Symantec: Underappreciated Market Leader With A High Return On Invested Capital

Jul.28.14 | About: Symantec Corporation (SYMC)

Summary

Symantec returns significant amount of their cashflow to shareholders with 90% of FCF returned through dividends and buybacks in FY2014.

SYMC has a negative cash conversion cycle, proving that they use their working capital very efficiently.

Large equity check, however, potential private equity target for specific segments: base-case LBO analysis shows an IRR of 21% on 6.5x total leverage.

Strategic firms may be interested in acquiring SYMC's various separable businesses.

Executive Summary
Symantec (NASDAQ:SYMC) is a global leader in security, backup and availability solutions. They trade at a discount to their peers with an EBIT yield of 10%, a ROIC of 24% and a negative 30 day cash conversion cycle. My analysis shows that their ROIC is much larger than their WACC. Due to this and their large market share position, any growth would create a large amount of value for shareholders. My analysis finds an intrinsic value for SYMC of $32.35 with a 26% margin of safety. Further, due to SYMC's divisibility along with their steady and stable cash flows, they seem to be a potential acquisition target for either strategic companies or private equity firms.

Business Overview
Symantec is quite the entrenched player in security, backup and availability solutions. They are the largest provider of security software in the world and market share leader in the backup software market. And, 99% of Fortune 1000 companies are Symantec customers.

Symantec has demand advantages in the market due to the very high switching costs involved. Their customers tend to be captive due to the time, money and effort it takes to replace suppliers. In addition to this, new systems are likely to bump up error rates - and, the applications involved are typically very critical to the customers' operations. Therefore, few companies will abandon a working system even if a rival has a better product due to the fact that these switching costs include the possible threat of harming the business.

During FY2014, SYMC implemented changes in three areas: simplifying organizational structure, redesigning their Go-To-Market strategy, and changing their product offerings. In terms of the organizational structure changes, SYMC aligned their organization by functional areas instead of market segments which is intended to improve accountability and execution. This should also align management incentives. The Go-To-Market strategy has been redesigned to focus on growth and renewals. They split their direct field sales team into security and information management specialists focused on new business only and also built a renewals group to make it easier for current customers to stay customers. Further, SYMC refocused product offerings by focusing on making their point solutions better and expanding offerings by partnering with network security vendors to offer multi-tier protection solutions.

From a first look at Symantec's metrics, we see that they offer a free cash flow yield of 7.7%, a dividend yield of 2.5% and a relatively low adjusted LTM EBITDA multiple of 7.2x (metric may differ as this one is adjusted for restructuring charges). From this first glance, it seems to be an interesting opportunity to get involved with a company that is generating this much return for shareholders.

overviewClick to enlarge

Competitive Analysis
From a comparable companies analysis, when excluding companies that are too diverse in their operations or too large in size, SYMC trades near the CYE2015 comparables, however, they should command a premium due to their lower CCC and higher operating margin, EBIT yield and ROIC.

Cost of Capital
Using the US 10 year treasury rate of 2.5% and adjusted Moody's Baa rating, taking into consideration SYMC's 2022 maturity, I arrived at a cost of debt of 4.5%. I then normalized the tax rate for items expected to recur and arrived at 25%. Further, I assumed the targeted debt-to-capitalization ratio to be 20%, in line with previous years and future expectations. Consistent with value investing teachings, I did not use beta, instead, I added the equity risk premium of a medium business risk / low financial risk business of 4% to the pre-tax cost of debt to arrive at a cost of equity of 8.5%. Therefore, I calculated SYMC's WACC to be 7.5%.

Return On Invested Capital
SYMC's adjusted cash ROIC is 24%. This, along with market share leadership, proves that SYMC operates with significant competitive advantages and are able to produce a great amount of return for shareholders. Due to this number being three times the cost of capital, going forward, any growth will add significantly to shareholder value.

roicClick to enlarge

Earnings Power Value
I calculated SYMC's earnings power to be $25.88, implying 8.6% upside. However, this is in a no growth scenario.

EPVClick to enlarge

The Value Of Growth
As mentioned, growth can add significant value here due to the large ROIC compared to WACC. Also, it is expected that SYMC will continue to grow cash flow in the coming years. Consistent with teachings from Greenwald and Kahn, I calculated a value of growth multiplier which is used to estimate the amount of shareholder value that the estimated cash flow growth rate would provide SYMC.

Intrinsic Value
As displayed, using a cash flow growth rate of 2%, we arrive at an intrinsic value of $32.35. Given that many analysts are estimating an EBIT CAGR over the next few years of about 2%-6%, this growth rate seems conservative. At this valuation, one would have a 26% margin of safety (or, MoS), implying that they would essentially be purchasing SYMC for 74 cents on the intrinsically valued dollar.

intrinsic valueClick to enlarge

Below is a sensitivity table displaying the potential outcomes at various cash flow growth rates.

IV SensitivityClick to enlarge

Potential Catalysts
Aside from Symantec seeming like a strong long-term investment due to the high ROIC and steady and stable cash generating qualities, there are still other characteristics that may act as potential catalysts. The management turnover that has been taking place may prove beneficial in the coming years as SYMC has not yet reaped the rewards of their salesforce restructuring. Also, SYMC is divisible & saleable, has high cash flow generating characteristics and a negative cash conversion cycle which makes it interesting for various strategic companies or private equity firms.

Quantifying Other Opportunities
To quantify these opportunities, I created a leveraged buyout analysis with conservative operating model assumptions to view the potential returns to financial sponsors. With 6.5x total leverage and a premium of 25% to the current share price (36% premium to the 90 day daily average share price), my analysis shows a 21% IRR. However, at this time, the deal would require a good sized equity check that would likely require a consortium of private equity firms. However, likely of interest, requiring a smaller check, is SYMC's various separable businesses: (1) user productivity and protection, (2) information security, and (3) information management; or, the various businesses within those.

LBO Assumptions

LBO SensitivityClick to enlarge

Conclusion
Regardless of the upswing in the share price of Symantec over the past few months, I believe there is still strong upside on the table for long-term value investors due to the high ROIC and strong cash flows. Further, the acquisition catalyst adds additional upside potential.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.