Stock analysts are mostly positive on the shares. According to First Call, most of the 27 brokers who cover VeriSign rate it a strong buy or a buy. And shorts have been busily covering their positions, according to Street watchers. Still, few analysts have jumped in with upgrades, fearing that VeriSign's acquisition-fueled growth may prove fragile. A big concern is that it overpaid for its latest acquisitions, as it did with Network Solutions. Cohan, for one, considers more big write-downs likely.

Making good on its claim of meeting first-quarter revenue targets is key for the company. Reporting strong numbers at the end of April could jump-start the stock and reinstate market confidence. Otherwise, VeriSign could see a cold winter extend into a chilly spring. Salkever is Technology editor of BusinessWeek Online


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