Description

NortonLifeLock (NLOK) is led by a proven value creator, Vincent Pilette, and is on the cusp of consummating a highly synergistic acquisition of its European rival Avast (AVST LN). We previously invested with Mr. Pilette during his successful tenures at EFI (EFII) and Logitech (LOGI). In both instances, he led a series of smart acquisitions, materially improved profitability, and worked eloquently with Wall Street to drive shareholder value while consistently beating expectations. We jumped at the chance to invest when he joined NLOK in May 2019. Since then, we’ve watched him engineer an impressive turnaround/repositioning, with steady revenue growth, 50% operating margins, and over $1 billion in annual free cash flow.

We believe the pending acquisition of Avast is a catalyst for re-rating as the combined company achieves significant synergies. We see upside valuation of $50 per share (+100%) within two years based on 15x CY23/FY24 EBITDA. We note that directors representing 36% of Avast shares are supporting the deal AND have elected to take NLOK stock instead of cash.  In the unlikely event that the deal is not approved, we think the downside is low as NLOK currently carries a dividend yield of 1.95% and trades at 12x CY21/FY22 EBITDA.

Company background

NLOK was written up by northhbs123 as a long idea on VIC on January 19, 2020. Please refer to that write-up for background of NLOK’s consumer business, divesture of the Symantec enterprise business and hiring of Vincent Pilette as CFO and his subsequent promotion to CEO. Since that pitch, there have been even more positive developments at NLOK:

·       Paid $12 per share in special cash dividend on January 31, 2020

·       Acquired Avira, a freemium anti-virus software company based in Germany, on December 7, 2020 for $360 million in cash

·       Announced the sale of office properties for $500 million

·       Reduced diluted share count by 10% since January 2020 via buyback

·       Announced acquisition of Avast, a global cybersecurity software company, on August 11, 2021 for $8.1-8.6 billion in cash and stock

The focus of this write-up is on why this opportunity exists, Vincent Pilette’s stellar track record and the pending Avast deal.

Why this opportunity exists

Perception that NLOK sells commodities: Many investors rightly view the anti-virus (AV) market as mature and low growth, and we don’t disagree. However, we disagree with the perception that NLOK sells a commoditized product that Microsoft gives away for free. While Microsoft’s AV product Defender has improved over the years, it has limited features and does not have privacy offerings such as VPN, dark web monitoring or password managers. Importantly, we do not believe consumers trust Microsoft enough to abandon independent third-party cybersecurity products. NLOK’s additional identity offerings are key differentiators against legacy providers/incumbents like McAfee/Microsoft. The company’s narrative should continue to expand well beyond core AV as privacy, cloud, online data, and other identity issues continually resurface and investors have few ways to directly play this theme. Because it does not sell commodities, NLOK has steadily increased its direct customers to over 23 million and maintained a consistent 85% retention rate.

Slower growth vs McAfee: At 12x EBITDA, NLOK trades at a discount to direct competitor McAfee’s 15x multiple. The main reason for this discount is that NLOK has been growing at 5-10% while McAfee has been growing at 20%. Prior NLOK management neglected to invest in the steady consumer business as the company focused on reviving the struggling enterprise segment which included legacy assets and the old Blue Coat Systems (BCSI).  As a result, McAfee has benefited more than NLOK from the COVID-driven spike in personal computer sales due to its stronger presence in the PC OEM channel, with exclusive partners such as Dell and HP. However, we believe this gap in growth and valuation should narrow as Mr. Pilette reinvigorates the consumer business and executes his consolidation strategy. Wall Street should begin to appreciate NLOK’s differentiation in scale and products. McAfee does not have an identity protection solution such as NLOK’s industry-leading LifeLock.

