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Verint: 'Big Data' For A Small Price

September 12, 2012 | 3 commentsby: Value Hunter | about: VRNT, includes: BV, CMVT, INFA, JIVE, NICE, NUAN, SPLK, TDC

Disclosure: I am long VRNT, NICE, CMVT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

One of the best ways to make money in the market is to discover a company before the big institutional investors figure it out. Usually, this involves a lot of risk - you might be betting on a small company or a speculative technology. I am a conservative investor, and I don't really have the stomach for speculation. In this regard, I think Verint (VRNT) is a very unique situation. It combines tremendous upside with a sizable company ($900m revenue) and a proven technology (big data collection and analytics).
So why hasn't the price already been driven up by the big institutions? Simple. Over 50% of VRNT is owned by another company, Comverse (CMVT), that was involved with a lengthy accounting investigation and restatement. Given the small free float of VRNT, the large institutions have been unable to purchase VRNT stock. This situation is about to change. VRNT and CMVT announced a plan to spin off the non-VRNT assets on October 31 and then collapse the holding company structure. This will leave VRNT as a stand-alone big data company trading for a very non-big data price. I don't expect it to remain at this price for very long once the large institutions begin to buy - my numbers get me to 70%+ upside.
Before I go into detail on the business, I just want to give a sense about the potential for the stock. I realize that "big data" is a buzzword, but it refers to a very real trend in technology. Big data is a catch-all for companies that are helping to collect, store and analyze the massive amounts of data generated in the modern world. Take one example where VRNT is involved - every store has security cameras designed to fight shoplifting. In the past, the video from cameras was essentially useless because it was analog - you had a security guard eating donuts and watching 20 monitors at once. If there was an incident, they could in theory go back and watch thousands of hours of tape for clues, but that was time-consuming and, in reality, impossible. As cameras have switched from analog technology to digital (IP) technology, the video is now stored in bits and bytes. Like all things in bits and bytes, it can be sorted and analyzed by computers for patterns and trends. The same is true for the digital information you generate from your web surfing, customer service calls, credit card transactions, social media postings, etc. This creates exciting opportunities for companies to better serve and understand their customers, but the amount of data involved is massive - hence the term "big data."
Wall Street has taken notice of the opportunity in Big Data. These are all very different businesses, but here are some examples of US-based big data companies - both small, fast-growth companies and more mature companies that will also benefit from these trends. The closest comparable company is NICE Systems (NICE) based in Israel (more on this below). I have used consensus Wall Street estimates going forward.

Company	Market Cap	Enterprise Value	Fwd Revenue	Revenue Growth	EV / Sales	Price / Earnings
Splunk (SPLK)	$3,520	$3,250	$156	82%	18.0x	No earnings
Jive (JIVE)	$890	$724	$113	45%	6.5x	No earnings
BazaarVoice (BV)	$997	$854	$156	47%	5.5x	No earnings
Nuance (NUAN)	$7,628	$8,503	$2,043	18%	4.2x	14.1x
Informatica (INFA)	$3,941	$3,390	$821	5%	4.1x	25.2x
Teradata (TDC)	$12,671	$12,132	$2,700	14%	4.5x	26.9x

I won't sit here and argue that VRNT will trade at an 18x sales multiple like Splunk, which is much smaller and growing much more rapidly. However, I do believe it is very reasonable to expect VRNT to trade at a similar multiple to the more mature (and profitable) companies on this list. In terms of revenue size and growth rates, VRNT looks a lot like INFA. Here is how VRNT stacks up:

Company	Market Cap	Enterprise Value	Fwd Revenue	Revenue Growth	EV / Sales	Price / Earnings
Verint	$1,400	$1,810	$860	10%	2.1x	10.9x

