The Issue No. 4: $VRSN

A business that has reduced its capital intensity while growing its earnings power

In The Issue No. 2 we discussed an approach to valuation that took capital intensity into account when determining the multiple to pay for a business.

The essential takeaway was the following:

In a world of 6% long term rates, one could pay 21x forward earnings for a business that could grow it’s earnings power at 12% per year for ten years, under the assumption that it spent close to 0 capital to do so and achieve a 20% annual compounded rate of return.

I’ll steal another back of the envelope calculation from a reader for further context:

Oli @WhiteWhaleHuntr

If interest rates are constant at 4% and a company’s current FCF yield is 5%. And, you expect that company to grow its cash flows by 7% on average over 20 years. Then it is at intrinsic value. This is the simple arithmetic that Buffett and Munger are talking about.

The maths is all very beguiling, and even tantalising to the novice investor (aren’t we all) - but the essential point here is getting conviction in the likelihood that a business can grow it’s earnings power for a multi-decade period. Today I’ll attempt to apply this framework for Verisign ($VRSN).

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Verisign is one of these great American companies that gets to make royalty income by selling access to an intangible: they operate the domain registry system for .com and .net.

American capitalism is so unique because it is one of the few places in the world where you can sell an idea. Since the end of the Second World War, many American ideas have travelled globally, carried by the charisma of economic success and the greatest military the world has ever seen.

The US is also a place where functions that should be run by the government are privatised. I think Adam Smith said something like: ‘privatise the profits and socialise the costs’.

I digress. Like all great monopolies, the origin of how Verisign acquired this economic goldmine is part historical mistake, part luck.