February 8, 2002
HEARD ON THE STREET
VeriSign Shares Have Taken a Hit,
Amid Queries About Its Accounting
By NICK WINGFIELD and JEFF D. OPDYKE
Staff Reporters of THE WALL STREET JOURNAL
The growing complexity of VeriSign Inc.'s business has raised eyebrows on Wall Street during the past, but this week, in another sign of the far-reaching effect of the Enron Corp. debacle, those worries turned into outright distress among some investors.
On Wednesday, shares of the Internet security and Web-address provider fell 10% after concerns about the company's accounting practices spread among investors. All told, the shares are off 35% since Enron sought protection under the U.S. Bankruptcy Code in early December. A big issue: VeriSign's "affiliate program," under which it receives millions in sign-up fees and royalties from overseas companies that then get the right to sell VeriSign products locally.
The company has signed up nearly 50 such affiliates during the past several years. Of those, VeriSign has made investments in 10. The investments have led to questions about whether VeriSign is "round-tripping" -- in effect, making investments in companies that would immediately come back to VeriSign in the form of affiliate fees, which boost revenue and earnings. VeriSign says all its arrangements with the affiliate companies in which it has stakes are proper.
Thursday, VeriSign shares edged higher, following the release of research notes by several Wall Street analysts downplaying the accounting concerns. In 4 p.m. Nasdaq Stock Market trading, shares rose 17 cents to $24.10. But in a sign of a more cautious mood on Wall Street since the collapse of Enron amid its many accounting issues, even analysts with bullish ratings say the accounting questions may weigh on VeriSign.
"There've always been a lot of rumors around" VeriSign, says Kevin Trosian, an analyst at Banc of America Securities, who has a "buy" rating on the shares. "I think people are starting to look more closely at them."
There are other concerns about the company, too. Some investors worry about the growth prospects for VeriSign's Web-address business, which involves handling most of the registrations for Internet addresses ending in ".com," ".org" and other popular cybersuffixes. The active community of short sellers betting on a decline in value of VeriSign shares points to a jump in receivables on the company's balance sheet as a possible warning that VeriSign customers are having a hard time paying their bills.
VeriSign executives, for their part, insist concerns about its affiliate relationships are unfounded. The company says its strategy of signing up affiliates is a speedier, more cost-effective way for it to establish a presence in new markets than opening its own offices in every country; of VeriSign's 48 total affiliates, 42 or 43 are outside the U.S., the company says.
Sometimes VeriSign signs up a large company such as British telecommunications concern BT Group PLC to sell its security products, but in other cases the affiliates are start-ups. Affiliates pay VeriSign a $1 million technology sign-up fee for opening a VeriSign franchise, plus royalty payments -- generally, between 25% and 30% of revenue from the sale of VeriSign security products.
VeriSign invests in start-up affiliates in markets where it believes the opportunity for VeriSign products is especially promising, Stratton Sclavos, the company's chief executive, said in an interview. The company's investments in affiliates average between $3 million and $5 million for a non-controlling minority stake in the start-ups of between 15% and 18%. Mr. Sclavos says there is no "round-tripping" of revenue, since VeriSign, on average, invests in an affiliate six to 12 months after it collects a technology fee from it.
Revenue from affiliates in which VeriSign has an investment is a small sliver of the company's business, amounting to less than 4.2% of total company revenue last year, VeriSign says. Total investments in affiliates since 1998, when VeriSign signed up its first affiliate, amount to $54 million, the company says. By comparison, VeriSign posted revenue for 2001 of $983.6 million. "We've been very open about this strategy," Mr. Sclavos said.
Concerns about its affiliate relationships first cropped up in November of last year, when VeriSign told investors it had signed up a whopping eight new affiliates during the third quarter after only signing up one during the previous quarter. VeriSign says it invested in only one affiliate during the quarter, and the investment wasn't in any of the eight new ones it signed up. Still, the upswing in new partners raised enough concern among some investors that analysts felt compelled to address the issue.
"Was VeriSign investing in entities to spur affiliate sign-up activity and generate associated up-front fees?" asked analysts Howard Smith and Craig Nankervis of First Analysis Securities Corp. at the time. "Conclusion: We are comfortable VeriSign isn't employing underhanded tactics and that its affiliate-investing policy is prudent."
Fast forward to this week -- less than three months and countless news headlines about the accounting misdeeds of Enron later -- and the worries about its accounting resurface.
Another analyst, Steven Sigmond of securities-brokerage firm RBC Capital Markets, summed up investor reaction in a research report with the headline: "VeriSign catches 'Enron-itis.' " Noting that during the past several days VeriSign shares had suffered from a "collapse in investor confidence," Mr. Sigmond said he had failed to find "anything resembling an Enron-style 'smoking gun' " in his review of VeriSign's disclosures of its affiliate partnerships and through discussions with other sources. VeriSign is a "top pick" for Mr. Sigmond.
For months, VeriSign has been a target of short sellers, betting on a stock decline. Among their hot-button issues: They say the company is plagued by bloated accounts receivable. For the fourth quarter, VeriSign's balance sheet showed receivables of nearly $315 million. That is greater than its quarterly revenue of $283.8 million, and marks a continuation of an upward trend in receivables as a percentage of revenue.
Tom Galvin, VeriSign's director of corporate communications, says the rise in receivables during the third and fourth quarters "came from the one-time effects of acquisitions" and the receivables associated with those deals. For the fourth quarter alone, Mr. Galvin says, acquisitions added $60 million to receivables "for which we booked very little revenue."
Write to Nick Wingfield at nick.wingfield@wsj.com1 and Jeff D. Opdyke at jeff.opdyke@wsj.com2
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