Revising Down Growth & Valuation on Domain Weakness…Well, this is a tough one for me to write. There is a valuable lesson in here that I had to learn about extrapolating growth rates in these micro cap names when looking forward.
As a bondsman to the brutal honesty of quantitative facts I could not write a response to domain base decline.
It is tough to continue to grow a business 20%+ YoY consistently, especially when there is an embedded churn rate within your existing customer base and there is little to no SG&A that is being driven into customer acquisition. It is a balancing act, with no definitive answer.
So, what happened. If you are not driving demand through Sales & Marketing you have to compete on price, which NameSilo does very effectively. The flip side is when you push incremental demand through price promotion in this industry given the rebate program you get on the backend results in a very effective strategy that NameSilo has done very well. Problem is… what happens when those domains have to get renewed at full price? This ends up in serious churn.
I believe this is what you are seeing here as there was significant outsized domain growth November – January 2018 on a promotion run where 498,079 domains were added in a 3-month period. Now you are on the flip side of this annual renewal period and are seeing significant churn.
I thought I was being conservative with my 3,871,537 end of 2020 domain count target and just a month later that number is in great question after bleeding off 95,388 domains in February already and January ended up losing net 54,339 domains. The question now becomes, what is the organic full price monthly net domain growth? After the last 2 months I have no idea how to answer that question… As a result, have to take down my growth assumption down a further 6% which results in my 2020 domain target coming down to 3,636,809.
There are bigger implications here that I want to hit on which is critical to the valuation target for the business that I think one has to get comfortable with.
1. 2nd Derivative Growth Rate Deceleration - if you take a step back its not time to pull the fire alarm and panic because the business is still growing YoY but you have to be aware the pace at which the business is slowing. These are the first two months in the young company’s history that they have seen monthly net outflows and the monthly QoQ growth rate has now gone negative as well. A year ago, the business was growing 100% YoY and that figure is now down to 25% and by the end of the year it will be down to single digits in the 5% range. The pricing of future growth in the multiple has to come down.
2. Long Run Margin Profile - this is where I think management vision is critical, if NameSilo has lost a material number of domains once they have come off promotional pricing are they competitive with industry against giants like GoDaddy and their marketing dollars on anything other than price? Or is there a sizable portion of professionally managed domains that makes up their current domain base that is very elastic demand that solely driven by price and willing to jump from promotion to promotion? As a result, what is the long run natural domain base they can accumulate without pushing SG&A or have we already reached that level? The danger is that the true all in Cash OpEx figure and resulting EBITDA margin (inclusive of an assumed salary for a CEO that currently isn’t take a salary) is still running in the single digits before they reach some level of market equilibrium without spending incremental dollars to drive domain growth. If they try to reaccelerate the domain base by spending on marketing does that kill EBITDA margin? To be honest… I don’t know what the answer is to all of those. Until we get a break out of ancillary revenue and what sort of pick up it is having there is more inherent risk into the long run margin profile of the business.
Re-Assessing 2020 & Valuation
In an odd way, this will accelerate what I was looking to move the story forward in ARPD growth in FY20 which I was looking for because you are bleeding off low revenue/low margin domains so we will get a significant tick higher in ARPD especially in Q1 when we look both QoQ and YoY. I think you can see that in the ARPD looking backwards. If you look at Q4 FY18 ARPD was $2.61/domain which dropped down to $2.39/domain in Q1 FY19 as these promo domains came online. As a result, you could get a reversal of that entire move and this entire post would become totally irrelevant as the EBITDA growth will persist… but I like to worry. Lol.
As my FY20 domain count is now revised down to 3,636,809 which results in Revenue $37,171,388 EBITDA $4,532,891 or 12.21% EBITDA margin.
Would just like to note here, the very small adjustment on the revision lower on actual Revenue and EBITDA numbers, the problem is not rate of change its direction. On the Brightside, I think you see a further acceleration in ARPD as a result of these promotional domains comes off which increases the value of each domain.
The BIG problem – Rethinking Valuation
I was previously using a 2.0x Sales or a 16.0x EBITDA multiple to value this business. Given the net domain losses and deceleration of growth rate that I did not see coming at this pace and my rethinking of the long run assumption of the elasticity of discount domain business I have to take down my valuation assumption until we get visibility back into domain growth or success of ancillary program. Put simply, the visibility into future revenue and EBITDA growth is less clear today than it was 1 month ago and my last post.
Taking out my growth multiple using a 1.0x Sales multiple and a 12.0x EBITDA figure now I get to targets of 0.47/share and 0.68/share for a blended target of 0.58/share or 27% upside until we see progress on domain growth or ancillary pickup.
LONG but have taken down my overweight position