A few months ago I wrote about NeuStar, Inc. (NSR) saying that the company looked too expensive given the uncertainty surrounding a key contract - the local number portability administration contract which is currently up for renewal under a new lease beginning in the summer of 2015. That contract is supposed to be awarded by the FCC by May 6th, but I fully expect the FCC to miss that deadline - they have missed almost every other deadline associated with this process. Since my last article in January, the stock has cratered by 30% to trade under $30 a share. Shareholders who bought in last fall have done even worse with the stock down as much as 50% from its all time high in recent days. The company reported earnings recently (beat consensus on the top-line, missed by $0.05 on the bottom due in large part to the company spending an extra $6 million on advertising and lobbying on the LNPA contract), and at this point I think it is worth going back to revisit the stock and see where it goes from here.
For the impatient reader, I won't keep you in suspense. I think if you are an investor who is willing to take on some risks, it is a good time to buy NeuStar. At this stage, the stock is very heavily shorted, and the wide-spread assumption seems to be that NeuStar stands a good chance of losing the NPA contract or seeing its profit on the contract cut significantly. I have thought all along that the odds of NSR losing the contract or seeing the profit cut dramatically were perhaps 40%. I still think those odds are roughly correct, though they have probably fallen a bit in recent months, thanks to a surge of last minute lobbying by NSR CEO Lisa Hook. That is, NSR is now a bit more likely to retain the contract on favorable terms than it was 3 months ago.
The CEO of NSR has been lobbying hard to keep the contract both publicly and with regulators at the FCC, and I'm inclined to believe this effort increases the firm's likelihood of keeping the contract. There are some good reasons not to give the contract to Telecordia and instead to simply cut the profits for NSR. This level of profit cut is very likely priced into the stock already though! A fair price for NSR with a reduced profit LNPA contract is probably $35 per share. LNPA revenues have been falling as a percentage of total revenues for years now and I think this will continue as evidenced by NSR's recent acquisition of the .co domain name registry which will add 2-3% to revenues. (The expanding gTLD market is probably going to be a key opportunity for NSR in the future, but that will have to wait for a fuller discussion in a future article.)
While the LNPA contract still makes up a little less than half of NSR's revenues, I estimate that the company would earn perhaps $1.50-$1.70 per share in 2016 and going forward annually even excluding the profits from the contract. At $30 per share then, NSR is trading at perhaps 17-20X profits exclusive of the NPAC. That's pretty good given that the non-NPAC revenues are growing in the low double-digits annually. The current stock price is too cheap especially given that the NPAC is not lost yet and may in fact never be lost. I think a fair price for NSR given the uncertainty surrounding the stock is $35. If NSR does in fact see a negative outcome in the LNPA situation, then the stock is probably worth $27-$32 per share. If it sees a positive outcome, the stock is probably worth $43-$48 per share. (Hence a conservative valuation is perhaps $35 at the current stage.)
NSR recently traded as low as ~$27 a share; I believe investors willing to take some risk should seriously consider NSR as a long position. The company does not have much debt (around $800 million), it is holding about $400 million in cash, and it's been buying back significant amounts of shares. I estimate based on a 60% NPAC margin that non-NPAC EBITDA is about $150 million annually and growing at a double-digit rate. (This figure is consistent with the 35-40% EBITDA margin that was cited on the firm's most recent earnings call.) Very astute bears on the stock, might point out that there is some dependence on NPAC externalities for the non-NPAC revenues (read my first article for more discussion of this), but with more than a year left on the current NPAC contract regardless of what happens with the renewal, NSR could ameliorate most of this issue.
There is no question that NSR is still a risky stock, and if in fact the company does lose the contract, the stock will have more downside. But I think this downside will be limited, and that the stock will ultimately bounce back given the growth rate on the non-NPAC revenues. Further, there is a fair number of examples where various firms have been hammered by uncertainty regarding government contracts only to bounce back once the details are cleared up. VeriSign (VRSN) is a great analogous example where the stock got hit hard on contract concerns a couple years ago, but has since bounced back strongly. This is just one example though and there are other instances of a similar pattern in healthcare and defense as well. There are two plausible outcomes for the next year then. Either NeuStar gets the contract at some slightly reduced rate, and the stock rallies hard (maybe 30% or more). Or NeuStar doesn't get the contract or pricing is cut, NeuStar sues over the process and presses its Congressional allies to lean on the SEC and FCC. This would result in uncertainty for the stock and perhaps a 10-15% fall in the stock price. It's also possible that the ultimate decision is delayed again and the FCC puts forward another round of bidding on the contract. That of course would just lead to a delay in one of the two options I already mentioned occurring. Over time though, I believe the stock will go higher regardless of the NPAC decision. Sentiment on the company is extremely negative right now, and once that sentiment is removed by any type of contract decision, I think it paves the way for a higher price in the future.
Disclosure: I am long NSR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
