Symantec - Can it forge a path toward profitability and growth
In a phrase - I think the odds favor both although it will be easier to enhance profitability than to accelerate growth. Late last month, after a well-rumored courtship, Symantec (NASDAQ:SYMC) formally announced its acquisition of LifeLock (NYSE:LOCK), a significant part of its strategy to stabilize its consumer security operation. Earlier in November, the company announced what seemed to some to be disappointing guidance for the balance of fiscal year 2017 (ends 6/30/17 and it also announced a CFO transition as the new CEO brought his own man to the position of CFO. Disappointments are in the eyes of beholders - while the shares declined a few percent in the wake of the earnings release, the reported non-GAAP results were a significant beat in terms of EPS ($.30 vs. $.21) and a still noticeable beat in terms of revenues. Further, the revenues derived from Blue Coat in the stub period in which it was owned, were 25% above the $100 million forecast.
Lots of the rationale for Symantec's acquisition of Blue Coat was cost synergies. As is fairly typical in many deals in this space, the synergies are progressing at a more rapid cadence than had been planned and the odds are that they (the cost synergies) will wind up to be larger than initially projected. I would be surprised if the guide-down implicit in the numbers presented by management during the November 3rd call actually come to pass. I imagine cost synergies will continue to be realized at rates above initial projections and it is encouraging as well, to see the consumer business declines attenuate as the company emphasizes mobile platforms.
Symantec is a company followed by a few enthusiasts and lots of doubting Thomases who have been victims of unrequited love over the years. I have my own share of experiences in that regard - but not with this name. Overall, with a modest 1st call rating of 2.5, the shares are set up for appreciation if the company is able to achieve decent operating performance.
I must confess that there was an amusing dialog during the conference call, almost certainly forgotten in the wake of the merger announcement, but CEO Greg Clark told a persistent questioner that things are going to get better on the consumer side. He said that guidance was conservative and finally he told the questioner that things are OK. He (The CEO) didn't quite say trust me John - but he came darned close. The analyst is one of those victims of unrequited love for the company - this is his 3rd CEO. It was an almost poignant dialog if you appreciate such things.
I think it is fair to say that the body language on the call was such as would lead many observers to believing that the numbers that were presented were numbers that management fully expects to beat, in both the next two quarters in fiscal year '18. Absent specifics, I will stick with the guidance in presenting valuation metrics, but will simply remind readers looking for catalysts that my expectation for Symantec is to see a succession of beat and raise quarters.
There is, I think, some danger in taking projections by management quite literally in forming expectations for companies, particularly those in the midst of multiple transitions. The fact is that the managements themselves can't forecast with precision, which makes it impossible to provide guidance that means exactly what the numbers say. I think "directional" is about as good as one can expect for a merger of the size and strategic impact of that between Blue Coat and Symantec. Things are likely to be better than anticipated and the tea leaves are good. 70 days and 25% greater revenue contribution is a pretty decent start. Anyone who thinks there is really much more that can be forecast is looking for that spare pot of gold at the end of Finian's Rainbow.
Forward guidance for this current fiscal year was increased by less than the amount of the beat, while forward guidance for FY '18 was unchanged primarily because the share count hadn't declined as rapidly as had been projected. In the wake of the impending purchase of LifeLock, the estimated share count will increase again, since the company has curtailed its share repurchase to fund the acquisition. I assume this perceived guide down was the reason why the shares sold down initially.
In the wake of all these developments, the shares are little changed - down about 4% since the end of September. That is about the same performance as the HACK index (Cyber Security ETF) which is also down 4% over the same time period.
Symantec has its share of detractors who think of it as a value trap. Despite its share price performance this year and estimates that are still modestly in value territory for fiscal year '18 starts 4/1/17, analysts have done very little warming up to the name. Of the 24 covering analysts, it has picked up a few buys lately but is still firmly rated by 1st call at the mid-point between hold and buy. Most analysts have not increased their expectations for next year in the wake of the LifeLock merger and have left their price targets alone. That is an error, I believe, regardless of what the explicit guidance provided by management. The shares are not heavily shorted and almost all of the shares are and have been held by institutions looking for ways to play the cyber-security space on the cheap.
