For investors in NeuStar, Inc. (NSR), the last 11 months have been hurting months. From January 2009, their stock had risen from a low near $15 to almost $58; for those who bought at the low, just a touch more would have given them a fourfold gain. But, in August of 2013, it began to fall down the mountain, down to less than $24 at one point, as the green line on the following GuruFocus chart shows.
The other line on that chart, the blue line, shows the P/E ratio. It’s fallen from almost 23 to less than 11.
Neustar is a tech company, spun out a major blue chip, the following information comes from the company website:
- 1996: Lockheed Martin operating unit Communications Industry Services wins a contract to provide local number portability (LNP) services in some areas of North America;
- 1997: the unit wins a contract to manage the North American Numbering Plan (NANP), the service that allows all telephone companies to access each others’ numbers;
- 1999: Communications Industry Services is spun out of Lockheed Martin, and named NeuStar, Inc.;
- 2000: A unit of NeuStar wins the first of a number of contracts to manage an Internet name registry;
- 2003: “Neustar made the first of several strategic acquisitions, buying out NightFire Software and creating Neustar’s Order Management Services (OMS) clearinghouse. After subsequent acquisitions, Foretec Seminars became Neustar Secretariat Services (2005); UltraDNS became a Neustar service (2006); Followap, Inc. became Neustar Next Generation Messaging (2006); and Webmetrics became a Neustar service (2008).”;
- 2004: announces its first major number portability initiative outside the U.S. (in Taiwan)
- 2005: NeuStar goes public company on the New York Stock Exchange;
- 2010: aquisition of BrowserMob, LLC, which provides load testing and monitoring services, and Quova, Inc., which offers IP geolocation services (“...to help online businesses optimize their web presence and also detect and prevent fraud, ensure regulatory compliance, manage digital content rights distribution and localize ads and web content.)”;
- 2011: acquisition of the Numbering Solutions segment of Evolving Systems, Inc., and finalizes acquisition of TARGUSinfo, which provides, “...real-time, on-demand information services, including Caller ID.”;
- 2013: acquires Aggregate Knowledge, a provider of workflow solutions for full marketing cycles.
Takeaways: Initially, NeuStar focused on organic growth, by winning contracts to provide infrastructure to the communications industry; in 2003 it began emphasizing growth through acquisitions. We also note it is diversifying beyond communication infrastructure to take in marketing technology.
NeuStar Business Model
According to the 2013 Annual Report, “2013 marked the second full year of our transition from a telecommunications infrastructure company to a growth-oriented information services and analytics company.” The company now operates in five major divisions:
- Marketing Services: Help clients plan, execute, and measure the effectiveness of advertising campaigns;
- Business Assurance Services: website performance monitoring and load testing analysis;
- Security Services: DNS services, providing protection against cyber attacks;
- Data Services: managing large, complex data sets so clients can process decisions and transactions in real time;
- Data Registries Services: “...dynamic routing of calls and text messages among all competing communications service providers in the United States and Canada, the provision of caller-name and related information to telephony providers, the management of authoritative domain-name registries and the administration of the U.S. common short codes registry.”
Takeaways: NeuStar is evolving from a utility-like company (infrastructure) to, as it says, a growth-oriented company, by providing marketing, assurance, and security services to business customers.
NeuStar lists the following risks in its 10-K for 2013:
- Potential loss of its North American Portability Management contract, which, the company says, provided almost 49% of its total revenue in 2013);
- Failure or interruption of its network infrastructure;
- Failure of security measures could result in theft of data, and lawsuits;
- Competition: Inability to adapt, and keep up with rapid technological and market change, could cost clients and/or market share;
- And more.
Takeaways: The Portability Management contract, which represents almost half of its revenues, is up for loss or renewal in 2015. Competition for that contract has heated up, and the company argues the process has not been fair. Whether fair or not, there is a possibility the company could take a serious hit in 2015.
In its 2013 Annual Report, NeuStar lays out four goals
“(1) Achieve our financial targets;
“(2) Further our strategy to become a leading provider of commercial insights and analytics;
“(3) Continue to compete vigorously for the NPAC contract that begins in July 2015; and
“(4) Continue to invest in our employees and platforms to drive growth and shareholder value.”\
Takeaways: The key, I would suggest, lies with the second goal, to rely less on business over which it has little control (infrastructure), by building new lines of business (marketing).
- President and CEO: Lisa A. Hook - joined NeuStar in 2008, after serving in the same roles at Sunrocket, Inc., and in senior management roles at other tech companies. Also served as a legal adviser to the Chairman of the Federal Communications Commission;
- Senior Vice President and Chief Financial Officer: Paul S. Lalljie has served in positions of increasing responsibility at the company for more than a decade;
- Chairman: James G. Cullen retired as President and Chief Operating Officer for Bell Atlantic in 2000.
