NortonLifeLock: Too Good To Pass Up

Summary

• NortonLifeLock is succeeding in its strategy to outperform the growth expectations from its huge installed base of subscribers.
• The outlook for profitability and cashflow growth has also improved.
• The modest valuation continues to under-represent the improved business profile.

NortonLifeLock's (NLOK) strategy for improving growth and profitability is driving results ahead of plans. The fast pace of execution has improved the cash flow prospect. The forward annualized FCF target of $900M will dilute worries about NLOK's debt load. This has given management the leverage to improve NLOK's growth options given the recent acquisition of Avira and other announced growth initiatives. There are sufficient reasons to believe NLOK will outperform in the coming quarters.

Demand (Bullish)

Avira-DAU/ARPU-Renewals-CyberCrimes-Innovation-Guidance

I am positive about NortonLifeLock's growth prospect given the improved DAU/ARPU momentum and new bets to accelerate the topline.

NLOK has consistently outperformed its revenue guidance since the sale of the Symantec business. The table below highlights the steady revenue improvement.

Source: Seeking Alpha

The revenue growth has been achieved from a blend of growing direct consumer revenue and partner revenue.

Direct consumer revenue is a function of Direct ARPU (average revenue per user) and ADCC (average direct customer count).

ADCC has improved meaningfully to 20.8m in Q3'21 (up from 20.1m in Q3'20). This points to the endearing strength of the Norton brand and the success of its sales activities.

APRU has benefitted from Norton's ability to grow sales from existing users, given its expanding product portfolio and renewal to a higher price point after the first year discount. ARPU now stands at $9.1 (versus $8.99 in Q3'20).

Partner-led revenue grew to $70m (versus $61m in Q3'20). This represents a growth of 15% year-on-year.

In Q4'21, Norton expects revenue of $655 million to $665 million. The guidance represents both a q/q and y/y improvement. I expect the acquisition of Avira to be accretive to both ADCC and ARPU. I also expect NLOK's improved sales strategy and the expanding attack surface for cybercriminals to be supportive of revenue growth. As a result, I will be reiterating my bullish rating.

Business (Bullish)

Product Updates-International Expansion-Digital Leads-FCF-Dividends

NLOK reiterated its product and sales strategies/moves during the last earnings call. The strategies have largely revolved around acquiring new customers while driving solid retention and expansion for the installed base.

As summarized in the table above, the moves are appealing because the consumer security business is a high-margin business.

One option worth expanding upon in the table above is the global release of Norton 360 for gamers. Targeted at gamers, this product validates Norton's decision to double down on the consumer security market, which has a lot of competition.

Our Global Games Market Report shows that in 2021, 2.8 billion gamers worldwide will help the global games market generate revenues of $189.3 billion. Emerging markets will drive much of these new revenues, as infrastructure and economies continue to grow across regions like Southeast Asia and the Middle East & Northern Africa

Source: NewZoo

The growth of mobile games and online streaming platforms opens up a market opportunity for NLOK to sell internet security and privacy protection solutions.

Cheaters often purchase tools that act like malware, hacking and injecting a game with specialized code that will change how it works. These tools have gotten increasingly complex in recent years, with whole underground communities and forums dedicated to ensuring aimbots and wallhacks remain undetected for monthly subscription fees.

Source: The Verge

The early product reviews for Norton 360 for gamers are mixed. Regardless, I believe NLOK can be up to something big if it cracks the market for gamers as there are growing concerns about hackers and cheaters on popular video titles.

TTM gross margin ow stands at 85% (A+ grade using SA Quant rating tool). This represents a significant improvement over the 5Y-average GM of 81.6%. The improved GM alongside cost optimization initiatives has powered TTM EBITDA margin to 40% (A+ grade using SA Quant rating tool).

EPS (non-GAAP) was $0.38 last quarter (versus $0.25 in Q3'20). The EPS of $0.38 consists of $0.30 of diluted net income per share, $0.04 of stock-based compensation, and $0.04 of amortization of intangible assets. EPS from the last quarter is important to highlight because it represents the first quarter with insignificant distortions from restructuring charges. In Q4'21, NLOK expects EPS to be flat at $0.38. The flattish guidance factor the projected accounting expenses from the acquisition of Avira. FY'21 EPS is expected to be $1.5

Source: Koyfin

The improved profitability is expected to drive solid cash flows as we advance.

