Verint Watches You, Should You Watch It?

By Stephen D. Simpson, CFA | September 10, 2012 AAA

Civil libertarians don't like it, but there is big business in monitoring employees and customers and analyzing that data for actionable information regarding marketing, customer relations, employee training and so on. Likewise, national governments are well aware of the intelligence to be gained through video surveillance and communications interception. Accordingly, it would seem that Verint (Nasdaq:VRNT) ought to have a fairly appealing addressable market for years to come, while the spin-off/merger transaction with Comverse Technology (Nasdaq:CMVT) will ultimately simplify this company's ownership structure.

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Conditions a Little Challenging Now
Verint reported results that were broadly similar to close rival NICE Systems (Nasdaq:NICE), as European government spending issues weigh on results. Revenue rose 10% as reported, with product revenue growth of less than 2%. Enterprise intelligence grew 10% overall, while strong communications intelligence growth (up 17%) was offset by a weakness in video (down 4%). Verint did reasonably well when we take a look at corporate profit margins. Although the gross margin slipped slightly from last year, good operating expense control led to a 23% operating income growth from last year.

The Comverse Transaction Is Complicated, but Necessary
Comverse Technology has long owned a large percentage of Verint, and that ownership has created problems with liquidity, visibility and investor confidence in management's freedom to make optimal long-term strategic decisions. Earlier this year, however, the companies announced a process by which Verint will be an independent company next year.

There is always a way to cash in on corporate restructuring, but the process is going to be convoluted. Comverse Technology (CTI) is going to spin off Comverse (CNS) to shareholders, after which there will be a reverse merger between Verint and the resulting shell. Comverse Technology shareholders are going to get one share of "CNS" and 0.13 of Verint, while Verint will issue more than 27 million shares to CTI to cover the ownership stake and convertible preferreds. When it's all said and done, Verint will be independent and, at least in theory, have a more liquid and attractive stock to offer to institutions.

The Race Is on to Drive More Value in Enterprise
I don't mean to give short shrift to Verint's government-oriented video and communications intelligence businesses. Verint is a major player in wiretapping and more than holds its own with the likes of Honeywell (NYSE:HON), Cisco (Nasdaq:CSCO), NICE, and BAE Systems (OTC:BAESY) when governments are looking for solutions providers to monitor cell phones, CCTV and so on. The question, however, is what the growth potential of the enterprise (corporate) side of the business is. Legacy businesses like data center monitoring/analysis aren't likely to be huge growers, but companies are collecting more and more data all the time as the cost of storing that data continues to drop. The question is what they do with that data.

Everybody reading this has heard that recorded message saying that your call may be/will be monitored for quality control/customer service purposes. While there is plenty of value to be created from doing this, companies have traditionally had to hire and train supervisors to listen to these calls and that takes quite a bit of time and money. This is where Verint, NICE, and Hewlett-Packard's (NYSE:HPQ) Autonomy come into the picture. The software that these companies develop and market can analyze hours and hours of calls without the subjectivity or variability of a human listener. This is the sort of analysis that can spot trends, identify good/bad areas of service and otherwise improve customer relations quickly and at an effective price point.

The Bottom Line
The bull thesis on Verint revolves around the extent to which the company can improve its free cash flow conversion in the coming years. If management more or less holds the line, the stock looks slightly undervalued but not so much as to be a compelling buy. If management can start improving margins and cash flow, however, there could be considerable upside to the shares. All in all, this looks like an interesting risk-reward trade-off - solid single-digit free cash flow growth would offer minimal downside, while outperformance into low double-digit growth could drive these shares well into the $40 range.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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