- After releasing earnings on July 24 Verisign has been on the rise.
- The earnings report has highlighted long-term profit drivers which probably had been misunderstood or ignored before.
- Some of these misunderstandings had actually been the subject of my article on Verisign. However I had missed the favorable tax treatment of the convertible notes.
- The SEC filing interestingly reports that Berkshire became a 10% owner on July 24, i.e. right before the earnings release was published.
Following its Q2 earnings release right after the bell on July 24, Verisign (NASDAQ:VRSN) jumped 10%, but the first impact in after hours trading was negative. Q2 EPS of $0.71 beat by $0.07, but revenue of $250.38M (+4.6% Y/Y) missed by $1.31M. I didn't find anything of surprising in the earnings release and no reason to change my mind on the company. Investors should have expected large buybacks, as they had been announced before and hundreds of millions had actually been repatriated with this precise intention. Hence I suspect the market was favorably impressed by the subsequent conference call, which highlighted some of Verisign's long-term profit drivers. I'll expand only on the one I missed to mention in my recent article on the company - the convertible debenture tax deductions:
One of the primary reasons for this lower expected cash tax rate relates to our convertible debentures. The interest expense deduction for the income tax purposes is based on the adjusted issue price of these debentures, and the adjusted issue price grows over time due to the difference between the 8.5% interest reduction on the adjusted issue price and the cash coupon rate of 3.25% on the principal amount of the debenture compounded annually. The total deduction, which includes the cash coupon amount, has grown since the debentures were issued in 2007 to a deduction of $137 million in 2012, $146 million in 2013 and $77 million through the first 2 quarters of 2014. These amounts are exclusive of any contingent interest payments, which are also tax-deductible. We have added additional detail to our second quarter 10-Q to help you better understand the specifics of the tax benefits the company receives from these debentures. Additionally, our cash tax rate will benefit over the next several years from the usage of various tax attributes, including $192 million of foreign tax credits.
This deduction effectively creates some sort of "float", i.e. money the company doesn't own, but can use for a very long time free of charge. As this kind of free financing is a long time favorite of Warren Buffett (and it is not the only source of float Verisign enjoys, as mentioned in my article), I'm not surprised to see Berkshire (NYSE:BRK.A) (NYSE:BRK.B) increase its stake substantially. The company, probably through one of the additional investment managers, now holds slightly over 10%, acquired right before the earnings release was published.