Neustar (NSR) is a provider of a wide array of communications information services. Examining all of the different services Neustar provides is an article in itself, but let's try to order them in importance to the company from a standpoint of revenue.
Neustar's Lines of Business
1) Numbering Services: 53% of total revenue, grew 7% in most recent quarter (mrq). These consist of databases that allow number portability - allowing customers to keep the same phone number even when changing cellular carriers or moving to a new address in the same area. Neustar is currently the sole provider of these services to the number portability administration center, or NPAC. We'll come back to this important fact later.
2) Internet Infrastructure Services (IIS): 11% of total revenue, 9% growth mrq. These are DNS directories which resolve textual Internet addresses to the IP numbers that the 'net is built upon.
3) Identification Services: 10% of total revenue, -4% decline mrq. Caller ID and geolocation services to carriers and some businesses.
4) Registry Services: 9% of total revenue, -4% decline mrq. Neustar is the sole registrar of the .biz, .us, .co, .tel, and .travel Internet domains, and provides registry gateways for the Chinese .cn and Taiwanese .tw domains. In addition, the company operates the Common Short Codes for text messaging (think reality show voting), and operates the UltraViolet digital management system you may have seen on recently purchased Blu-ray discs.
5) Verification & Analytics Services: 6% of total revenue, 8% growth mrq. A relatively new field for Neustar, these are services that allow customers to assess the conversion potential of telephone or web-acquired leads.
6) Local Search & Licensed Data Services: 3% of total, 17% growth mrq. A system that allows local search platforms to verify the identities of their listings.
7) IP Services: 1% of total, -2% decline mrq. Routing services for MMS "text" messages.
An Excellent Business
Neustar has a great model. It possesses many of our 5 Characteristics of a Great Business.
One is robust recurring sales. Over 90% of revenue is derived from long-term contracts! What's more, the current NPAC contract stipulates annual revenue growth rates, meaning Neustar knows a near-certain baseline of revenue a year or more ahead of time. It is hard to understate what a tremendous advantage this is to most companies.
The firm generates a high return on tangible invested capital and robust cash flows. The majority of Neustar's assets are in informational databases, which require little hard capital to maintain. Free cash flow margin has been steady at about 30% of sales for the past 5 years.
Finally, the company has two key competitive advantages. First, the NPAC contract is exclusive, locking out competition and protecting the firm's largest source of revenue. Second, many of its other services are key to their client's processes, making them difficult to switch out of without much effort (i.e., "sticky"). To illustrate the stability of this business, in 2009, a year which most companies suffered big sales declines, Neustar's revenue fell a minuscule 1.7%.
NPAC Renewal and Growth Strategy Are Risks
The key risk is the renewal of the NPAC contract. Most analysts expect Neustar to win renewal, as it has managed the portability database for 17 years, but expect it could come at reduced terms. Unfavorable terms, and certainly a loss of the contract, are the key risks. We should know the status of the renewal by the end of January, and the current contract ends in 2015.
Also, Neustar has diversified into several alternate fields through the acquisitions of Targus and most recently, analytics firm Aggregate Knowledge. While I feel Targus has certainly provided value, growing by acquisition is always quite risky ... I'd like to see Neustar grow a little more rapidly by organic means.
Not Quite Cheap Enough
All told, Neustar is a relatively low business risk investment. So the question comes down to valuation.
Following about 10% cash flow growth this year, I expect another 9% next year before tapering off to 7% on less favorable NPAC terms, offset some by growth in analytics and local services. The discount rate of 10.5% reflects a lower-risk profile. My earnings yield expectation of about 8.5% is a bit conservative but not unreasonable. All told, this gives me a target price of about $55. Unfortunately, with the stock currently at just over $49, this is not much margin of safety to invest at. For now, we'll put Neustar into the "watch list". I'm interested around $43.