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The Investec Global Franchise Fund seeks to invest in quality companies that have strong business models and management teams, generate high-quality profits that are mostly converted into cash to reinvest back into the business, and consistently compound shareholder wealth at superior rates of return over the long term.
Verisign, which is listed on Nasdaq, is a key holding in the fund for all these reasons. Ever wondered who is responsible for administering the .com and .net at the end of just about every website? More than likely, you could bet on it being Verisign.
The company generates the majority of its cash flow from the operation of these registries, which power the navigation of the internet, under an agreement it has with ICANN, the internet governing body.
In addition to the .com and .net domain names, its top-level domains (TLDs) also include .tv, .edu, .gov, .jobs and .cc. The vast majority of domains are still under the .com or .net TLD, and at last count these totalled in excess of 130m!
In return for monitoring and providing the server infrastructure that backs a large portion of the internet, Verisign receives an annual fee per TLD that is registered.
Verisign then sells these domains to a myriad of registrar companies, which in turn are responsible for retailing the domains to outside parties – companies, individuals and other organisations – who wish to set up a website.
The company operates as a quasi-monopoly, given that it controls, allocates and administers the most widely used TLDs in the world – by a factor of many. It is highly unlikely that any other company could make a strong competitive case for being awarded the contract it has with ICANN.
Besides the assumption by both parties that Verisign will continue to operate the registries, moving it would not be a simple task and would potentially jeopardise the stability of the entire internet – something that ICANN is unlikely to be prepared to stomach even if the process were a competitive one.
Growth in core .com and .net domain names is likely to slow going forward with the rise of “convergence” risk (for example, previous creators of web pages gravitating towards simply having a Facebook page) and an increase in other TLDs.
However, the business may have some untapped pricing power that could come into play when the next ICANN agreement is concluded in 2018. In the previous agreement signed in 2012, pricing for .com was capped at $7.85 per domain. Prior to 2012, Verisign could (and did) raise its pricing on an annual basis.
What does the future hold?
Given the brand value of .com, there is some significant pent-up pricing power in the event that Verisign is able to negotiate more favourable pricing terms in the future.
In the vast majority of cases, $4 per year, for example, would not make much difference at all to the end-customers’ purchase or renewal decision on a .com domain name, but could represent an opportunity for Verisign to increase its revenue base by nearly 50%.
Notwithstanding future growth challenges, the company has done a remarkable job in expanding its operating profit margin – firstly through focusing the group on its most profitable business (domain name registration) and thereafter controlling costs over a period of significant revenue growth.
There is no doubt that Verisign is a high-quality company, but it is also attractively valued. In summary, it is a unique business with a very capable management team operating as a quasi-monopoly.
It boasts a number of attractive characteristics – extremely high returns on capital, cash generation in excess of earnings, a high level of recurring income comprising many low value transactions and, we believe, a high probability of growth over the medium term.
*Abrie Pretorius is a portfolio manager at Investec Asset Management.
This article originally appeared in the 21 April 2016 edition of finweek. Buy and download the magazine here.
