What Big-Money Investors Really Think of the VeriSign Deal

SNOWBIRD, Utah -- There's nothing like $21 billion to get people talking. VeriSign's (VRSN) massive acquisition of Network Solutions (NSOL) dominated talk in the hallways of the Cliff Lodge here at the Chase H&Q plaNET.wall.street conference.

Rumors of the deal began to filter through the 10th floor Aerie Lounge near midnight Monday, as money managers and a few CEOs flocked to the only bar in an otherwise dry town. Amidst the revelry, a few investment bankers in the know sported sly grins -- but said nothing.

The deal was officially announced at 6 a.m. local time, and the huge valuation might have had shock value. But on more careful consideration, it seemed to make sense. Last Thanksgiving I wrote a story called "Is Network Solutions a Game of Monopoly Without Risk." On Valentine's Day I wrote about VeriSign, with the headline "A Veritable Security Blanket." In both of these stories, I had extensive discussion of the hidden cash flow that was a central engine to each business model. Really, these four charts tell the whole story.

The Fat Wallet VeriSign has had plenty of the green stuff.

Source: VeriSign

The Best Is Yet to Come VeriSign's deferred revenue has been bigger than revenue for more than a year.

Source: VeriSign

Money Bag Massive deferred revenue gives Network Solutions quite a dowry.

Source: Network Solutions

Here and Now Network Solutions' cash on hand is part of the appeal of the deal.

Source: Network Solutions

The similarity in these charts reveals two big ideas. First, here are two Internet companies with remarkably similar balance sheets; indeed, they have remarkably similar business models. Second, both companies are throwing off massive piles of cash. That might be common in the cable and telecom world, but it's a rarity in the Internet world.

"When the deal closes, there will be $1 billion on the balance sheet," VeriSign CEO Stratton Sclavos told me after his presentation today. "But that's not how we valued this. If you look at Internet deals these days, they're being done at about a 50% to 75% premium. This deal on Friday was at a 47% premium to Network Solutions. So we think it's a pretty good price. If you were to look at price to revenues or price to cash flow, we'd have had to pay a lot more."

When these charts first ran, Network Solutions was trading at 156 1/4. It's up 161% since then. And VeriSign, despite today's wicked fall, is off less than 1% since my first story ran.

Wall Streeters at Snowbird had plenty to say about the deal.

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"This is definitely a case of two-plus-two equals five. You took very complementary companies and put them together here. Each relies on subscription revenue, each throws off serious cash flow. Imagine what this is like for customers of these two companies: You give 'em a name on the Web, you give 'em trusted e-commerce capabilities ... VeriSign is really saying to customers, 'We're the company that will get you on the Web.' "

-- Brian Solerno, portfolio manager of (MNNCX)Munder NetNet fund

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"This is huge, I mean, c'mon. These guys will have to throw off some serious money to make this work. What is it, $21 billion? For that, I'd like to see a company that gives you $7 billion in revenues a year. Who does that?"

-- Larry Dunn, hedge fund manager of the John Galt Fund

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"You think they overpaid for Network Solutions? Think of Network Solutions as a tax on the Internet -- now what do you think?"

-- an investment banker "familiar with the matter"

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"They know each other very well. Stratton sits on the board of Network Solutions. They're already doing all kinds of development deals together. They essentially have the same business model. So I think that the integration risk that might afflict other mergers doesn't apply here.

"The other thing that no one is giving them credit for are all their venture deals. Both VeriSign and Network Solutions have pieces of a bunch of strong, pre-IPO companies."

-- Chris Lord, general partner of the Pivotal Asset Management hedge fund

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"It made sense to me. The thing the market may not like is the purchase accounting and the three- to five-year amortization. It's going to hurt the bottom line. The question is, Is the market going to look beyond that?"

-- a fund manager, who is long both stocks and wishes to remain anonymous

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"It's a customer-acquisition play, and I think it's a very smart one. The hardest thing for any Internet company to do is acquire customers. [VeriSign is] acquiring a massive potential user base for their software and their security products."

-- COO and CFO Ted Philip of Lycos (LCOS)

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"We're extremely happy about the deal. Network Solutions represents the maturity level of what all Internet companies can be, throwing off free cash flow in magnitude, showing significant operating leverage with significant barriers to entry. That's what we hope all of our investments can be.

"We're the largest shareholder of Network Solutions -- we've owned it since it was $10 a share -- and the fourth-largest shareholder of VeriSign. If anything, the market potential of VeriSign has increased 10- to 20-fold. And where else are you going to find a company that will throw off $60 million in free cash flow quarterly? Only AOL (AOL) can match that. The only company that I can think of that has bigger market potential is Infospace.com (INSP), which we also own."

-- F. Quint Slattery, portfolio manager of Pilgrim Baxter (PBNOX)New Opportunities Fund and the (PBHEX)Select Equity Fund

Senior Writer George Mannes contributed to this story.

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