A large part of the story is the new sheriff, CEO Greg Clark, who came along with the Blue Coat merger. Symantec has suffered from a series of truly unimpressive CEOs over the years. The amount of value destruction these men oversaw is a lesson as to why it is almost impossible to overpay good CEOs. (I knew if I thought hard enough I could figure a way of saying that the company had a series of plausible, but incompetent, highly paid CEOs.) This is a company that has let the likes of Palo Alto (NYSE:PANW), Fortinet (NASDAQ:FTNT) and others pass it by as though it were a passenger waiting for an old New Haven RR train to arrive.
Mr. Clark has bought himself a little more time with the Life Lock deal in which to achieve - if not operational excellence - at least the category above operational mediocrity. He is off to a good start in the opinion of this writer.
The purpose of this article is to take a more thorough look at LifeLock and the strategy that Symantec is developing in trying to maintain in position in the consumer security space, take a look at where the company is within the highly controversial space of enterprise cyber security and to see if the company's shares are still worth an investment. It is another of those names whose shares can do well if they can deliver what they have promised but achieving what has been promised is nothing to be taken for granted.
LifeLock - A potential lesson in how to take a sow's ear and make it into some kind of purse.
The years have not been kind to Norton and to Symantec's personal security business. While many people, including this writer, still subscribe to Norton anti-virus on their PCs, there are lots fewer PCs and lots fewer still users who haven't found alternatives for Norton anti-virus. Many of the users of Norton, are customers because of laziness - not perhaps a marketing strategy that resounds with investors and one that has produced a negative CAGR.
LifeLock is a company that offers its users a subscription model for protecting their identity. The strategy that is now articulated around the combination of Symantec and LifeLock is that Symantec is going to be a company that offers consumers the leading digital safety platform which should protect the information, devices and identity of consumers. How much is hype and how much is real is perhaps an unfair question to raise. It is marketing and it is real and it is both at the same time. Marketing to some is a bit of a skill like 3 card Monte. Marketing is something that seems uniquely American, at least in its genesis, and can have outsize impacts on the success of different business strategies.
For the last several years, the Norton component of Symantec has been producing the kinds of results that are typically seen in a hospice. Revenues consistently contracting, ASPs declining, renewal rates diminishing. When writers on this site and others talk about Symantec being a value trap, part of the argument has been the outlook for Norton. The acquisition of LifeLock is a bold attempt to staunch the hemorrhage of that operation on the overall company. It is a reasonable bet that has a reasonable chance of achieving cost synergies and some chance of achieving revenue synergies as well.
LifeLock's current revenue run rate is just shy of $670 million and its financial metrics have been quite decent. The company is expected to achieve free cash flow of $85 million. The premium that is being paid by Symantec to acquire LOCK is almost 50%. The company's most recent quarterly results were decent, if not spectacular. LOCK is in the early stages of actually having something other than brand awareness as a differentiator. The company has completed its Theft Protection Services platform which basically uses analytics to detect fraud and to notify customers in terms of suspicious use of their credit. The new technology has been forecast by LOCK management to add to both growth and margins. The platform is based on LOCK's extensive data set, particularly in those areas such as sub-prime lending that are uniquely exposed to fraud.
LifeLock is neither without flaws or competitors. The company has been fined by the FTC a couple of times and is still paying off its most recent fine for essentially not fulfilling its full guarantee to competitors. I am going to make the assumption that the bid that was made by Symantec was done with the investigation of these instances by its counsel and that there are no further unexplored land mines. LifeLock spends a fair amount of resources on compliance related activities - but it is a risk worth mentioning.
