Commerce Dept. Review Could Kill Verisign’s Margins With Lower Pricing Terms

Verisign‘s (NASDAQ:VRSN) stock price dropped 20% after it announced that the Commerce Department has yet to approve its proposed agreement with ICANN for the .com Registry. The stock is currently trading at $40, 15% below its market price a couple of weeks ago. The company had agreed on terms with ICANN for the .com registry rights beyond November 2012 in late June this year and forwarded it to the Commerce Department for its approval. Considering the company’s record in keeping the .com domain name resolution services available all the time, only the pricing terms could get revised after the review.

The Commerce Department is reviewing the document as required by the Cooperative Agreement between the company and itself. It reviews the agreement to ensure the continued security and stability of the Internet domain name system and the prices & other terms being in public interest. Its failure to complete the review prior to November 2012 could result in a six month extension of the current agreement.

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Proposed Agreement Structurally The Same As Old One

Both the Commerce Department and Justice Department were involved in reviewing the current .com Registry Agreement in 2006 and had approved it as being in public interest. The approved version of 2006 included pricing terms and the ability to raise prices in four of six years. The proposed .com Registry Agreement tendered to the Commerce Department for review is virtually identical to the current one approved by it in 2006 except for new provisions regarding indemnification, audit rights and more stringent service levels (SLAs). As per the current agreement, if the Department needs more time to review, the term of the .com Registry Agreement may be extended by six months or such term as mutually agreed between the company and the department. ^[1]

Pricing Terms May Change Post Review

With the Commerce Department satisfied with the company’s record on security, stability and the continual availability of domain name servers for .com domains, the registry rights will most likely stay with the company. However, the permitted hikes in the fee VeriSign charges for .com domains and the frequency of such hikes may be revised lower in which case the revenues it earns from the .com domains will be lower in the future. The .com domains contribute almost 88% of the domains to the .com/.net mix, and a revision of permitted hikes would substantially lower the company’s revenues in the future. You can modify the forecast of the combined VeriSign fee from .com and .net domain names in the graph below and see its effect on the company’s fair value.

Lower Fee Could Put The Stability of DNS System At Risk

The .com domain universe constitutes around 40-45% of the total domain names in existence with majority of economic activities relying on it. VeriSign maintains considerable overcapacity and redundancy in its DNS system to mitigate the risk of the .com domain becoming unavailable. A downward revision of pricing terms could see the company compromise its margins to maintain the current service levels. Another option available to the company would be to cut down on investments and lose some of the overcapacity which could result in it compromising its stellar performance record for .com domain name resolution which has been now been available for 15 consecutive years.

As part of the Cooperative Agreement between the company and the Commerce Department, the former is required to ensure “the continued security and stability of the Internet domain name system and the operation of the .com registry” for it to retain the .com registry rights. Hence, we believe that the company would not cut down on investments and maintain the current overcapacity and redundancy levels. Instead, it would compromise its margins if the pricing terms are revised.

Another threat to the company’s margins comes from the fee it pays to ICANN. As per the old agreement, the company used to pay $4.5 million as a quarterly lump sum fee. However, as per the proposed agreement it would be paying up-to $0.25 per year for any .com registered, renewed or transferred. At the current levels it could translate to an additional annual expense of $10 million from the .com domains alone.

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1. VeriSign Statement On .com Registry Agreement Renewal, VeriSign Inc., November 2012 [↩]