Verint has an attractive business and financial model that is typical of a high-quality, large enterprise software company. I believe that revenue should exceed $900m in 2013. The business has 65-70% gross margins, 20-24% operating margins, and 30-35% of revenue is generated from a recurring and very stable maintenance stream. Top line growth has been in the high single-digits (slightly lower in the back-half of this year due to some softness in Europe), but the increasing adoption of analytics should lead to an acceleration of growth to 10%+. Over the next two years, in addition to revenue growth expansion, I believe that operating margins should expand annually and the company will use its excess free cash flow to do small tuck-in acquisitions and pay down some of its debt. As a result earnings should grow in the mid to high teens and once freely floated, over time the company should trade at 15-17x earnings, which would be a stock in the high 40's range, up from $28 today or 70% upside.
More on the business
Verint is not a new software start-up. The company was founded in 1994 as a recording company for call centers, trading floors and security surveillance systems. Think "your call is being recorded for quality management purposes." Since that time, Verint has grown into a global industry leader in recording. This recording and data capture represents a bit less than half of Verint's non-maintenance business and is a very stable, very profitable, modest growth business. In fact in the 2009 depression, Verint's revenue only declined mid-single digits.
The other half of Verint's software revenue and the part that is becoming increasingly important to large companies is software that analyzes all of the unstructured data that Verint records. That is the big data opportunity. Analytics, which are now approaching 50% of non-maintenance revenue for Verint, is growing in the mid-to-high teens range and should lead to an acceleration of overall revenue growth over the next few years, as more and more companies look to generate intelligence from the increasing amount of unstructured data generated and captured. For one customer, Verint records 50 million customer telephone calls and 300 million customer emails and text messages; Verint's analytics software takes this huge amount of data and analyzes it to present an overall snapshot of customer sentiment and individual customer needs. That is truly big data analytics!
As an example, about 50% of Verint's revenue is generated from selling recording and analytics into large call centers and back offices of Fortune 500 companies around the world. Using analytics, the VRNT software can pinpoint key words, voice inflection, or decibel levels to figure out when customers are angry or frustrated. Furthermore, VRNT's software can link customer interactions beyond the call center to email, social media, texting, etc. By aggregating this increasing number of customer touch points, VRNT can present managers and chief marketing officers with a more complete picture of their customer base.
The other primary application for Verint's software is using voice and video analytics in the call and video surveillance markets. On the commercial side, the VRNT video management software is used by large retailers and banks to analyze customer behavior patterns from their video monitoring equipment. Verint's growth in this business is being driven by the shift from analog surveillance cameras to IP-enabled cameras, which allows for this type of data analytics. On the government side, Verint's software is used by law enforcement agencies around the world to analyze video data generated at ports and airports as well as voice data generated through wiretaps. As touch points proliferate, (mobile phones, text, email, etc), recording becomes more complex and analytics becomes essential to obtain a holistic picture of a customer or surveillance target.
More on valuation and potential M&A
Despite this shift to big-data analytics and an expectation for accelerated revenue growth, VRNT trades at under 10x 2013 earnings (~$2.95). The biggest reason for the valuation discount is as I mention above, 55% of the company has been owned by Comverse, which has left VRNT's stock to be somewhat illiquid and generally ignored by Wall Street.
Beyond the increasing liquidity and the realization that Verint is a "big data" play, I also believe there is a reasonable chance of a transformative and highly accretive merger with Verint's largest competitor NICE Systems. Nice has a very similar revenue size and profile to Verint with recording and analytics in voice, video, and data. NICE is similarly off the radar screen of large investors because the company is based in Israel. A combination of the two companies would be a home run for both shareholders and customers. In fact JPMorgan research speculated about a merger between these companies earlier this week. The combined business would have close to $2B in revenue and easily $100m in immediate cost synergies. In that scenario I think the combined company could generate close to $500m in free cash flow, and we could see 100-200% upside for both stocks. It is always difficult to speculate on M&A, so I am not buying this stock expecting a combination. However, I think this is a very attractive free option.
Conclusion
The bottom line is that this is an opportunity to buy an unnoticed big data play that is cheap because of a technical issue. We have clear visibility towards the resolution of the overhang and as the company executes on its big data analytics vision, it should get a multiple more in line with other mature software companies that are plays on big data.
The shares also offer good downside protection; as mentioned above Verint's revenue only declined 6-7% in the 2009 recession. While its maintenance and recording revenue drags down the overall growth rate, both businesses do provide baseline revenue stability should the economy significantly worsen from here. Verint has $410m of net long-term debt and is levered at 2.3x EBITDA. The company does not have any meaningful maturities over the next 5 years, and I expect it to use its free-cash flow to slowly de-lever overtime.