25% Downside For VeriSign If ICA’s Recommendations Go Through

The Internet Commerce Association (ICA) took a strong position in a letter ^[1] to the Department of Commerce (DOC) and Department of Justice (DOJ) on the pending approval to the renewal of .com registry rights. They’ve urged the government bodies to not approve the renewal of the contract between VeriSign (NASDAQ:VRSN) and ICANN unless the former agrees to bring down the prices of .com domain names to the price it charges for .net domain registrations. It has also asked it to further limit the price hikes in the future.

We believe that the dominant position of the .com domains in the mix of .com and .net domains would result in a major negative impact on VeriSign’s revenues from .com and .net domain registrations. Also, limiting the permitted hikes would result in VeriSign’s margins shrink over the coming years.

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What are the reasons’s behind ICA’s position?

ICA contends that VeriSign operates the much smaller (~1/7th the size of .com registry) .net registry for a price of $5.86 per domain yet charges $7.85 to manage the .com registry while using the same facilities, staff, equipment and infrastructure. It finds the price difference unfair. Its second contention is that VeriSign gets to arbitrarily increase .com registration price in every 4 out of 6 years without providing a rational to support the hike. With the company known to operate at almost 80% margins the right to increase prices gives it an unfair advantage. Instead of the permitted hikes, ICA proposes that the hikes be limited to the increase in the Consumer Price Index (CPI).

If effective, what would be the impact?

The current contract expires on November 30th and an extension clause in the current clause will ensure status-quo for at-least the next six months. However, if the company is re-awarded the contract under the condition that the prices be brought down to .net domain levels, the stock prices would see a downside of 15%. Similar pricing for .com and .net domain names would negate the dominance of .com domain names (because of their huge number relative to .net domain names) in the .com/.net domain mix and as a result the prices will drop to ~$5.8. You can see the effect of the change by adjusting the graph below.

A further limitation on permitted hikes would result in the gross margins shrinking over the coming years. An assumption of margins shrinking by a percentage point every year going forward coupled with the decline in .com domain registration charges presents a 25% downside to our current estimate.

The higher margins help VeriSign maintain systems and redundancies in place which has ensured the continued security and stability of the .com domain name system and registry. With the .com domain names constituting almost 40% of the entire domain name universe, we expect the DOJ & DOC to uphold the current proposed version which is practically the same as the existing one.

We have a $50 estimate for VeriSign which is 25% above the market price.

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1. ICA Letter to DOC, ICA, November 2012 [↩]