The Scenario That Can Significantly Impact VeriSign’s Valuation

VeriSign (NASDAQ:VRSN) is the authoritative registry service provider for all .com and .net gTLDs (Generic Top-Level Domains) and is the leader in the domain name market. However, the company has reached a matured stage in the industry where its .com brand is saturated and its .net brand doesn’t enjoy .com’s level of market demand. Also, the entry of numerous competitors in the domain name industry is adversely impacting VeriSign’s performance. However, VeriSign is also ramping up its marketing and related activities. In this article, we examine two scenarios, one in which VeriSign fails to gain traction for its .net brand in the face of competition, and the other in which VeriSign’s efforts improves its .net market share. We further observe the impact of the two scenarios on VeriSign’s price estimate.

Our Trefis price estimate of $62 for VeriSign is slightly above the market price .

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VeriSign .net Demand Lags Due To Competitor gTLDs And Price Hikes (~10% Downside)

VeriSign had been the market leader in the domain names business over the last few years, enjoying almost 50% of total market share. However, VeriSign’s market share had been declining with time.

The reasons are twofold. One, the demand for VeriSign’s .com domain — the most popular domain name in the world, has saturated in recent years. This has caused limits to new additions. Two, VeriSign’s .net domain has still not received the level of acceptance as .com.

The .net zone growth had been flat in 2014. At the end of Q4 2014, the total base of active registered domain names in .net was 15 million. This number has been almost constant since 2013. ^[1] The primary reasons for the flat growth of the .net zone were attributed to: 1) the introduction of a rival gTLD program that is providing stiff competition to .net growth, and 2) confusion regarding similar sounding domain names among the newly introduced gTLDs, which adversely impacted their own demand, as well as .net’s demand, 3) .net is a relatively lesser known brand, as compared to .com. ^[2]

Additionally, the demand for .net is expected to decline further with the hike in prices from $6.18 to $6.79 that occurred in February 2015. The company is trying to compensate the sluggish volume growth in the .net domain, with an increase in price to generate more revenue. However, this might lead to further erosion of .net demand. Also, with the increased influx of competition from rival gTLDs, the existing VeriSign users might decide to switch loyalties.

We currently forecast VeriSign’s .com and .net’s global market share to decline from around 47% in 2014 to less than 40% by the end of our review period. In case of a further decline in .net demand the global market share can decline further to around 35%, then there can be over a 10% decline in our valuation for VeriSign.

VeriSign’s Marketing Activities And Efforts To Raise Market Entry Barriers Can Boost .net Demand (~20% Upside)

VeriSign is aware of the saturation in its .com demand and the lack of sufficient traction for its .net brand. Towards this end, company has revved up its marketing activities.

VeriSign’s year-on-year marketing spending increased by 3% to $92 million in 2014 (as against an almost 9% decline in 2013). In Q1 2015, VeriSign’s marketing expenses witnessed a 10% year-on-year growth to reach around $22 million. ^[3] The company channels the majority of its marketing campaigns through affiliate registrars such as GoDaddy and BigRock, or other resellers.

Last year, Google announced a plan to act as a registrar and sell a package of services, including domain names, with the aim of developing online presence for smaller businesses in the US. The .com and .net domains would be among its offerings. Hence, Google acting as “retail outlet” for VeriSign’s products might greatly aid in expanding its reach.

Towards the end of 2014, VeriSign’s performance made a turnaround after undergoing a sluggish period. VeriSign attributes a lot of this success to the marketing activities undertaken by its registrars. VeriSign is also investing in international markets with potential for its growth.

Additionally, VeriSign might be gearing up to protect its turf through other means. The bigger players in the domain name industry might be trying to raise a legal battle with a spate of patent applications. Leading registrar, Go Daddy, has applied for 8 patents related to Domain Name System (DNS). VeriSign applied for several patents, including, technical aspects of domain name system (DNS), enhanced privacy protection, and abuse protection. Most of the patent applications cover common practices in the industry.

With the huge advent of top-level domains in the market, the existing players are attempting to protect their market shares from competition by patenting common areas of touting domains.

The number of top-level domains had more than doubled in the last few months, as 500 dot-words, ranging from .london to .xyz have been added to the existing 300 domains. The number is expected to increase by an additional 500 by the end of 2015. Technology related patents help in creating entry barriers for new players. For example, if a new company becomes successful, it can be drawn into a legal battle related to patent violation by the market leaders. ^[4]

We currently forecast VeriSign’s gross margin to slightly increase from 82% in 2014 to almost 83% by the end of our forecast period. In case VeriSign boosts the market demand for its domain names even further and captures a greater share of the domain name market than predicted by us, i.e, around 45% by the end of our review period (as against the current forecast of 40%) — then the revenues and margins for the company can receive a further boost. Under that scenario, if we consider VeriSign’s gross margin to reach around 85% by the end of our forecast period, then there can be around 20% upside to the valuation of the company.

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1. VeriSign’s Q3 2014 Earnings Call Transcript, Seeking Alpha, October 2014 [↩]
2. VeriSign’s Q4 2014 Earnings Call Transcript, Seeking Alpha, February 2014 [↩]
3. VeriSign Form 10Q For The Period Ending 03/31/15 [↩]
4. WHY are GoDaddy and Verisign stockpiling patents? Do I smell war?, The Register, March 4, 2015 [↩]