Picking at Domain-Name Stocks

Date: Wednesday, January 10, 2007
Author: James Altucher, Thestreet.com

URL: http://www.thestreet.com/newsanalysis/techstockupdate/10331607.html

Internet domain names such as vodka.com (sold for $3 million in 2006), business.com (sold for $7.5 million in 1999), sex.com (sold for $12 million in 2006) and even a misspelled word like mortage.com (sold for $242,000 in 2006) are part of the land grab of the 21st century.

Following the fortunes of companies that are stockpiling domain names -- the "arms merchants" of the domain name business -- is well worth your while, regardless of the state of the economy.

The Internet is only going to get bigger, and domain names are the keys to the kingdom if you want to do business online. And the supply is diminishing every day. I want to keep an eye on the top public companies that are stockpiling domain names and building up tangible value on their balance sheets without most of Wall Street being aware of it -- and identify those that are good buys.

But first, a brief detour.

To find out more about domain names, I called Robert Chapman, founder of activist hedge fund Chapman Capital. I've written about Chapman many times in the context of his activist holdings. Bob is a story unto himself: He had great returns for many years, broke his back surfing, quit the hedge fund business, traveled the world three times over and has now made a great comeback over the past year. I've been following his activist play on Cypress Semiconductor (CY) , among others (see his portfolio page for details).

So what does this have to do with domain names? Turns out that Bob has been buying them for a decade: "In March 1996, it was obvious to me that .com was beachfront real estate available for lease at $35 a year," he told me. "A true no-brainer."

I asked him if he had received any offers for any of the domain names he owns. "Yes," he said, "but they were not bought with the intent to sell for a profit. I wanted to use them. Several telco service operators have offered me over $3 million for calls.com so they could compete against Skype. But I am holding out for a much higher price, given my view that all calls are going to be made over the Internet in the next 10 years, and calls.com is the hotels.com of that space."

Bob owns, among other names, sherry.com, helmet.com, hedgefunds.com and takeovers.com.

The Business of Domain Names

The Domain Name Index on Stockpickr has three large-cap companies with good domain name portfolios and businesses, and three small-cap companies with many domain names among their assets. Here's a look at the large-caps.

The granddaddy of the domain name business is VeriSign (VRSN) , which provides all the .com and .net domain names out there. The registrars are simply reselling the domain names they acquire through VeriSign. If you go to register.com, for instance, and buy a domain name for $30 a year, you're actually paying VeriSign $6 a year at the base of that transaction.

VeriSign has a clean balance sheet with $500 million in net cash and trades for just a little over 10 times cash flows, or enterprise value over EBITDA (earnings before interest, taxes, depreciation and amortization).

GoDaddy.com is one of the biggest registrars of domain names out there. You can catch its Super Bowl commercials every year during the game. The company recently filed to go public, but was making so much cash that it decided not to. However, Google (GOOG) recently signed a deal with the company to resell domain names to small businesses through GoDaddy.com. This further cements Google's symbiotic relationship with its small-business customers, and will allow it to resell advertising services, Gmail and even the so-called "Google Office" that is starting to come together.

Marchex (MCHX) was started by Go2Net founder and former CEO Russ Horowitz. Marchex owns more than 200,000 domain names, including the domains for every ZIP code in the country. The stock trades just slightly over 10 times cash flows and had year-over-year revenue growth of 26% last quarter.

To see the other three stocks in the Domain Name Index, check out its portfolio page.

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