AVGO - Gen Digital: Continued Changes At This Cybersecurity Play

2023-06-16 14:19:22 ET

Summary

• Gen Digital, perhaps better known as NortonLifeLock Security by investors, has seen its share price dominated by the Avast deal.
• After years of divestments and simplification, the company made a decisive move in 2022.
• Despite apparently solid earnings, I am cautious about Gen Digital stock despite low earnings multiples amidst high leverage and a troubled past.

At the start of 2021, I offered some thoughts with regard to the shares of NortonLifeLock, now known as Gen Digital Inc. ( GEN ). At the time, NortonLifeLock had ended 2020 with a bolt-on acquisition after divestments have made the business a pure play on cybersecurity, with tailwinds seen on the back of the pandemic and a reduction of stranded costs amidst simplification of the business.

Valuation multiples were anything but demanding, as investors have been rightfully skeptical after they have had to endure many disappointments in the past. Appeal was seen if execution could be delivered upon, which was a big if.

A Recap

The story around NortonLifeLock saw a big impact from Broadcom ( AVGO ) acquiring its enterprise security business Symantec in a massive $10.7 billion deal in 2019. Proceeds from this deal were largely paid out in the form of an $8 billion ($12 per share) dividend in January, with shares trading at $20 in the aftermath of the dividend.

For 2020, NortonLifeLock saw sales up a percent to $2.5 billion, and earnings coming in at $578 million, although that earnings of $0.94 per share benefited from some items. Adjusted earnings of $0.90 per share rose thirty cents, but this excludes a $0.19 per share stock-based compensation expense, for instance.

With shares trading in a $17-$25 range, the valuation looked more than fair, as the company had taken on a modest net debt load of $2.0 billion, for leverage ratios close to 2 times. Moreover, the company had seen some organic growth in the first half of 2021 with earnings improving to a run rate close to $1.50 per share.

This started to look quite compelling, with shares trading in the higher teens and some stranded costs following the Symantec divestment being eliminated. This should have driven some earnings improvement, but the lack of track record in terms of execution made me too cautious to get involved.

Investment Thesis Changes Dramatically

As soon as August 2021 , the investment thesis around NortonLifeLock changed in its entirety when the company merged with Avast in order to create a more comprehensive giant in this field.

Forwarding to May 2022, the company grew the fiscal year 2021 sales by 10% to $2.80 billion, with GAAP operating profits improving at a similar pace to $1.00 billion. GAAP earnings were reported at $1.41 per share with adjusted earnings improving to $1.75 per share, excluding a $0.12 per share stock-based compensation expense. These results and the outlook were overshadowed by the pending deal with Avast, which closed in September of last year.

In May of this year, Gen Digital (as it was called by then, of course) posted its 2023 results with sales up 19% to $3.34 billion. While GAAP earnings improved spectacularly, adjusted earnings rose a mere six cents to $1.81 per share. The impact of the deal was more seen in the fourth quarter results, with sales up 32% to $947 million, although that adjusted earnings for the quarter were flat at $0.46 per share.

This was due to some dilution from the deal, which furthermore bloated the balance sheet as well. In fact, net debt has risen to $9.0 billion, which looks quite high as I peg EBITDA around $2 billion per year here (and adjusted for stock-based compensation a bit more). The company itself saw net leverage around 4 times some 12 months after the deal closing, likely due to some deleveraging and realization of synergies.

What Now?

The reality is that, after fast-forwarding about two years in time, we see shares trade at similar levels, after the company has made a transformative merger with Avast.

With Gen Digital Inc. shares trading at about a mere 10 times adjusted earnings multiple, expectations remain low, but leverage has been bloated again following the deal with Avast. This comes as earnings are adjusted, and investors likely should take a wait-and-see approach here, despite the promise of $3 in earnings per share in 2025, as I am joining the cautious wait-and-see approach for now.

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