VeriSign

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VeriSign, Inc. is a company focused on one of the two great issues confronting the Internet today, both relating to its overall infrastructure. The first issue involves increasing the speed of data flow into the home or office by fifty- or a hundred-fold to exploit the Net’s potential as a true multimedia system with voice and video transmission.

Trust & Security
The other, of which VeriSign is a part, involves ensuring trusted and secure communications and commerce. Without trust and security the Net will never be used for serious transactions. Indeed, the ability for business to take place on the Net in any meaningful way is not feasible until there’s absolute assurance that the business transactions performed are initiated and received in precise and desired ways, reach a specific and desired destination, and are not amenable to pilferage along the route. As it is today the Internet, which has enormous inherent power, is necessarily limited to passive and non-critical uses. Even so, the Net still can be dangerous to the unwitting. Without trust and security nobody downloading a piece of software from a website can be assured that the file they receive on their end is the file they want. Nobody looking at a company website can know with certainty that it emanates from the company itself and hasn’t been constructed by a rogue developer. And nobody will communicate anything of importance and secrecy while there remains the possibility for others to intercept the message and learn its content. Without trust and security we are left with the Internet as a resource of vast, unexploited power.

Releasing The Power Of The Internet
However, within a framework of trust and security the Internet becomes an engine of fundamental change within society. The world’s financial industry will be as changed with the Internet as it was with the computer. The use of the credit card, the use of credit, in fact, the use of money will take on forms not achievable before the Internet; it begins the process of creating a new financial order for the 21^st Century. The effects of the Internet will be revolutionary to companies and the way they do business ultimately energizing the manufacture of product and the creation of service.

Falling out from all of this capability will be a powerful, new industry called electronic commerce. E-commerce will lay open the world’s inventory of products and services to anyone sitting before a computer monitor. With keystrokes and mouse clicks they’ll be able to view enormous amounts of information and compare products from around the world. Then with a few more keystrokes they might be able to make the purchase online and have it arrive at their doorstep a few days later.

Accelerating World Commerce
The implications of the Internet in its ability to accelerate all the activities of world commerce are extraordinary to contemplate. Everyone knows the stakes are high. Off in the distance looms a gigantic pot of gold, which has sent a thrill through every company with a shred of capability to advance the effort in its direction. About $8 billion was transacted on the Net in ’97; some researchers are projecting its growth to $327 billion by the year 2002, but first we have to crack the trust and security nut.

Enter VeriSign
VeriSign is one company with such pretensions of doing so, and it’s received glowing press coverage in its march toward a $40 million IPO. Some even call it the most exciting IPO of the year and to justify this position tick off its strategic alliances with the great movers and shakers. Microsoft holds an equity position as does Intel and Cisco and Hewlett Packard along with VISA and Security Dynamics. If such heavy hitters support VeriSign, it should indeed give the investor a basis on which to consider the Company in a serious light.

The Good Moves Of VeriSign
There can be little argument that VeriSign is making some very fine moves. Since its inception in ’95 it has grown to 162 employees, proliferated a variety of sophisticated products, opened two Digital ID Centers, one in California, the other in Japan, made important alliances, and participated in the setting of standards. Every dedicated Net surfer will occasionally find the VeriSign digital certificate appearing on their monitor warning them about something dubious somewhere and assuring them that an action has been taken to keep things on the straight and narrow. We breathe a sigh of relief, although we’re not sure for what. But as a mechanism for brand name development it couldn’t get any better. Thus we have a picture of a company that is aggressive, vibrant, smart, capable, and actually achieving things. It’s not a false picture.

Behind The Curtain
So does it deserve to be the year’s most exciting IPO, and should investors stampede in its direction?

