Spruce Point Capital Releases A Strong Sell Research Opinion On Verint Systems Inc. (Nasdaq: VRNT)
NEW YORK, May 23, 2019 /PRNewswire/ -- Report entitled "A Short Cloud Call" outlines how Verint faces 60-70% downside risk to approximately $17.00 to $25.00 per share due to the market's misunderstanding of the Company's flat-to-negative organic sales growth, which, obfuscated by frequent M&A, a "beat-and-raise cookie jar," and aggressive accounting measures, is misunderstood by the Street. With the market valuing Verint like a high-flying SaaS company on an aggressive and low-quality measure of adjusted earnings, Spruce Point believes that the stock's recent surge is unsustainable and will correct as recent accounting-driven benefits are anniversaried.
- Low-Quality M&A Obfuscates Organic Growth And Appears To Facilitate "Beat & Raises": Since FY15, Verint has spent ~$1B on M&A. KANA, its biggest acquisition, failed spectacularly in our view, as sales growth immediately turned negative once the acquisition was anniversaried. Verint has continued to pursue smaller tuck-in acquisitions since, but most deals go unannounced, and are not explicitly named in SEC filings. We believe that, after taking into account M&A, FX, and the effects of ASC 606, organic growth was in the low single digits in FY18 and negative in FY19, far below reported top-line growth in the high single digits. Last quarter, management raised guidance by just $20M upon acquiring ForeSee Results, Inc., whereas court filings indicate that ForeSee was generating $80M in sales at the time of the bankruptcy of its former parent, Answers Corp. (2016), and was projected to grow to $130M by this year. We believe that subsequent sales growth characterized as organic was largely driven by this and other acquisitions, and that its underreported inorganic sales contribution created a "cookie jar" which Verint used to beat Q4 and raise FY20 guidance.
- Aggressive Accounting Measures Flatter Performance And Boost Executive Compensation: Verint includes in "cloud revenue" sales from term-based licenses, which can be recognized up-front under newly-adopted accounting standards (ASC 606) and thus inflate management's depiction of recurring cloud sales. Management's adoption of ASC 606 boosted revenue by $47M (5%) and net income by a massive $51M (75%) in FY19 – far out of line with NICE Ltd., its closest peer, whose revenue declined with the change. Newly-capitalized commission costs and questionable add-backs accounted for ~25% of FY19 Adj. EBITDA and ~65% of Non-GAAP Net Income, both of which would have seen zero growth in FY19 (vs. reported mid-single-digit growth) without capitalized commissions alone. Management performance metrics are padded by even more questionable add-backs which appear nowhere in Company filings but the notes to its proxy. Spruce Point believes that management would have missed five of its six comp targets in FY18-19 without these add-backs.
- Key Executives With Dubious Pasts: Dan Bodner has been CEO of Verint since its founding in 1994. For much of the 1990s and 2000s, it was a subsidiary of Comverse Technology, whose CEO, CFO, and GC orchestrated a massive options backdating scandal during this time. All three sat on Verint's Board and were the sole members (with Bodner) of key Board committees. A later investigation found that Verint had carried out aggressive business practices under Bodner to decrease sales volatility and inflate reserves. CFO Douglas Robinson worked for Computer Associates for 17 years through the 1990s and 2000s, including stints as a senior member of the finance department. CA was similarly shown to have engaged in aggressive revenue recognition practices to inflate sales and earnings. Though Robinson was never implicated, his close association with CA's finance department at the time of the fraud concerns us.
- Slow-Growing Call Center Software Provider Priced Like A High-Growth SaaS Company: The Street believes that VRNT trades at a ~35% discount to peers based on an improper view of Adj. EBITDA and net debt. Even then, the avg. analyst price target of $66 yields just 8% upside. After restating EBITDA for questionable add-backs and newly-capitalized expenses, and after removing non-transparent restricted cash items from liquidity, we find that VRNT trades at almost exactly its peer median multiple, despite contracting organic sales and stagnant cash flow. Meanwhile, insiders are dumping the stock just as it approaches all-time highs (up 45% Ytd). We believe that its current multiples – its highest in recent history, and comparable to high-quality take-outs SAAS and BSFT – are unsustainable as M&A fails to grow cash flow, as it falls further behind call center software peers and out-of-favor with SaaS-oriented investors, and as it laps FY19 ASC 606 tailwinds. We value the slow-growing Company at an EV/EBITDA multiple of 8-10x for a price target of $17-25, yielding 60-70% downside.
The research note can be found at www.sprucepointcap.com and updates will be posted on twitter @sprucepointcap.
Spruce Point Capital has a short position in Verint Systems Inc. and stands to benefit if its share price falls.
About Spruce Point Capital
Spruce Point Capital Management, LLC, is a forensic fundamentally-oriented investment manager that focuses on short-selling, value and special situation investment opportunities.
