Description

Short VRNT:

Verint Systems (NASDAQ: VRNT) is a crock pot of puffery and we think management guidance is due for a stern reckoning with reality in the coming quarters. Given that it reports earnings next week, this writeup will be relatively succinct. Borrow is GC, ADV is ~$14mm and SI is LSD – this is as good a setup as any for a short.

VRNT’s boilerplate pitch is that it helps organizations assess and improve the customer experience, while also automating customer engagement across their channels. Practically speaking, clients use it for call/screen recording, to monitor end customers’ emotional states and to track employee productivity/process adherence. VRNT spun off Cognyte Software in 2021 and it is now a pure play customer engagement company.

Management has been pitching its SaaS/cloud transition since before 2019, and it is finally set to “finish” in 2024. They define completion to be when 90% of their software revenue comes from recurring sources. SaaS revenue grew at a 30%+ clip through FY23. Consolidated revenue has grown at a MSD clip. Today the SaaS segment comprises slightly over 50% of total sales. For reference, VRNT’s FY ends on January 31.

This is the lazy bull thesis: VRNT is finishing its SaaS transition -> the macro improves -> the SaaS segment (growing as a % of overall sales) accelerates topline. Then OpEx should normalize as it finally laps the cost dis-synergies that came from doing the spin-off. At ~3X NTM Sales, it’s not so expensive. Sounds good, right?

The reality is management has been playing gimmicks to avert investors’ attention away from the deteriorating fundamentals.

My first point of contention: management breaks down “SaaS” revenue into Bundled SaaS and Unbundled SaaS (roughly a 50/50 split). As per the footnotes, Unbundled SaaS revenue is recognized at a point in time, while Bundled SaaS revenue is recognized over time. Unbundled SaaS is not actually SaaS, it’s more like term licensing revenue: the quality of the topline is overstated here. I’ll caveat that there are some recurring maintenance fees mixed in, but how is revenue that is recognized at a point in time (read: one-time) considered recurring? Innocent enough mistake, right? I just wonder why they explicitly call it SaaS revenue…

In the most recent quarter, the SaaS segment grew 24% and consolidated revenue was slightly negative/flat (depending on if you account for currency effects). Yet management guided to 25-30% growth in its SaaS segment and ~3.6% consolidated topline growth for the full year. The sellside has taken this growth trajectory largely at face value.

VRNT posted its first quarter of negative YoY RPO growth ever, at -2.7% vs. an average of 8.6% in FY23 and 25.7% in FY22. Current RPO growth decelerated to 0.6%, an all time low compared to averages of 8.3% in FY23 and 34.3% in FY22. Since RPOs provide visibility into (the lack of) deals, which drives future revenue growth, the projected acceleration in topline has to come from new wins. Just this past quarter, management announced their “significant SaaS wins”, including seven- and eight-figure deals. The TCV from the three wins they highlighted was $30mm. Sounds reassuring, right? The RPO balance includes the total value of contracted services yet to be invoiced, while TCV represents the future revenue associated with contract wins. This is to say growth in TCV should be reflected within RPOs. The RPO balance declined sequentially by $35mm; these “big” wins could not make up for the lack of wins from new customers!

Taking a step back, what exactly are the Contract Assets on CGNT’s B/S? Per the footnotes, “the majority of VRNT’s contract assets represent unbilled amounts related to multi-year unbundled SaaS contracts.” The Contract Assets are Unbilled Receivables, or revenue that has been accounted for but not yet invoiced. It’s concerning to me that Unbilled DSO has reached its highest point ever since the spin-off, while A/R DSO is actually declining sequentially! I would not be surprised if CGNT is pulling forward revenue to keep their growth story alive. To make matters even worse, this growth is predominantly from unbundled SaaS contracts, meaning this revenue isn’t even coming from the “actual” SaaS segment!

What makes this situation even more appalling is that management isn’t just blissfully unaware of the underlying financials, they’re actively playing games to mask the truth. In Q4FY23, management cited their “evolving disclosure from transitional to traditional operating SaaS metrics” and introduced SaaS ARR. At this point in time, SaaS ARR had grown at over 30% in the past two years. This sounds pretty good and I am all for increased transparency. Then why is it that after one quarter, they stopped disclosing this new metric? In their most recent 10Q, management qualified the language used to describe their competition, who now “may be able to grow faster than [VRNT].” It’s interesting to me that the CFO stepped down at the start of CY23. Meanwhile management continues to sell shares in the public markets.

Valuation:

My take is that the uplift from VRNT’s SaaS conversion buoyed up past growth figures and cracks are finally starting to show as this transition nears its end. Management’s guide for acceleration will have to come down as SaaS continues to decelerate to a blended high teens clip. Meanwhile the sellside is taking management’s optimism at face value.

I value the Bundled and Unbundled SaaS separately as they are not the same quality and Bundled grows slower than Unbundled. This past quarter, Bundled grew ~20% YoY (vs. ~22% in FY23) while Unbundled grew 27% YoY (vs. ~62% in FY23). Given the points discussed I think Bundled can realistically decelerate to a mid-teens clip while Unbundled can grow at a low-20s clip given management’s tomfoolery. The other “recurring” revenue stream is Optional Managed Services which is shrinking, qualifies as ancillary support revenue and is lower GM. Then you have the nonrecurring segments: Perpetual Revenue and Professional Services Revenue.

Being generous, Bundled deserves a 4X Sales multiple, Unbundled deserves a 1.5X and Optional Services deserves a 0.5X. Perpetual Services deserves a 0.5X as it is shrinking (in line with the transition away from on-premise licensing revenue) and Professional Services is worthless given it operates at ~10% GM/is a loss leader. I model based on my FY25 numbers (basically ~1.5 years out from now). Bundled is ~$1.2bn, Unbundled is ~$500mm, Optional Services is ~$100mm, Perpetual Services is ~$50mm. That gets us an EV of ~$1.85bn. Then VRNT has a fat stack of debt and preferred equity on its B/S which accentuates the downside to the equity. I get to an equity value of roughly $1.25bn, compared to the $2.1bn market cap it has today. That is roughly 40% in downside from here in less than two years.

Given the low SI and visibility we have into future revenue streams, I think the risk/reward skew is compelling as a short. Considering management’s string of antics, several zero-revenue acquisitions in past years, and miscellaneous lawsuit settlements I do not view their capital allocation fondly. The market should acknowledge the decelerating revenue growth, fake nature of their "Unbundled SaaS" revenue stream, and management’s many shady antics appropriately.

Catalyst

Earnings