Vincent Pilette’s track record

Mr. Pilette has proven to be a value creator since starting his first C-level position at EFI in 2011 (see Table 1).  When we first met Mr. Pilette in 2011, we were immediately impressed not only by his financial acumen, but also his strategic vision to create shareholder value. Vincent’s title at EFI and Logitech was CFO, but we believe his role was more influential than that of a simple bean counter. Hence, when he was recruited to be the CFO at NLOK, we anticipated he would be given a shot to succeed interim CEO Rick Hill, who had come off the board to oversee the enterprise divestiture. Vincent’s quick progress at NLOK led the board to name him the permanent CEO in seven months. The anecdote shared by Mr. Hill during NLOK’s May 2019 earnings call best characterizes what we think of Vincent:

“I would like to share a short story with you about Vincent. A couple of weeks ago, Sue Barsamian [another NLOK board member] and I, at the request of the Board, were meeting with the executive staff and others in the board room, where I was expressing my views on the importance of all the management having the fundamental skill of financial alacrity. Sue said to me, "What's that mean?" Well, on last Sunday, when Sue and I again were meeting with the executive staff, this time with Vincent Pilette present, I asked Vincent if he would like to say a few words to the group. He jumped up and in his deep Belgian accent, "Well, of course." He grabbed the marker and a flip chart and began to outline the financial model for the company in real-time. As he captivated the staff, I returned to Sue and said, that is my definition of financial alacrity. You will all be very pleased.”

We believe Mr. Pilette’s experience at EFI and Logitech are valuable and relevant to NLOK because both companies had growth challenges and were perceived to be selling commodities at the start of his tenure. At EFI, he shifted the company’s revenue mix to higher-margin software by executing over a dozen acquisitions, and he drove significant profit improvement. In a short period of time, EFI doubled its operating margin from 6.4% to 13.5%. At Logitech, he helped execute its M&A strategy and expanded operating margin from 9.4% to 12.6%. At NLOK, he quickly divested the Symantec enterprise business, disposed non-core and real estate assets, repositioned to a highly profitable consumer business that had been neglected under the prior regime, swiftly eliminated excess costs, and returned capital to shareholders via a massive special cash dividend and buyback. Vincent has already achieved the goals he set out in 2019 (see Figure 1).

Table 1: Vincent Pilette’s Performance

 ^ includes $12 per share in special cash dividends

Figure 1: NLOK Post-Transition Model Goals vs Progress

Source: NLOK investor presentation

Pending Avast deal

We believe the pending Avast deal will accelerate Mr. Pilette’s goal of double-digit revenue growth while unlocking even greater operating leverage (see Figure 2). NLOK is valuing Avast at 17x CY21 EBITDA for a company that generates over $500m in revenue with 55% EBITDA margin. The price paid may appear high compared to NLOK’s own multiple, but NLOK believes it can unlock significant value creation through $280 million of annual cost synergies and potential revenue growth acceleration.

Both companies have some product and geographic overlaps, but there are some differences. NLOK offers premium and identity products, while Avast has freemium and privacy offerings. NLOK has a bigger presence in North America, while Avast is stronger in Europe and Latin America. NLOK believes the combined company will have 1) scale for innovation and acceleration in growth; 2) geographic diversification; 3) stronger product differentiation with identity and privacy solutions.

The transaction offers two alternative consideration elections for current Avast shareholders. The Majority Stock Option is valued at 551 pence per Avast share with a mix of 31% cash/69% NLOK stock. The Majority Cash Option is valued at 608 pence per Avast share with a mix of 90% cash/10% NLOK stock.  Avast Directors, including Founders, representing 36% of Avast outstanding shares have irrevocably undertaken to support the transaction and elect the Majority Stock Option. We believe Avast Directors are signaling their confidence in the value of the combined company.

Figure 2: Avast Deal Rationale

Source: NLOK/Avast investor presentation

Valuation

We believe NLOK/Avast offers upside valuation of $50 per share (+100%) within two years based on 2023 EBTIDA and multiple in-line with McAfee’s today (see Table 2). We assume revenue CAGR of 10%, a slight acceleration from both NLOK and Avast’s current fiscal year outlook of high single-digit growth. We also assume blended EBITDA margin expands from 53% pre-synergies today to 60% post-synergies.

Table 2: Norton/Avast Combined Valuation

Risks

Avast deal falls through: We believe the likelihood is low as 36% of Avast shares have already been pledged to support the deal, and NOLK is paying a premium EBITDA multiple of 17x. In the event of a deal break-up, we think NLOK shares have downside protection as NLOK currently carries a dividend yield of 1.95% and trades at 12x CY21/FY22 EBITDA.

Increased pressure from Microsoft and McAfee: We believe NLOK is differentiated from Microsoft as an independent third-party cybersecurity product with additional features such as VPN, dark web monitoring and password managers. McAfee currently does not offer identity solutions comparable to NLOK’s LifeLock.

Catalyst

Completion of Avast acquisition