It’s easy to be charmed by VeriSign and to conclude, as some have, that it’s "way out in front of everybody." In reality such a claim is difficult to support when one views the Company in the context of its industry and competitors. VeriSign did $6.1 million through the first 9 months of ’97. Now consider who it’s going head to head with—IBM, which did $78 billion last year, GTE, which earned $2.8 billion on $21.3 billion in sales, probably Hewlett Packard, $34 billion and owner of VeriFone, which they purchased for $1.3 billion, and other similar companies with the expertise, the maturity, the distribution, staying power, and deep pockets to enter the fray and compete at a high level for the biggest chunks of money. It’s not likely that VeriSign with its $8 or 9 million for the year has those corporate giants stricken with panic or that they’ll yield a rich market to a small startup showing little in the way of resources or technology.

VeriSign has acknowledged directly that there’s nothing unique about its technology, and if it says so, it should be believed. The Company’s only hope for survival in this realm of its business is to dash as fast as possible in the creation of a brand name in order to motivate market share "before competitors offer products and services with features similar to the Company’s current offerings." The products they’ve come out with, and there appear to be many, may be of high quality but aren’t anything that can’t be replicated or even exceeded by companies with broader and deeper expertise and with the money and will to do it. So why haven’t such companies appeared?

The Unsettled State Of The Industry
To get way out in front of the others is good, in particular when you’re nearing the finish line. But to commit to a technology before the race has begun is a risky strategy, and the race is only now beginning. The hesitation so far has been a lack of standards among the protocols to be used.

Electronic commerce is an industry that will partition into a score of market segments, each ruled by a protocol guiding and constraining the development of software and hardware so that in the end all the systems of the world operating in this domain can be assured of communicating in the same way. These protocols are the central element inhibiting the advance of the industry and for a very good reason. They haven’t been completely formulated or brought under the aegis of an international standards organization and accepted universally. There are many alternative protocols. Rushing the acceptance of a standard at too early a stage could result in an inferior system; nobody wants that.

VeriSign has moved forward on the assumption that the protocols it uses are the ones which ultimately will be accepted by the standards organizations. If they’re right, they gain some momentum; if wrong, they’ll take a financial hit in having to redo their software and reorient their customer base. Major players aren’t hanging back because they’re confused or incapable; it’s because they consider a technological commitment at this point to be premature.

The SET Protocol
One protocol specification, which appears finalized, is SET, used mainly for credit card transactions. Visa in conjunction with MasterCard and several others in the credit card industry have given definition to SET and come to agreement on its standard. There’s an urgency on their part to accommodate the online use of the credit card, because that will be the primary way consumers make payment. Furthermore, it should significantly enrich the services of the card companies and become a major revenue stream for them.

VeriSign intends to emphasize the development of products involving SET, and as well it should. But they won’t be alone. SET is an open standard, which means it’s available to anyone to do the same. Visa is actively soliciting vendors and encouraging product development. This grand effort will create the essential infrastructure for the secured use of the credit card online. Many other companies as well as VeriSign are heeding the call, and in the end the industry will be highly fragmented, grouped first among the major players like IBM, GTE, and HP who get the lion’s share of the action, then among the secondary players like EDS at the billion dollar level, and finally among the tertiary players who will have to seek the cover of a niche for survival.

The Need For A Niche
VeriSign will be one of those scuttling after a niche. It has neither the funding nor the eminence of name nor the advantage of serious worldwide distribution nor the technology to compete for major market share in anything but the nooks and crannies of the industry. VeriSign has plenty of opportunities to make money so long as it avoids combat in areas where it can’t possibly win. To date, very few if any sales have been made from the Company’s SET-related products, because the industry hasn’t matured sufficiently. It shows, however, that their $6 million in revenue is nicely validating their other products. A market clearly is there. How big it is and how vulnerable they are to competition is anybody’s guess, including their own.

VeriSign Tackles Everything
VeriSign can’t be accused of thinking small. They sport a list of products and services that seem to address every facet of the trust and security problem. "But wait," as the Ginzo knife salesman would say, "there’s more!" They’re acting as a marketing and sales group, which needs abundant resources, and most curiously, as a Certificate Authority (CA) housed in two complex Digital ID Centers.

The range of their activities is impressive but also alarming because of the potential for spreading themselves so financially thin that they become unable to compete effectively in any area.

