[GDDY – GoDaddy; VRSN – Verisign; EIGI – Endurance International] Value Migration in Web Services
When you type “scuttleblurb.com” into your browser, that domain name is translated into a unique series of numbers called an IP address, which corresponds to a particular computer that all other networked computers comprising the internet reference in order to find and deliver my website to you. A non-profit entity called the Internet Corporation for Assigned Names and Numbers (ICANN) was formed in 1998 to approve new generic top-level domains (gTLDs like “.com” and “.net”) and act as a central database for IP addresses…basically, an internally consistent global “phone book” that matches IP addresses to domain names.
Under 6-year agreements with ICANN, Verisign acts as the exclusive registry for the “.com”, “.net”, and “.name” gTLDs, which means Verisign is responsible for maintaining the second-level domain names – “scuttleblurb.com” or “scuttleblurb.net” – under each of these gTLDs, so that when you type “scuttleblurb.com” into your browser, one of its computers serves up the IP address so that you can read this post. Verisign provides the IP address for every dot-com and dot-net query, over 140bn of them per day. There are many other top-level domains like dot-biz, dot-name, dot-pro without nearly the gravitas of dot-com that are managed by over a thousand other registries who, in theory, compete for Verisign’s gTLDs, but in practice, don’t really stand a chance because Verisign’s agreements with ICANN are practically on auto-renew so long as it doesn’t screw up its 20 year track record of uninterrupted DNS availability for these two crucial top-level domains.
[Verisign was incorporated in 1995 and, true to the spirit of the times, went ape shit during the late 90s buying all kinds of random businesses – billing and payments services, mobile entertainment, retail point of sale data, security consulting, and SSL protocol implementation, among many others – that resulted in $14bn of impairments in 2001 and 2002. Starting in 2007, the company endured 4 years of unwinds that left only the registry service and internet security businesses]
Verisign is often thought of as a government sanctioned monopoly, as contracts carry presumptive rights to renewal and aren’t, for the most part, subject to competitive bidding processes. Still, Verisign and ICANN engage in sporadic standoffs: ICANN has approved new gTLDs to compete against entrenched ones, and the dot-net TLD was at least ostensibly put out for bid in 2005. What is clear, however, is that because the consequences of service interruption are so profoundly deleterious and per-domain registry costs are small (~$9/year for dot-net and ~$8/year for a dot-com), there isn’t really a concerted industry-wide effort, outside the complaints of domain registrars who resell the domains, to rock the boat.
It’s easy to see why value guys love this stock. Verisign operates under long-term exclusive contracts with contractually permitted price increases and requires very little capital to grow (toll booth! capital light!). It drops nearly all incremental revenue down to operating profits and has aggressively (and in retrospect, wisely) retired its share count over the last decade. It spends very little on R&D (4%-5% or revenue) and sales/marketing (~7%) and generates 60%+ operating margins. There is no other layer of the web services stack that comes even close to rivaling those margins. Berkshire owns the stock.
Still, I fail to see the incremental value creating magic brewing within and feel there is latent instability in a company that thrives largely on switching fears and government granted exclusivity, rather than on inimicable advantages. If license to raise prices must be officially granted to you at regular intervals according to the whims of a government body, you do not have pricing power, you have pricing permission. The result may be the identical, so who really cares, but the means by which pricing is achieved, and the relative bargaining strengths implied, taints my view of the quality and reliability of those price hikes. Unassailably secure infrastructure management is obviously vital, but I doubt Verisign is uniquely capable of providing it. Verisign has the asymmetric risk profile of an investment grade bond…it is very likely money good but also exposed to cliff risk without the compensatory potential of vertiginous value creation. It’s a stunningly profitable company that conversely seems fragile (or at least not anti-fragile). To throw this into relief, you might consider Verisk´s core ISO business [let´s set aside that Verisk would have been better off pulling a Verisign and heaving ISO´s considerable free cash flow into share purchases, rather than into a mediocre motley of unrelated businesses]. A straightforward checklist approach to investing would reveal several superficial similarities. Like Verisign, Verisk also offers an indispensible service to a steady end market, requires little capex to grow, and produces lofty, consistent, and accreting operating margins (~55%). But, in fact, the way these two companies claim value could not be more different. As I wrote in a prior post: