Verint: The Hurdle Is Greater Than Anticipated

Summary

• Verint is now fully focused on the customer engagement market after the spin-off of the cyber intelligence unit.
• The profitability profile and competitive posture of the new business are appealing.
• The big concern is the huge reinvestment rate given the unpredictable nature of consumers in its addressable market.
• The market is right to discount these concerns.

Photo by DKosig/iStock via Getty Images

Verint System's (NASDAQ:VRNT) valuation is similar to a popular development in which the market is slow to digest a tech company's shift to a subscription/cloud model. Similar examples can be found at Teradata (TDC), Cloudera (CLDR), and FireEye (FEYE).

I believe this slow digestion represents an attractive risk/reward opportunity for the following reasons.

1. Verint trades at a low sales multiple

2. Verint is profitable, unlike most SaaS companies

3. Verint gets to benefit from a rotation to value given its above-average value grade ( using SA's quant rating tool)

4. Verint is cash flow positive. The opportunity to boost total return to shareholders is clear.

5. Verint continues to trade at a significant discount to its SaaS peers (peers include Medallia (MDLA), Everbridge (EVBG), and PagerDuty (PD)).

Growth

I am bullish on Verint’s growth prospects due to the improved demand for its cloud and license offerings and the positive outlook for the customer engagement business.

After carving out the cyber intelligence unit into a standalone company, Verint is better positioned to focus on the customer engagement market. This market covers capabilities in knowledge management, workforce engagement management, and digital experience management.

Here is how Gartner defines the Workforce engagement management space (the biggest revenue driver):

The emergence of workforce engagement management (WEM) software characterizes the evolution of the established, multibillion-dollar workforce optimization (WFO) software market. An emphasis on improving the operational performance of customer service staff persists. Recording and assessing employee performance and forecasting and scheduling optimum staffing levels remain key activities, driven by tight integration and workflow across these functional domains.

I believe this is similar to Medallia’s business model.

Verint estimated the market opportunity at $65B. This estimate is rich. Here's the breakdown using insights from the latest annual report.

• Verint projected that $30 billion of this TAM is derived from customer engagement software for contact center use cases.

• The other $35 billion is derived from other use cases across other parts of the enterprise outside of the contact center with customer touchpoints.

• Verint noted that the estimate is a function of the number of customer engagement employees and the amount of software investment spent on average per employee per year.

The huge TAM is also supported by some attractive features of Verint’s business model worth highlighting. These include:

1. Blend of on-prem and cloud subscription

2. Robust partner ecosystem

3. Ease of deployment

4. Global reach

5. Ease of evolving solutions across multiple verticals

Source (author, using data from Verint)

Cloud revenue growth has outpaced growth from other segments in recent quarters. This has mostly affected perpetual revenue.

Verint is in the midst of migrating more customers to its cloud platform. The dip in support and professional services revenue is due to billings weakness from COVID-19. Verint noted in recent calls that the weakness has normalized.

Besides these trends, Verint conducted a survey that highlighted the drivers of the adoption of its platform. These include:

1. Expanding customer engagement channels. This is obvious given the proliferation of social media platforms and remote collaboration tools.

2. The need to adapt to rapidly changing customer behavior

3. Increasing adoption of automation and AI tools

4. The growing demand for unified data analytics solutions given growing data siloes

There aren't many granular growth indicators to cling to. Verint has focused more attention on the momentum in the software segment. This includes cloud subscription uptake and recurring revenue. This means the forward growth indicators will be more of interest to SaaS/Cloud investors. Some interesting metrics/trends include:

1. The growing mix of SaaS revenue

2. The growth of the cloud segment

3. The growing portion of recurring revenue.

Verint didn't share customer retention metrics, though it noted during previous calls that renewals have improved despite the customer migration process and headwinds from COVID.

We're targeting cloud revenue growth of approximately 30% CAGR over the next three years, driven by strong new SaaS bookings, healthy renewal rates, and ongoing SaaS conversions.

Source: Verint

Going forward, investors might not be overly excited about the topline revenue guidance for FY'22 due to the impact of the shift from perpetual revenue. Also, cloud revenue is still a small portion of overall revenue. Regardless, investors can find solace in the long-term guidance for revenue to accelerate to $1B by FY'24. This assumes strong cloud revenue growth in the coming years.

To achieve this growth, management shared some strategies worth exploring.

Business

From an expense perspective, given our strong Q4 and in anticipation of double-digit new PLE growth in fiscal '22, we increased our hiring in Q4. And our first quarter expense run rate will be higher than Q4 and will increase sequentially throughout the year.

Source: Verint

On the sales front, Verint continues to build upon its strong network of partners. It has also ramped hiring.

On the product front, we have the ongoing cloud migration.

On a more positive note, Verint recently added data management and workforce management solutions to its offerings.

