GEN - Gen Digital: Impact Of New Acquisition Yet To Be Determined

2023-04-03 04:28:31 ET

Summary

• Gen Digital has taken on $9B of debt to acquire Avast and had a healthy first quarter with the new company under its wing.
• It has posted consistent net profits and cash flows for the past 10 quarters.
• However, the firm is now paying significant interest that came to over 40% of free cash flow in the most recent quarter.
• While a scale player that controls most of the consumer cybersecurity market, it is now newly sensitive to shocks due to its debt.
• All of this, along with a weak quarter in the run-up to the purchase, create a body of counteracting signals that net out to hold while we see how this year progresses.

Overview

Gen Digital ( GEN ) is a cybersecurity software company. Better known by its founding name, Symantec, Gen Digital has now changed its name 3 times in the last 5 years; it was rebranded as NortonLifeLock in 2019. It took on its current name with its acquisition of Avast in Q3 2022. It is a pure play computer security company that nonetheless has a distinct offering from what Symantec has traditionally brought to market. This was due to three significant M&A events over the last 7 years, the most recent of which was the Avast acquisition.

The first of these material M&A events was the spin-off of Veritas Technologies by Symantec in Q1 2016. Although a successful division, management thought this was a reasonable choice in order to further focus the firm's offering; Veritas' software was focused on enterprise data management as opposed to security. The next noteworthy M&A event occurred in Q3 of 2019 and involved Symantec selling off its entire enterprise security division. Now, the company only had a consumer-facing offering. The Avast acquisition expanded the company's consumer cybersecurity footprint while maintaining what was now its core competency of consumer cybersecurity products.

Since this company's actual business has iterated significantly over the years, we should consider its stock price over several time horizons. Looking at its performance since first going public in Q2 1989, we see that the company has underperformed the NASDAQ index significantly on a price-return basis.

Before we get too hasty, however, we should also look at the price return adjusted for dividends (note this only includes dividends from GEN and not NASDAQ constituents). On this basis we see the company for the stalwart that it has been as well as the very strong performance it has put up over the years.

Looking at the stock since 2014, things don't look quite as good. Even with an adjustment for dividends, Gen Digital has still underperformed the NASDAQ by nearly 50%.

Gen Digital's dividend remains solid and is well above the Information Technology sector average - although the IT sector isn't exactly known for its dividend yields. Nonetheless, this dividend yield serves to inform us that it continues to be a mature and profitable company.

This article will review the company's financials to see how they are progressing and whether the company may be a good investment at this time.

Financials

Although we have extensive financial data going back over 30 years for this company, I think the significant changes to its business model - as well as the recent acquisition - warrant looking at it in a more granular way, quarterly.

Starting with revenues, we see that growth has continued unabated - although not at a particularly brisk clip. Additionally we should note the down quarter in fiscal Q2 of 2022, which is certainly a yellow flag. The company appeared to return to growth the quarter thereafter and was able to pad its revenues materially with the recent acquisition coming online in its most recent filing. While this may not be the most exciting level of growth, I think its solid for a company of this size.

As to gross margin, we should note that Gen Digital took a hit in this regard from its most recent acquisition. Indeed, cost of revenues ticked up significantly more than they had at any other time during the last 10 quarters, and gross margin also decreased roughly 3%. I think this comes more from the friction of the acquisition and wouldn't expect this differential to persist; ultimately, Avast was in the exact same business that this company has been in and it should be able to recapture scale economies within a quarter or two.

Net income has also remained solid and has been consistently positive over the last 10 quarters.

Although a bit more variable than I would like with such a mature technology entity, we must chalk this up to the fact that it sells into consumers. It is rare to see such fluctuation with such a mature technology company, and the quarter prior to the acquisition was notably weak on net income as it was on revenue. Overall we can average this out but the figures are too volatile for that number to mean too much, but on the whole it seems to work out pretty well in a given quarter.

While revenues and profitability certainly look solid, we should evaluate the balance sheet. Here, there are immediately a few points of concern. The company appears to have taken a page out of the private equity playbook and took on significant levels of debt to execute its most recent acquisition. It is also now a net debtor to a far more significant degree than before, having $9.3B more in liabilities than assets.

As can be expected with this kind of maneuver, the company has faced a deterioration in its current ratio, with it now having half the assets on hand versus liabilities for the year ahead. While this number is certainly on the lower end, I won't consider it too concerning given the firm's profitable track record. It is, however, another data point - if profits/cash flows dry up, they're in for some trouble.

Indeed, Gen Digital is now paying significant interest on this debt - $149M last quarter alone. This began to eat into its cash flows significantly, although they still appeared quite robust in the wake of the acquisition. Nonetheless the interest payments last quarter were 41.8% of unlevered (pre interest) cash flow - a significant number. It's manageable but can be considered precarious and a number that is sensitive to shocks to the firm's bottom line. The first thing to go would of course be the dividend, but there's no reason to assume the worst right now.

Conclusion

Gen Digital has a complex set of financials. While it has overall continued to grow, it did waver for very recent quarter and continually posts a relatively volatile set of metrics due to operating as a consumer company. Additionally, the debt that it has taken for its acquisition is significant and will weigh on cash flows and profitability going forward. At current numbers, however, I don't foresee the company having any difficulty continuing to pay its dividend and pay down its debt.

The difference is that this company now has what many other debt-laden companies have: sensitivity to shocks. Yet, it's also a very large player in its market, one that seems to have most well-known antivirus brands. Its size is in itself a moat, and I don't think the market for consumer antivirus is going anywhere; it seems like most new computers (for Windows, at least) seem to come with one of these things pre-installed. Overall my approach here is to wait and see how things progress for the next quarter or two. I want to see the company recapture its recent gross margin and continue posting double digit net margins. If either of these waver I will be further concerned. I think this company is discounted properly by the market and will rate it a hold for the time being.

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