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Analysts divided over VeriSign's purchase of Network Solutions

The security software maker wants to become a gatekeeper of the Internet economy, but it is unclear whether its proposed acquisition of Network Solutions will provide the key.

Security software maker VeriSign wants to become a gatekeeper of the Internet economy, but it is unclear whether its proposed acquisition of Network Solutions will provide the key.

The company today said it would pay $21 billion in stock for the leading Net name registrar in an ambitious move aimed at vastly expanding its core offerings.

"VeriSign's goal is to be a transaction hub," said Martin Pyykkonen, an analyst with CIBC World Markets. "People still see them as an encryption company, but that stops short of what they're all about."

Building on Network Solutions' (NSI) domain name registration service may seem like a natural way to expand almost any franchise on the Net. Still, analysts were deeply divided in their response to the deal, with some emphasizing potential cooperation and others questioning the high price tag.

"They don't have a clear road map in place," said Forrester Research analyst Frank Prince, who echoed others in criticizing the cost. VeriSign paid $17 billion for "a public mailing list, and that's all," he said.

Mark Fernandes, a senior analyst at Merrill Lynch in San Francisco, said he sees good operational synergy in the deal but added that the "price to new opportunity is high."

Fernandes said the biggest advantage appears to be in cross-promotion, something he says could have been worked out in a partnership deal. In addition, he said that although NSI may be well positioned to capture new business from small companies looking to create an e-commerce strategy, the deal does not appear strong on the business-to-business front.

Investors also reacted negatively to the news, driving down VeriSign's stock price by nearly 20 percent.

But supporters of the deal suggested the reaction had more to do with accounting than with business fundamentals. Before the announcement, VeriSign was trading at 375 times revenues compared with 75 times revenues for NSI, according to Pyykkonen, who said that depressed value could only be expected given the steep divide in the companies' valuations.

In addition, because the deal is structured as a purchase rather than as a pooling of interests, VeriSign will be forced to recognize the acquisition on its books through amortization charges that could amount to $1 billion a quarter for the next four years.

"Some people got freaked out by the amortization," said John Powers, a senior analyst at Robertson Stephens, who said he liked the deal.

With the company's stock swooning, Anil Pereira, vice president of VeriSign's Internet Services Group, took another shot at explaining the deal today.

"By marrying our infrastructure we are able to provide a basket of services to our customers," he said. "We're thrilled with this combination."

A mere partnership would have served some of the same benefits for both firms, but the $17 billion acquisition was necessary to serve the customer more completely, Pereira said.

That story resonated with John Pescatore, research director at the Gartner Group, who said he believes the deal is a good move for VeriSign. In particular, he noted that the company has made alliances that have given it an edge in offering digital signature services and digital certificates, which serve as electronic IDs.

"I think it's a very good fit," Pescatore said. "It ties right in with VeriSign's effort of going beyond being considered a security business. This will make it a lot easier for large companies to do e-business with their smaller suppliers."

VeriSign has been the most visible issuer of digital certificates for the Internet but has recently experienced heightened competitive pressures. The company, along with rivals such as Entrust Technologies, GTE's CyberTrust and other firms, develops software to secure online transactions using Public Key Infrastructure (PKI) technology, as companies begin to conduct far more complex transactions over the Internet; PKI systems issue and manage digital certificates.

NSI was the sole registrar of Internet addresses from 1992 until last spring, when the Commerce Department approved the creation of new registrars to compete in the booming market. Before then, NSI operated as a monopoly under contract with the U.S. government, giving it exclusive rights to register coveted ".com," ".net" and ".org" addresses.

The testing period for the new competitive system ended in November, opening to consumers more choices and better prices for obtaining an online identity.

Now there are roughly 100 registrars accredited by the Internet Corporation for Assigned Names and Numbers (ICANN), the body that oversees the Internet's address system. ICANN is meeting this week in Cairo, Egypt, to discuss the possibility of introducing new top-level domain name endings such as ".firm" and ".shop."

A logical next step?
According to CIBC's Pyykkonen, VeriSign's move to expand its offerings is nothing new. For example, he credited VeriSign's management with creating innovative business strategies in the encryption industry early on, offering encryption services on top of pure software packages. That decision, he said, helped catapult VeriSign to a stunning $22 billion market value prior to the merger announcement with NSI today.

"Don't underestimate (their) vision," he said.

The Gartner Group's Pescatore acknowledged that VeriSign paid a steep price for its purchase. Nonetheless, he said he believes the partnership will take off. As entrepreneurs register Web addresses for their new businesses with NSI, they will get an offer for VeriSign's security system.

"You can't underestimate the power of transparency when it comes to security," Pescatore said. "The way business people view it, security is something that should be ignored or will slow you down. But when security is a discrete step in developing a business, then it becomes more powerful."

NSI CEO Jim Rutt said in a statement: "VeriSign and Network Solutions have a long-standing partnership, which makes this combination a natural evolution for our business and for the Internet."

Bear Stearns analyst Bob Lam questioned the acquisition of NSI, however, as it focuses more on consumer business than on corporate transactions.

"The big question here is how does this facilitate (VeriSign's) movement forward into (business-to-business) e-commerce?" Lam said.

Lam noted that VeriSign already has solid relationships in the business-to-consumer market for its security products. "It's not a B2B play," Lam said. NSI "is clearly coming out on top in this deal."

Forrester's Prince added that it is unclear what NSI could offer VeriSign, saying that perhaps there is a hidden long-term strategy that has not yet been disclosed.

"This is one-stop shopping in an empty mall," he said. "It's a lot like setting up a booth in front of the Department of Motor Vehicles selling cars to people who are registering. It's not going to boost your business."