What caught my attention
Verint first appeared on my radar screen last month when I was researching the prospects of Palantir. What caught my attention was that two well-regarded investment firms, APAX Partners and the The Baupost Group--both top investors with very different styles--had invested over than $300 million in the company.
Baupost is a $10 billion value-oriented hedge fund that sees value where others miss. APAX, on the other hand, is a private equity investor with well over USD50 billion under management that specializes in, among other sectors, software, and the internet. It has deep industry expertise, is known for taking active roles in its portfolio companies (it has a board seat), and has committed to investing an additional $200m (on top of the $200m already invested) after Verint separates into two independent companies early next year.
Table 1: Baupost position
The valuation is attractive
The company generated trailing twelve month (“TTM”) revenues of $1.2 billion and free cash flow of $243 million but is only valued at $3.8 billion, for a free cash flow yield of 6.4%. Companies in this category with far less free cash flow and are valued at free cash flow yields of less than 2% (e.g., Slack, Palantir, and Snowflake have market caps of $23 billion, $50 billion, and $90 billion respectively).
Figure 2: Valuation of Verint
(I note that free cash flow is significantly higher than net income because of non-cash amortization expenses resulting from earlier acquisitions that VRNT is required to take in accordance with accounting rules).
So what's the catch?
The reason why the market has priced VRNT as such a valuation is because of the slow growth compared to its peers. The highly valued internet companies are growing at revenues at 40-60% p.a., but VRNT only managed to grow its top line at 6% from 2019 to 2020.
Segment contribution over the same period only grew by 8.8%, but free cash flow grew by 22% (source: Yahoo Finance).
Figure 3: TTM revenue growth since 2015
However, as VRNT had issued a lot of shares between 2016-17, the per-share financial metrics are even worse--the dip in the company's per-share revenues exceeded the pullback in revenues due to weakness in its cyber intelligence business over that period.
Figure 4: per-share financial metrics
Margins began contracting in 2015 due to the compression in gross margins and did not bottom out until 2018. R&D spending as a percentage of revenue has grown by 350bps since 2015 but overall SGA as a percentage of revenue has been flat. This suggests that the company may have cut back on selling and marketing over that period.
As a whole, margins are decent but not close to the eye-popping levels of larger comparable companies that have more operating leverage from greater economies of scale.
Figure 5: Margins, R&D, and SGA as a percentage of revenues
What does Verint do?
The company currently operates two distinct segments: customer engagement and cyber intelligence. While both drawn upon artificial intelligence and big data analytics, there does not appear to be much in sales and marketing synergies as the segments address two very different sets of customers.
The customer engagement segment has a broad portfolio with software for workforce engagement, customer self-service, experience management, and enterprise recording for fraud and compliance. The company's products serve over 10,000 customers, including 85% of the Fortune 100, and works with Adobe's customer engagement segment. According to the company's 10K, industry experts such as Gartner, Forrester, and Ventana Research have recognized Verint as a leader in customer engagement, and the products have won a number of awards--some continuously for over a decade.
Macro trends, such as digital transformation, cloud migration, and automation, are expected to drive growth. However, revenues only grew 6% last year, which is dismal for a company that purports to be benefiting from strong tailwinds.
Segment's reason for existence: Verint customer engagement products make more efficiently and cheaper for its enterprise clients to communicate with their customers or staff (in the case of workforce products), and ensure compliance with government regulations . As I do not have the resources to evaluate or survey the company's customers as Gartner, Forrester, or Ventana, I have no choice but to rely on their data points as a proxy for the product quality.
The cyber intelligence solutions segment provides data mining software that"empower government and enterprises [...] to identify, neutralize, and prevent terror, crime and cyber threats". The company's monitoring systems and software are used in critical infrastructure (e.g., airports, power plants, transportations systems) and by telecom carriers, counter-terrorism, crime syndicate investigations, and fights against drug trafficking (sounds a lot like Palantir). The need for these systems can only increase over time.
Segment's reason for existence: The cyber intelligence solutions products help keep our infrastructure and transportation facilities safe, track criminal activity, and protect corporate assets. I can see Verint taking flak from privacy rights activists for monitoring citizens as they going about their daily activity, but it would be far worse if another 9-11 type attack happened again.
What could unlock value and why now?
According to the most recent 10K filing, 56% of Verint's revenues are recurring (up from 51% the previous year), which is attractive as the recurring revenues create some stickiness and cushions the volatility of earnings and cash flows.
I see a few catalysts that could unlock value after the separation:
(1) As independent companies, the two segments will be free to focus on their respective competencies and driving growth both organically and through acquisitions
(2) VRNT does not appear to be widely covered by the investment community, possibly because of the small market cap and the company's two ostensibly unrelated segments making it neither fish nor fowl. The separation could bring increased focus from the investment community
(3) APAX Partners, which has deep expertise in internet and e-commerce, will be investing an additional $200m in the customer experience segment once it becomes an independent company. I believe APAX will bring best practices, particularly in sales and marketing, to help drive sales
(4) if the growth and stock price do not pick up, it would also be easier to find potential acquirers for each of the products:
the cyber intelligence segment's assets and customer base could be very attractive to Palantir, which as a $50 billion company by market cap, can well afford the acquisition and benefit from the opportunities to cross-sell to Verint's government and commercial customer base,
the customer experience segment could be a good fit for Adobe or its competitors,
the fraud and compliance product could be attractive to the financial IT solution providers, and
the workforce engagement and customer self-service product could be a good fit with Salesforce.com, ServiceNow, or other SaaS providers
I believe the company is, in some ways, stuck in no-man's land. It has good cash flow generation, which makes it a unique creature for a company its size, but lacks the scale to achieve the eye-popping margins of its best-in-class brethren, and it is not growing quickly enough to get to the necessary scale or to capture the full attention of the investment community.
However, VRNT has a portfolio of unique and critical assets that should grow faster with the implementation of enhanced marketing strategies. Furthermore, value can be unlocked following the separation of its customer engagement and cyber intelligence segments into two separate companies. The separation is expected to be completed by early 2021, which could create a potential opportunity to benefit from both a relatively near-term pop in the stock as well as longer term growth.
Analyst's Disclosure: I am/we are long VRNT.
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