Despite these moves, margins have improved at a modest pace which is encouraging.

TTM Gross margin (non-GAAP) for the customer engagement segment now stands at 69.1%. This is consistent with the prior year at 69%. In Verint's case, non-GAAP metrics add back items such as revenue adjustments, amortization of acquired technology, stock-based compensation expenses, restructuring expenses, impairment charges, and settlement expenses.

EBITDA margin has also improved. Verint (the customer engagement segment) exited the year with an EBITDA (adjusted) margin of 28% in Q4'21. FY'21 adjusted EBITDA margin (non-GAAP) stands at 30%. The major headwind to margins is the dis-synergies from the Cognyte exit, which will only affect FY'22.

The positive earnings, in addition to the cash on its balance sheet, have helped in two major ways:

• Verint can support Cognyte with some liquidity.

• Verint can continue its share buyback program.

Given the faith the market has in subscription business models, Verint has also raised more capital to boost its liquidity.

Being able to raise money when the market is valuing SaaS stocks with modest risk premium is advantageous. A lot of companies have capitalized on this development. It also helps if COVID is educating lenders on the importance of remote working platforms like Verint.

Source: Verint

With this setup, while the mixed topline metrics might impact valuation, profitability should be accretive.

In addition to profitability, Verint also has an interesting competitive posture worth exploring. The profitability grade is expected to make up for growth volatility. It should also build a solid foundation for Verint's competitive moat.

Competition

With the Spin-off of Cognyte, Verint is now positioned as a full customer engagement platform. It also helps that cloud adoption has been kicked off.

This setup gives Verint an advantage over old-generation platforms.

The competitive moat includes the platform's openness, the inclusion of AI/automation capabilities, and its robust partner network. These capabilities have earned Verint a leadership spot in Gartner's assessment of the workforce engagement management space in recent years.

In 2019, Verint generated approximately $1.3 billion in revenue, of which Gartner estimates $670 million came from WEM.

Verint is a Leader due to a WEM vision that matches the market’s needs, a global presence and a complementary set of engagement benefits derived from its customer engagement center (CEC) portfolio.

Source: Gartner

There are worries that Verint isn't early as strong in the CRM space. This isn't much of a concern, given that Verint more than makes up for this with strong partnerships. Also, the WEM business drives a bigger portion of revenue, and it appears the CRM business is fine being a perfect complement to the cash cow (WEM business).

The major competitors to worry about include Medallia, Nice, and other private companies. Besides the usual threats, the nature of the customer engagement market is more of a concern.

Because data siloes shift, and customers are tough to predict, I have observed a pattern of rapid acquisitions in the customer engagement market. Customers are forcing players to switch strategies faster due to their expanding adoption of new communication channels.

This development is supported by the rise of a workforce engagement management offering by Zoom (ZM).

This explains Salesforce's numerous acquisitions over the years. Medallia and Verint are not exempt. The premium on each future acquisition represents a huge reinvestment cost. I expect the market to discount this reality, and this might partially explain Verint's modest valuation. It can be argued that a significant portion of future growth won't be organic. These acquisitions also come with a lot of integration costs and synergy-related risk concerns.

Valuation

Source: finbox

Verint has two major attractive valuation factors: value and profitability.

The profitability factor builds upon its high-margin subscription business model. This model is expected to attract high-margin renewals in the coming years as Verint evolves more solutions.

The weak topline growth outlook has masked the growth factor. This has contributed to the conservative value factor given that Verint trades at approx. 3x P/S using the forward revenue projection of $1B by FY'24. Powering this revenue estimate is the cloud business which is growing at over 30%, y/y.

Another interesting point to note is that Verint is cash flow positive.

Lastly, the weak momentum grade doesn't paint the true story. The YTD share price decline is due to the market repricing the spin-off of the Cognyte business. Readers will recall that Verint shareholders own Cognyte shares.

Overall, we are mostly concerned about the growth grade, which isn't as bad as it appears if we focus on the growing cloud business.

My price target of $54 assumes gradual topline revenue growth, a modest EBITDA margin of 18%, a long FCF timeline (10 years), and a discount rate of 8% (range of 7%-9%).

Risks

The top risk factors to the growth story include execution risk, earnings volatility given non-recurring expenses, pressure from competitors, slow adoption of cloud solutions, a weak price discovery post-Cognyte spin-off.

Conclusion

Verint now has the opportunity to fully focus on the customer engagement market after the spin-off of the cyber intelligence unit. Topline growth indicators remain lumpy. Steady profitability and an improved competitive posture will assist the volatile growth grade. I expect the market to gradually catch up to the new narrative as execution worries abate.

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.

Comments

[kalu0003]

Is VRNT really a good long term play as compared to PEGA? I greatly appreciate your views. Thanks

[Tony Montana Munich]

Thanks for the article, I am invested since 5 years now.