Competition in the space is significant although LifeLock is the category leader and it and its largest competitor share almost 2/3 rd of the market between them. I am really not in a position to evaluate the competing services - sites exist that try to do that. According to what I have read, the top LifeLock alternative is Identity Guard. But at the end of the day, this is a service that depends on marketing to create awareness of both the problem and the vendors that try to solve it. Being #1 and having marketing dollars to spend is a substantial advantage and partnering with Norton is going to reinforce the advantage - Norton does have a strong reputation in the anti-virus world - even if that world is shrinking.
Not being a user of the products, and never having ever considered them, it is lots easier for me simply to consider the financial ramifications of the transaction. I am sure there will be users for whom that methodology is unsatisfying - but all I can do is mention my perspective and leave readers and potential or current Symantec shareholders to draw different conclusions if they so wish.
The key performance metrics (KPIs) that one looks at in this kind of a company include sub adds, retention rates, cost of user acquisition and ARPU. The results for Q3 were more or less in line although the retention rate dipped by 1 basis point, while the growth in new subscribers at 254,000 showed little year-to-year increase and overall the gross new membership metric has declined year to date. The ARPU, however was up 3%. The cost of acquisition was impacted by more expensive media costs because of the election cycle which drove up advertising rates. Still, overall gross margins improved noticeably both sequentially and year on year as the result of the transition of LOCK's users to the new platform which is far less costly to operate, overall. I think, without exploring the issue at great depth, that LifeLock is not a sick company and compared to Norton, overall, it is a pillar of strength with positive growth and many opportunities. The company's technology and its brand are driving demand and identity theft remains an issue for many consumers.
And the synergies are…
Symantec has forecast a modest level of cost synergies relative to what I think is more likely to happen. The LifeLock model is expensive to operate because of the expense of acquiring customers. "Call this number on your screen now" is expensive and is probably less effective for younger consumers as time passes. Selling LifeLock to the enormous Norton user base will be far more efficient. Developing bundles that include LifeLock and Norton is going to be an attractive opportunity for both cost and revenue synergies.
LifeLock plans on $330 million of marketing spend in its next fiscal year - that is 4 times what it spends on research and development and more than 4 times what it is spending on general and administrative costs. There ought to be a significant level of low-hanging cost fruit that is probably under-estimated in the current guidance. Further, there is almost certainly some kind of revenue synergy that will be developed over time. (Symantec is only looking at $30 million of cost synergies out of a total opex base of $500 million at LifeLock in fiscal 2018. It would be surprising not to see more cost synergy than that.) Overall, Symantec is expecting that the transaction will be neutral to its EPS results in fiscal '18 after allowing for the dilution of additional shares coupled with the costs of its borrowing. The extent to which cost synergies exceed $30 million will be additive to EPS next fiscal year and whatever revenue synergies can be add will also be additive to expectations. Overall, management has spoken to a potential of $80 million of cost synergies by fiscal 2020 - just a bit more than 2 years from now. $80 million in cost synergies, would increase after-tax EPS at Symantec by $.10/share in after tax EPS and a more likely estimate probably yields total synergies of between $.15-$.20.
Despite the dismal record of the past few years, Norton has more than 50 million users. That is a much more compact and easier to reach target than trying to sell LOCK services to consumers over the television and through call centers. It is believed that there already have been some cross-marketing trials between LifeLock and Symantec and one of the factors that lead to Symantec's LifeLock bid was the success that the company had experienced in terms of its ability to market LifeLock subscriptions to its Norton base.
Is this a transformative transaction for Symantec? Not quite. LifeLock is a company with a revenue run rate of $670 million. That is a relatively large number compared to the current size of Norton whose run-rate revenues are less than $1.6 billion and currently shrinking at a CAGR of 5%-6%.
It is not, however, a particularly large number compared to Symantec as a whole which is forecasting $4 billion revenues this year with some moderate level of organic growth, including the impact of the Blue Coat acquisition. I see it as a decent deal that will have a noticeable positive impact on the P&L of a magnitude greater than that currently being forecast by the consensus numbers. It probably will improve the organic growth rate by a couple of hundred basis points and the core profitability of LifeLock is a bit greater than the current operating margins that Symantec had been forecasting.