- Governance: NSR gets an excellent score on the ISS Governance QuickScore, 1 out of 10. As the ISS website notes, “A decile score of 1 indicates lower governance risk, while a 10 indicates higher governance risk.” It draws one red flag, for Voting Formalities, while scoring stars for Board Composition, Board Practices, and Voting Issues.
Takeaways: Both senior management and the board appear capable of executing the company’s growth and diversification strategy.
GuruFocus data, unless otherwise noted:
- Gurus: seven gurus followed by GuruFocus own NSR stock; the biggest holder is PRIMECAP Management (Trades, Portfolio) with 3.8 million shares;
- Institutional Investors: 55% owned by mutual funds (Morningstar)
- Insiders: 12%
- Shorts: 33.4% - As the following chart shows, short interest has climbed dramatically in the past two years:
Takeaways: NSR’s short interest raises concern; significant numbers of investors obviously think the price has more room to fall; on the other hand, the relatively high level of insider ownership provides a vote of confidence.
NSR by the Numbers
Takeaways: Both the trailing and forward P/E ratios sit well below 15; the company does not pay a dividend; and the company's share repurchase program removed about 6% of outstanding stock in 2013.
GuruFocus gives NSR a Financial Strength rating of 6 (out of 10), and a Profitability Growth rating of 9 out of 10.
GuruFocus also issues two Severe Warning Signs:
- Short Percentage Of Float: high (as noted above) - at more than 33%;
- Asset Growth: faster than revenue - to check, we’ll consider the risk by looking at a process Peter Lynch describes (in his book, One Up On Wall Street); we use the GuruFocus 10 Year Financials to pull up the following data:
- Current assets & marketable securities - 2013: $223.3 million
- Current assets & marketable securities - 2004: $63.9 million
- Long-term debt - 2013: $610.7 million
- Long-term debt - 2004: $8.0 million
- Net cash position - 2013: $159.4 million
- Net cash position - $2004: $55.9 million
Takeaways: As the data shows, NSR’s net cash position has almost tripled over the past decade; the company does not pay a dividend and so it does not face any concerns in that area.
As the chart shows, the three GuruFocus estimations available in the Valuation box show NeuStar as undervalued (based on a $26.32 closing price on July 2, 2014):
- Projected Free Cash Flow comes in at $49.58
- Median P/S Value suggests $52.81
- Peter Lynch Value is $61.75
- Moving to another section of the GuruFocus site, we can see a Discounted Cash Flow valuation of $70.03 (12% discount rate and 62% margin of safety).
- Turning to the predictability portion of the Undervalued Predictable screen, we note a predictability rating of 4.5. Based on backtesting, GuruFocus says stocks with this rating have averaged gains of 10.6% per year, and only 10% of stocks with this rating remain in a loss position after 10 years.
Against all this optimistic data are a couple of major concerns:
- First, the process by which the new (2015) Local Number Portability (LNP) contract will be awarded has been controversial. The company said in a news release that “The process has also been marred by apparent leaks of confidential information, as well as substantive and other procedural problems.”, and goes on to note that a confidential email, apparently sent by an aide to the chair of the North American Numbering Council (NANC) to the FCC, recommends that the contract be awarded to another company.
- Second, although the company reported stronger demand for its Marketing Services and Data Services in 2013 (altogether, a 15% increase in non-NPAC revenue), these are relatively new business lines for NeuStar and more competitive than utilities/infrastructure.
- Third, guidance for 2014 suggests a modest 15% increase in revenue, and an even more modest adjusted net income target of zero to 4%.
Takeaways: Looking beyond the income statement and balance sheet gives us pause about the future value of the company.
Valuations without the news suggest NeuStar could double or more in price. With a range of projected valuations from $49.58 to $70.03, this looks to be a tempting target.
The news, however, removes much of that temptation. With LNP representing almost half of its revenue, loss of this contract could knock down the share price even more.
Of course, we might argue the share price already reflects this uncertainty about the LNP contract; however, we also know the market often overreacts to bad new, and official news (so far the news has been unofficial) of a loss might push share prices lower again.
Further, given the contentious nature of this bidding process, there’s a likelihood of lawsuits, by whichever side loses, leaving continuing uncertainty and a stalled share price, well after July 2015.
NeuStar is moving in the right direction, acquiring and developing new lines of business that will make it less vulnerable. In the meantime, though, investors likely will see little pricing improvement until a decision on the LNP contract is fully finalized.
About the author:
As a writer and publisher, Abbott explores how the middle class has come to own big business through pension funds and mutual funds, what management guru Peter Drucker called the Unseen Revolution. In Big Macs & Our Pensions: Who Gets McDonald's Profits?, the first of a series of booklets on this subject, he looks at the ownership of McDonald’s and what that means for middle class retirement income.
In an eclectic career, Robert Abbott was a radio news writer and announcer, a newsletter writer and publisher, a farmer, a telephone operator, and a construction worker. When not working, he has been a busy volunteer, which includes more than a decade of leadership roles at the Airdrie Festival of Lights, one of North America’s leading holiday light displays. He lives in Airdrie, Alberta, Canada.