The Certificate Authority
Becoming a CA may be a very forward-looking strategy to take. Alternatively, it could be an infinite sink for money and time, returning little. A Certificate Authority is a physical location containing the computers and software used, first, to verify the trustworthiness of a transaction, and second, to issue a digital certificate ensuring its authorization. Putting such a Center together is a painstaking endeavor requiring level upon level of security starting with access to the computers and thence to the critical data containing the most valuable of information, such as credit card numbers and financial accounts. The rooms to the building must be secured and every conceivable precaution taken, even down to the construction of the entire building, whose structure for VeriSign conforms to military standards. All of it is designed to make sure it’s safe from any intruder with malicious intent. Beyond that, the computers must be able to sustain a catastrophic outage and still not have a loss of data.

It’s to the Company’s credit they’ve been able to create such a facility, which surely required unique expertise to achieve and substantial expenditures. It also shows their ability to accomplish hard and expensive tasks. The dark side of the picture is that in this early stage, when sales are failing to match expenses, they’ll have to spend precious resources keeping the computers humming and the security high and maintaining a staff of specially selected employees with pristine backgrounds. The money spent on Digital ID Centers will be money taken away from product development, or vice versa. And it may be a very long time before the Centers achieve their breakeven points.

The consequences could be significant. Until they reach breakeven, they’ll continue underutilized and will require corporate support. A consistent drain on working capital will force VeriSign back to the public trough. They may get the money through more offerings, but the increased level of stock drifting into the market will impose a drag on stock price and disillusion investors. Perhaps the negative effects of increased equity sales can be countered if they show serious revenue growth and have a promising story to tell about their future potential.

The Gorilla In The Alley
Investors should take note that VeriSign is operating in an area against some very big players whose strategies could have a negative impact on the Company. One in particular is the decentralized model of the certificate authority versus the centralized model.

GTE, which did $21 billion in ’96 and is powerfully funded, has depth of experience in creating secured facilities. As with VeriSign they’ve set up certificate authorities in the U.S. and Japan, but they, far more than VeriSign, will have the cachet to pull in the very largest of accounts. Furthermore, GTE will assist each company for which it makes sense in creating its own internal CA center properly staffed and conforming to the highest levels of trust and security. Companies, which are reluctant to deliver data on all their crucial accounts to a third party, will find this proposition of interest. The centralized approach toward CA centers, as promoted by VeriSign, versus the decentralized approach as offered by GTE, enriches the industry with options. Whether it has negative consequences for the Company or whether it produces opportunities is an unknown at this incipient stage. However, it points out the major uncertainties confronting the smaller player if it were to commit to a direction not taken by the industry.

VeriSign has anticipated the growth of decentralized CA centers and has responded by offering a software product called VeriSign OnSite. Based on their description it doesn’t seem to be a product of much maturity. Here we have the dilemma of their size. To remain competitive in their battle with large companies they must counter every major move. Doing so, though, will tax their finances and their expertise and in the end simply may not be enough. It behooves them to find niches to dominate and not try to lead in every area.

It well may be the demand for digital certificates increases at an exponential rate; such indeed will be required if the claim of $327 billion in e-commerce transactions is to be met by 2002. Under those circumstances the VeriSign Digital ID Centers would be operating at their maximum, and the Company would be constructing more with great urgency. So far, there’s no indication yet that the curve is beginning to slope up dramatically. It’s also unlikely the Company could compete effectively against the same customer base with GTE. They don’t have the past history, the maturity, the contacts, the name, or the funding. Where they will succeed will be with the smaller companies, assuming it’s not a market of interest to the larger players, and their competitive advantage probably will have to be based on price. Business with smaller customers certainly could be enough for them to flourish, but the investor should have a stronger sign of growth beyond what we see to date that it’s actually happening.