Meanwhile, back at the farm
Symantec, for better or for worse, is an enterprise security company and its future is wrapped up in the enterprise security business. That is fundamentally the reason Greg Clark has become the CEO and if one looks at the range of potential outcomes for Symantec the dog is enterprise security and not Norton.
As many readers are aware, Symantec has had its share of transition activity this year, shedding Veritas, buying Blue Coat and installing a new CEO/CFO and now buying LifeLock.
It was a pleasant surprise to see the rate of decline for the company's consumer business to compress a little, but the impact of that is less than 1% in terms of total revenues at Symantec. Management at the time of its earnings conference call in early November, spoke about its progression in offering consumer's solutions that ranged beyond PC malware and were focused on mobile devices as potential drivers in terms of demand. At this point, however, focus is going to shift to LifeLock and its integration with Symantec as the potential synergies are almost certainly greater than the amount of growth that the consumer security division could generate on a stand-alone basis.
Last quarter - or should I say the last 70 days of the last quarter was the initial period of operation for the combination of Symantec and Blue Coat. The revenues for the quarter came in about $30 million, or 3% above the prior consensus. There were some revenue synergies in the enterprise business and some signs that the long decline in the consumer business is attenuating. Management deliberately chose not to raise guidance for this quarter and beyond in the interest of conservatism. Given the history of this company, that is prudent.
I think that the most relevant issue of interest to investors is the competitive position of the newly combined enterprise. I think it is very early to attempt to try to do a deep dive into what is working and what is not in terms of the merged enterprise. I think the basic question for investors is to try to determine if this new business can compete successfully with Palo Alto, Fortinet, Cisco (NASDAQ:CSCO) and many others in terms of both technology and sales execution.
There are areas in which Symantec, perhaps unbeknownst to many is a technology leader. In the DLP space, Gartner ranks Symantec a resounding #1. Gartner gives Symantec strong marks for its Endpoint Protection Platform and the Forrester Wave report says that Symantec has a leading position in Cloud Security Gateways. I could, I suppose, try to compare Palo Alto TAPS to Symantec or look at how Palo Alto Wild Fire stacks up against Symantec ATP but that is really outside of my comfort zone and I am not too sure what it means in terms of share price performance over the coming quarters. No one really thinks that Symantec is going to outgrow PANW organically. It would be more than enough if Symantec could stay in the running in the ATP space.
At this time, most of the companies that review products have yet to try to incorporate Blue Coat's additions to the Symantec fabric in their evaluation. I think it is fair to say that even in areas in which PANW and its competitors have been dominant, Symantec has a reasonably competitive solution. It simply has had a difficult time in terms of sales execution and 70 days of upside is probably not enough from which to draw any conclusions as to how and how much that might change.
Looked at holistically, I think that it is fair to say that Symantec offers a competitive portfolio of security solutions and in some markets it is the undisputed leader. The question that hasn't been resolved just yet is whether Greg Clark and a new team can take a competitive set of solutions and garner growth that is at least within hailing distance of market growth performance. In recommending the shares going forward, that is the bet I am making and I think based on the record of Clark it is not an outlandish one. At the least, the valuation of the shares is such that the risk/rewards of making a commitment at this point seem well weighted to rewards.
Some thoughts on Symantec's Valuation
For as long as I have known Symantec is has been a valuation name, sometimes deep and sometimes less so. It was described as a value trap by one contributor a few months ago, and looking at the company's record at that point, the analysis seemed historically valid. In these days of activist investors and massive consolidation, however, historical analysis often doesn't work. If Symantec had not chosen to remake itself, the odds are that private equity would have chosen to take on the job. If the cutting and pasting doesn't work, it seems likely that Elliott will be urging the management to do some surgery. Capitalism can work if it is left to do so.
