I've been analyzing some of the recent stock purchases made by Warren Buffett, or more accurately, Berkshire Hathaway. Among the companies I've looked into—like Occidental and Sirius—one stands out as my favorite. It's a high-quality business with a robust competitive advantage, or "wide moat," that makes it incredibly difficult for competitors to disrupt its model. This company operates much like a toll bridge—you have to go through it and pay a fee to access its services.
I'll provide a quick overview of this business, share my thoughts on its model, evaluate its fair value, and discuss whether it's a great opportunity at its current price or if we might already be too late. I'll also consider whether there might be better alternatives for the multiples this company commands. As I always say, it’s not just about what you buy, but how much you pay for it. Overpaying for even the best businesses can lead to losses.
Recently, Berkshire Hathaway has been purchasing significant amounts of this stock, investing over $5-6 million in the past few days. The stock in question is Verisign (VRSN). Over the past year, its performance has been modest—up just 2%, with a similar return over the past five years. It has struggled to even keep up with inflation, partly due to some previous management challenges.
Business model
Verisign has a fascinating business model. The company manages over 69.6 million domain names, including the iconic .com and .net domains. This means that if you want to create a website like youtube.com or godaddy.com, you have to pay Verisign for the rights to use those domains. It’s an ingenious and lucrative model.
Earning Overview
Revenue: $391 million, a 3.8% increase from Q3 2023. Operating Income: $269 million, up from $254 million in the same quarter of the previous year. Net Income: $201 million, with diluted earnings per share (EPS) of $2.07, compared to net income of $188 million and diluted EPS of $1.83 in Q3 2023. Cash Flow from Operations: $253 million, an increase from $245 million in Q3 2023. Share Repurchases: 1.7 million shares repurchased for $301 million during the quarter, with $1.28 billion remaining under the share repurchase program as of September 30, 2024.
Fundamental Analysis
While the company’s renewal rate for domain names is 72.2%—which is strong—it’s slightly below what I would have expected (perhaps closer to 85-90%). Moreover, the number of domain names has seen some quarter-on-quarter declines, and overall growth has been slow. Revenue is up only 3.8% year-over-year, and operating income has grown by just 5.9%.
This limited growth is largely due to Verisign’s regulatory agreements with the NTIA (National Telecommunications and Information Administration). These agreements cap its pricing at $10 per domain per year and only allow price increases of up to 7% in four out of the next six years. This restricts the company's ability to drive revenue growth through price hikes.
While Verisign’s business model is impressive and its competitive position remains strong, its growth limitations and modest renewal rates raise questions about its long-term investment potential. I'll dive deeper into whether it's worth the current price or if there are better opportunities available.
If I had to estimate the growth potential for this company, I wouldn't expect more than a 7% increase, as outlined in the contracts they've signed. This limitation explains why the stock has been relatively flat. While it's undeniably a high-quality company with a wide moat that protects its business, the growth simply isn't there.
Free Cash Flow
The company can't easily acquire others due to potential antitrust concerns, and its ability to expand is restricted. Its primary options are stock buybacks and possibly issuing dividends, though it has primarily focused on buybacks. This strategy inflates earnings per share (EPS) without significantly growing the underlying business. For example, in 2023, the company repurchased $900 million in shares while generating only $800 million in free cash flow, borrowing to bridge the gap. A similar pattern occurred in 2022, with $1 billion in buybacks and $800 million in free cash flow. This approach explains why EPS growth (13.1%) has outpaced revenue growth (3.8%).
Guidance
VRSN reported its third-quarter 2024 financial results, highlighting a 3.8% increase in revenue to $391 million compared to the same quarter in 2023. Operating income rose to $269 million from $254 million, while net income reached $201 million, resulting in diluted earnings per share of $2.07, up from $1.83 in the third quarter of 2023.
The company ended the quarter with 169.6 million .com and .net domain name registrations, marking a 2.5% decrease from the end of the third quarter of 2023 and a net decline of 1.1 million domain names during the quarter. Additionally, Verisign processed 9.3 million new domain name registrations for .com and .net, down from 9.9 million in the same quarter of the previous year. The final .com and .net renewal rate for the second quarter of 2024 was 72.7%, slightly lower than the 73.4% observed in the same quarter of 2023. Revenue projections have been revised to a range of $1.554 billion to $1.559 billion for the full year.
In light of these trends, Verisign has adjusted its guidance for the full year 2024. The company now anticipates a reduction in its domain name base by 2.0 to 3.0 million, a steeper decline than the previous quarter's forecast of a 1.75 million to 0.25 million decrease.
Risk & Challenges
Despite these challenges, the company has a phenomenal business model with net income margins around 50%, among the highest in the market. For every dollar in revenue, 50 cents become profit—higher than giants like Microsoft, Apple, and NVIDIA. However, EPS growth has been inconsistent, ranging from 7% to 16% depending on buyback activity. Based on contractual constraints and historical performance, I would expect long-term EPS growth to average around 7%. Coupled with a 50% net income margin, this is still a remarkable business.
Valuation
Verisign's financial position remains robust, with cash, cash equivalents, and marketable securities totaling $645 million as of September 30, 2024. The company continues to return value to shareholders, repurchasing 1.7 million shares of its common stock for $301 million during the third quarter, leaving $1.28 billion available for future repurchases under the existing program.
At its current valuation, the stock trades at approximately 25 times earnings, close to its historical average. For a business of this caliber—with consistent 7% EPS growth and a wide moat—this isn’t too expensive. Over the long term, I’d anticipate total returns to align with EPS growth, around 7-8% annually, excluding any multiple expansion. If the stock reverts to a higher multiple (e.g., 30-32 times earnings), returns could rise to 12-13% annually.
Conclusion
That said, while Verisign is a safe investment with solid returns, it wouldn’t be my first choice for a quality company. For example, Visa is trading at about 28 times earnings, just a small premium over Verisign’s 25 times. Visa has an equally strong business model, if not better, due to its ability to adjust pricing indirectly through inflation. If ticket prices rise 10-15%, Visa automatically benefits as its transaction fees are percentage-based, leading to proportional revenue growth.
Additionally, Visa boasts higher net income margins (56% compared to Verisign's 50%) and more consistent EPS growth (13-14%). For me, paying slightly more for Visa provides better long-term potential. I already own Visa, having purchased it at a lower price, and have discussed it in past videos.
In conclusion, Verisign is a great company, offering 7-8% expected returns over the long term, potentially 10-11% with multiple expansion. It’s a safer bet than Sirius, in my opinion, and a solid investment for those prioritizing stability. However, if you're seeking the best use of your capital for a high-quality, wide-moat company, alternatives like Visa or even certain railroad stocks may provide better opportunities.
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