VRNT/Verint: Looking Under The Hood Before It Separates Into Two Independent Companies
Long Only, Long-Term Horizon, Growth, Growth At A Reasonable Price
Seeking Alpha Analyst Since 2018
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Summary
- Verint Systems ("VRNT") is not a fast top-line grower compared to the high-flying internet companies, but the quality of revenues is higher today as its recurring component has increased.
- Operating margins expanded in the last quarter. However, as it was accompanied by a reduction in R&D spending in the quarter, I do not expect the trend to continue.
- GAAP operating income, which is negatively impacted by non-cash amortization items and one-time charges, understates the quality of earnings. The decision to separate VRNT into two entities could unlock value.
- At a free cash flow yield of about 5.3%, VRNT's valuation is undemanding, particularly as it appears on track to complete its separation into two independent companies shortly after February 2021.
As discussed in my previous entry on Verint, the company is comprised of two main segments, a Customer Engagement Segment ("CES"), and a Cyber Intelligence Segment ("CIS").
I. Customer Engagement Segment:
In the aggregate, CES annual revenues grew by 20% from 2016-2019, or about 6% per annum (purple line, figure 1). While decent compared to a consumer company, it is far below the 30-60% annual growth rates of high-flying internet companies such as Palantir and Snowflake. (Foreign currency fluctuations had a small but not significant negative impact on revenues)
The bright spot is the fact that cloud revenues (orange line), which is higher quality due to its recurring nature, more than doubled over the last 3 years.
Figure 1: CES annual growth
Quarterly growth accelerated in the 3rd quarter of 2019, but pulled back due to the outbreak of the COVID-19 pandemic in early 2020 (figure 2). However, it appears to be recovering and resuming on its longer term growth trajectory.
Figure 2: CES quarter growth
For the period 2016-19, the increase in cloud revenue was $120m (orange line, figure 3), far more than the total increase of $20m from the other 3 segments combined.
Figure 3: CES annual change
Over the last 6 quarters (since April 2019), perpetual revenues declined by $25m (blue line, figure 4). Even though the growth in cloud revenue (orange line) was not enough the offset the decline, the net present value of each dollar in new recurring cloud revenues is higher than that of perpetual revenues.
Figure 4: CES quarter change
CES percentage of software and recurring revenues: Since early 2018, software revenues increased from about 82% to over 85% (blue line, figure 5). More significantly, the recurring component of software revenues rose from 71% to 82% (orange line) before pulling back in the quarter ended August 2020.
Figure 5: Quarterly software and recurring software revenues
While margins have been stable over the last 2 years, I note that there is a wide spread between fully-allocated non-GAAP operating margins (green line, figure 6) and GAAP operating margins (orange line) largely due to non-cash amortization expenses and non-recurring expenses from acquisition, restructuring and separation charges (table 7). However, the largest non-cash expense, stock-based compensation expense, is expected to continue.
Figure 6: VRNT margins
Table 7: Reconciliation of CES GAAP operating income and non-GAAP fully allocated operating margin:
II. Cyber Intelligence Segment:
Annual revenues at the CIS segment grew by about 29% since 2016, or about 9% per annum (green line, figure 8). Like the CES segment, the higher-quality recurring revenue component has shown stronger growth compared to non-recurring revenues, and now accounts for almost 50% of the segment's total revenues.
Figure 8: Annual CIS revenue growth (indexed to Feb 2017)
Figure 9: Annual CIS revenue change, by segment
Figure 10: Quarterly CIS revenue change, by segment
Figure 11: CIS percentage recurring revenues, by quarter
CIS margins: Annual margins have been on a slight uptrend over the last 3 years quarters (figure 12), as have quarterly revenues (figure 13).
Figure 12: Annual margins
Figure 13: Quarterly margins
Like the CES segment, there is a spread between fully-allocated non-GAAP and GAAP operating margin due to non-cash items (mostly stock compensation) and one-time expenses. After adjusting for these non-cash and one-time charges, the CIS segment's EBITDA and operating income have grown nicely since 2018 (figures 14 and 15).
Figure 14: Quarterly margins
Figure 15: Reconciliation of CIS GAAP operating income and non-GAAP fully allocated operating margin:
III. CES R&D as a percentage of CES revenues: R&D cutbacks in 3Q 2020 have made margins look stronger
While R&D as a percentage of revenues has increased by 300bps from 2015 to 2020 (figure 16), I note that R&D as a percentage of revenues declined by 200bps at both CES and CIS for the quarter ended October 2020 (figures 17 and 18). As such, I would place less stock in the margin expansion over this last quarter.
Figure 16: VRNT R&D as a percentage of total revenues
Figure 17: CES R&D as a percentage of CES revenues
Figure 18: CIS R&D as a percentage of CIS revenues
IV. Free cash flow yield
VRNT's free cash flow yield of ~5.3% is attractive on a standalone basis. However, as many of the high-growth internet companies are valued far higher than VRNT (i.e., at a lower free cash flow yield), the acquisition of parts of or assets from Verint could be highly accretive to their earnings. This may be potential route to unlocking the hidden value within VRNT.
Analyst's Disclosure: I am/we are long VRNT.
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