Alliances Are Easy, Making Money Hard
What then to say about all the impressive alliances the Company has with the likes of Microsoft, Netscape, VeriFone, and Visa, and the dazzling array of stockholders including the world’s greatest semiconductor company, Intel? None of the alliances, it should be noted, is an exclusive. That Microsoft has entered into an agreement with VeriSign hasn’t precluded them from entering into agreements with any or all of the Company’s competitors. Even spunky little CyberCash, which will manage to rustle together a couple million in sales this year, claims alliances with fairly much the same group of greats and near greats. In this early exploratory stage where the development of the e-commerce infrastructure hasn’t been settled, companies are quick to make alliances and as quick to leave them. Every company is looking for opportunities to exploit, some might be hedging their bets, and some might be trying to influence the ultimate direction of e-commerce to their advantage. Except for possible agreements among credit card companies and financial institutions, it’s too early to know which alliances have actual substance.

A Passel Of Appealing Stockholders
It’s to the Company’s credit to have Cisco, Microsoft, Hewlett Packard, Visa, and Intel as stockholders. The cynical would say their involvement speaks more for encouragement than for any deep abiding interest. Consider Cisco, the leading company for Internet networking equipment. It’s invested $6.5 million in VeriSign and at the same time has a strategic alliance with their arch competitor GTE CyberTrust. Together Cisco and GTE intend to develop some fancy products, which may or may not impact the Company. These are major players to contend with, so one can assume that as an alliance they’re going after very big fish. Any negative consequences to VeriSign resulting from the products they make would be of doubtful concern to Cisco even though it’s a stockholder.

Intel and Visa each purchased 144,000 shares way back in February ’96 during the pre-larval stage of e-commerce when few could have had a clue about its subtle issues. Both have since gone on to increase their position to 6% of the stock outstanding. This is a healthy amount but still chump-change to these companies. Its greatest value to VeriSign is in letting them enthuse over Intel and Visa’s involvement as stockholders. If the Company showed the potential for an unusually strong position in the marketplace, you’d surely find far deeper involvement by them or someone else. Microsoft is notorious for investing in many companies with competing technologies and then eventually leaving them or buying them out later once they see which way the wind is blowing. In November, ’96 Microsoft took a 5% position with the purchase of 812,500 shares. Later on, they accepted another 100,000 shares as payment for VeriSign becoming a Preferred Provider of digital certificates. The Company’s involvement with Microsoft is important. Microsoft’s products will be authorized with VeriSign’s digital certificates. It tells the world they actually have a functioning service sanctioned by Microsoft, and it should give them high visibility in the marketplace. Whether they get a boost, a big boost, or a very great lift in sales, enough for viability, simply can’t be determined at this point. They may be talking to the wrong set of customers. Certainly, it makes for a good story and should generate enthusiasm in the stock market.

Competitors
VeriSign will do about $8 or 9 million in sales for ’97. It’ll be a major increase over the $1.4 million of ’96 indicating excellent growth and the creation of a market for their products and services. To achieve this position they’ve amassed losses amounting to $25 million, and this will be just the beginning. It’ll be costly, because they presume to go against some very big players—GTE, IBM and others "in the financial and telecom industries." They caution that their "biggest competitors may not have entered the market yet." If so, it should give one pause, because GTE and IBM are not small companies.

VeriSign vs GTE CyberTrust
It’s worth comparing the Company’s effort against that of its acknowledged competitor GTE CyberTrust, the operating arm of the telecom giant, GTE. Table 1 lists the applications the Company is addressing. One cannot but be struck by the breadth of their offerings, from email certificates, which could run as low as $10 a year for an individual, all the way up to SET certificate solutions for large financial institutions at $500,000 a year. If these products have achieved commercial quality, where they’re able to endure the pounding of daily and intensive use, then VeriSign has indeed accomplished something creditable. More likely, however, the complex products are partially formed and not up to the demands that would be levied on them in the real world at this time. In fairness, this doubtless can be said of all the Company’s competitors as well. The difference comes down to the substantial amount of funding and expertise needed to design, develop, and maintain such a variety of products. Advancing all these products to maturity will require money well beyond the return they reasonably could expect for the first several years. It’ll drive up their deficit and force them to sell equity for the capital they’ll need to continue. If they can show promise in the marketplace and rapid revenue growth, investors might be forgiving; otherwise, we can expect deterioration in the stock price. In contrast, larger companies won’t have these concerns.