As I have tried to point out, the Symantec of 8 months ago has been recast through a series of mergers and a management change. It still may be a value trap as I understand the concept. But it has a better chance of morphing into a competitive cyber-security vendor.
As I mentioned, I think part of the case for buying the shares is that management has deliberately set guidance significantly lower than it thinks it can achieve. That makes some of the valuation metrics, particularly the P/E, more extended than I think they really are. The same could, perhaps be said about many companies. I just think in this case, the CEO and retiring CFO were fairly direct in how they discussed the setting of expectations.
But investors can make their own judgment regarding how to evaluate valuation metrics for a company like this that has so many aborted turnarounds. In the long run, it won't matter that much. The shares are cheap enough to buy and most investors and analysts are going to claim pleasant surprise if the company is able to beat and raise consistently.
The company has about 640 million shares outstanding currently and hence has a market capitalization as I wrote this of $15.5 billion. The company has a gross cash balance of $5.6 billion and its current debt is about $7.2 billion. That brings the enterprise value to $17.1 billion. The LifeLock transaction is to be done by using $1.55 billion in cash and raising $750 million in debt. So, including LifeLock in the valuation calculation will result in the company having an enterprise value of $19.4 billion.
I think in looking at an EV/S calculation, one has to annualize the impact of the recent Blue Coat acquisition. That is going to bring the guided/consensus estimate for the period to about $4.5 billion. To that I think one ought to add an expected annualized revenue contribution of $700 million from LifeLock. So, on a pro forma basis, the EV/S calculates at 3.7X. That is not deep value perhaps, but represents a reasonable valuation of the company can execute at some reasonable level.
The company has guided to non-GAAP EPS of $1.70-$1.80 for fiscal '18 and the consensus estimate is $1.73 for the period. While the shares are going to perform based on whether or not the company misses or beats, I think using the current year earnings as a valuation metric makes little sense due to the multiplicity of costs that are flowing through the non-GAAP income statement in the wake of the consolidations with both Blue Coat and then LifeLock. The current P/E on consensus fiscal 2018 EPS is about 14X. I think it would be reasonable to expect that fiscal '19 would see a further step function growth in earnings as additional cost synergies are realized and that would, for no other reason, bring EPS to $2.25 at which time the P/E would be 11X. Yes, there is many a slip twixt cup and lip as the saying goes, but these are cost synergies that have almost certainly been properly identified by the due diligence done when companies are acquired. I think the EPS could be significantly greater than both the consensus for FY '18 which starts June 30 of next year and for fiscal '19.
I like to use free cash flow as my favorite tool in valuing a business asset. That is hard to estimate for this company because of its acquisition of Blue Coat and all that has done to deferred revenues and other items in CFFO. The CFFO the past 6 months is negative because the company paid down $840 million of income taxes that are not reflected in its operating numbers. In addition, the company had a cash use of $153 million related to discontinued operations. Given all the moving parts, the company has not chosen to forecast either CFFO or free cash flow. I would assume, for the purposes of modeling, that free cash flow will be a bit higher than reported non-GAAP earnings as the company has the ability to improve consolidated balance sheet ratios and because an increasing proportion of revenues is coming from subscriptions. If that turns out to be correct, then it is reasonable to think about a fiscal 2018 free cash flow yield of greater than 8%, with the yield accelerating to as high as 10%+ in fiscal '19.
The company pays a modest dividend and its current dividend yield 1.26%. I see little reason to believe that the dividend will increase. The company has a goal of de-levering its balance sheet and returning to a net cash position and it is likely to use all of its free cash flow to pay down debt.
There have been more than a few issues in the cyber-security space in the past few months - hence the relative under performance of HACK which is just up 4% YTD compared to the IGV which is up 6.5% and the SPY which is up 9%. But I think that the combination of both valuation and underappreciated synergies afford SYMC the opportunity to generate further positive alpha in the short term.
Disclosure: I am/we are long SYMC.
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.