Why Verint Systems (VRNT) Has 60%-70% Downside Risk

Key Highlights

Verint is a long-time underperforming software company that is up 45% YTD as shareholder Neuberger Berman wages a proxy fight, and it gives lip service to implementing a cloud solution.
Based on our customer and industry checks, we believe Verint has fallen behind industry incumbent Nice/InContact in the cloud space, while younger/nimbler entrants also steal market share.
Once a subsidiary of Comverse, Verint's CEO is a lieutenant of Kobi Alexander, the felon who led Comverse through an accounting scandal. Verint's CFO came from Computer Associates, another fraud.
We believe Verint has engaged in dubious M&A to portray organic growth, and uses numerous cookie jar and aggressive accounting methods to portray itself as a growing cloud story.
Sell-side analysts have boosted price targets to as high $75/sh despite Verint having taken limited steps towards proving it can successfully transition to the cloud (already years behind its competition NICE/inContact). Adjusting its results for aggressive accounting choices and applying a reasonable multiple consistent with a no-growth software company, we can justify 60%-70% downside risk.

Report Entitled "A Short Call Report"

Spruce Point is pleased to issue a unique investment research report on Verint Systems, Inc. ("Verint," " VRNT " or "the Company"), a provider of "Actionable Intelligence" solutions (think call center solutions and surveillance activities) - with 60-70% downside (approx. $17-$25 per share). The full contents of our report are available on our website . We also encourage readers to follow us on Twitter @sprucepointcap . Please review our disclaimer below.

Executive Summary:

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. Bodner's boss and business associate Jacob Kobi Alexander plead guilty to fraud and was sentenced to prison, but later fled the United States to Namibia. 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, and its CEO Sanjary Kumar was sent to prison . 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 On An Uproven Transition:

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 8x-10x for a price target of $17-$25, yielding 60%-70% downside.

Disclaimer

This research blog expresses our research opinions. You should assume that as of the publication date of any presentation, report, blog or letter, Spruce Point Capital Management LLC (possibly along with or through our members, partners, affiliates, employees, and/or consultants) along with our subscribers and clients has a short position in all stocks (and are long/short combinations of puts and calls on the stock) covered herein, including without limitation Verint Systems Inc ("VRNT"), and therefore stand to realize significant gains in the event that the price of its stock declines. Following publication of any presentation, report or letter, we intend to continue transacting in the securities covered therein, and we may be long, short, or neutral at any time hereafter regardless of our initial recommendation. All expressions of opinion are subject to change without notice, and Spruce Point Capital Management does not undertake to update this report or any information contained herein. Spruce Point Capital Management, subscribers and/or consultants shall have no obligation to inform any investor or viewer of this report about their historical, current, and future trading activities.

This research blog expresses our research opinions, which we have based upon interpretation of certain facts and observations, all of which are based upon publicly available information, and all of which are set out in this research presentation. Any investment involves substantial risks, including complete loss of capital. Any forecasts or estimates are for illustrative purpose only and should not be taken as limitations of the maximum possible loss or gain. Any information contained in this report may include forward-looking statements, expectations, pro forma analyses, estimates, and projections. You should assume these types of statements, expectations, pro forma analyses, estimates, and projections may turn out to be incorrect for reasons beyond Spruce Point Capital Management LLC's control. This is not investment or accounting advice nor should it be construed as such. Use of Spruce Point Capital Management LLC's research is at your own risk. You should do your own research and due diligence, with assistance from professional financial, legal and tax experts, before making any investment decision with respect to securities covered herein. All figures assumed to be in US dollars unless specified otherwise.

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