OCF (operating cash flow) was $293m last quarter. TTM OCF has been distorted by restructuring activities due to the sale of Symantec.

The improved OCF and modest Capex reinvestment rate will ensure NLOK generates $900m+ in annualized FCF in CY'21. This will help Norton drive total returns to shareholders via its dividend and share-buyback operations.

In Q3, we returned approximately $207 million to shareholders in the form of our regular quarterly dividend and share repurchase

Source: NortonLifeLock

NLOK noted that it had approximately $420 million remaining in its $1.6 billion share buyback authorization during the last earning.

Readers will note that the current EPS trend implies an attractive earnings yield of 7% if NLOK continues its buyback.

Source: Koyfin

We ended Q3 with over a $1 billion of total cash and a $1 billion of undrawn revolver capacity. We continue to have a strong liquidity position and are levered at approximately 2 times net debt.

Source: NLOK

While the acquisition of Avira hasn't hit the balance sheet, I am less worried about its impact on NLOK's liquidity ratios. The acquisition appears cheap at $360m, given that NLOK will potentially acquire 1.3M paying customers and over 30M active users. At NLOK's current ADCC of $9, this represents an annual revenue run rate of $100M.

NLOK also noted that it would benefit from the deal in the following ways.

1. Accelerate presence in Europe and emerging markets. NLOK noted during the last call that it has now moved from the number three spot in market share to number one in Germany after the acquisition of Avira.

2. Achieve its vision of reaching more consumers globally.

3. Improve pace of innovation. NLOK noted that Avira has a gaming booster function that can be incorporated into Norton 360 for gamers. It appears this is an extension of the performance optimation solution offered by Avira.

4. Customers will enjoy more flexible buying options via Avira's robust freemium model.

5. Accretive to growth. Expecting a 50% operating margin post-synergies.

Besides the highlighted points above, I observed Avira has compelling security capabilities that extend beyond its primary antivirus offerings.

Avira has products for all Windows, Mac, Android, and iOS devices. Beyond AV, Avira has offerings that cover capabilities in Privacy, performance, and IOT. These include the Phantom VPN, Privacy Pal, Password Manager, API services, SDK services, threat intelligence, and Home Guard (IoT).

Valuation (Bullish)

Growth-Profitability-Value-Momentum

I am bullish on NLOK's valuation due to its improved factor grades. For a company that offers products that play into the digital economy, NLOK's valuation is modest at a forward P/E (non-GAAP) of 14x. The forward P/E represents a 44% discount to the sector median P/E of 25x. In addition to the value grade (B+), NLOK enjoys an A- growth grade. This impressive growth grade is a function of the margins expansion and cash flow growth since the sale of the low margin Symantec business.

Source: Seeking Alpha

The weak profitability grade isn't bad if we take a closer look. NLOK excels on metrics like gross margin, EBIT margin, EBITDA margin, net income margin, return on equity and return on assets.

As explained earlier, the weak FCF margin is a function of the temporary headwinds to cash flow due to the exit from the Symantec business over the trailing twelve months. FCF has improved significantly, as explained earlier. CAPEX/Sales appears weak to indicate that NLOK isn't investing in assets that will drive future sales.

On the contrary, the low CAPEX/Sales ratio reflects the low capital requirement of the business given the maturity of the consumer security business.

Lastly, Asset turnover appears weak due to the presence of stranded assets after the sale of Symantec.

Source: Koyfin

As the table above depicts, Asset turnover has actually improved significantly over the past twelve months. This trend is expected to continue as NLOK finds acquirers of the remaining stranded assets on its balance sheet. This will ensure the balance sheet reflects the true assets required to run the consumer security business.

Risks

The risks to my bullish view include weak execution, weak pricing power due to congestion in the consumer security business, continued sales volatility due to the pandemic, and the growing correction in the tech space.

I expect the congestion worries to be offset NLOK's endearing brand.

I also expect NLOK's impressive value factor to offset worries about a rotation away from expensive tech stocks.

Conclusion (Outperform)

It's tough to pass on NLOK despite concerns about modest topline growth. NLOK's strategies and financial moves appear to be supportive of growing its huge installed base of subscribers. These subscribers are driving impressive earnings and cash flow for NLOK to ensure it continues to grow total shareholder returns. Barring execution issues, the valuation outlook remains appealing.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.