This company provides the opportunity to profit from a fundamental change in the internet’s domain name system. Visibility is very low and uncertainty regarding future top line growth is high. Whether the company’s business plan turns out to be successful, will be most certainly known within 12 to 18 months from now. This is not a typical value investment as the margin of safety is difficult to quantify and therefore a permanent loss of capital becomes more likely. On the other hand, Mr. Market seems to ignore the inherent opportunity and perspective of this business. As a consequence, I regard this investment as a mispriced option with significant upside potential.
Naming and branding of web domains is currently facing the most significant change since the introduction of the internet
Since the emergence of the internet just a small number of top-level domain names (TLDs) have been in use. TLDs are the last part of the web address (domain name) to the right of the last dot for instance like .com, .net or .org., while second level domain names (SLDs) are the first string of characters to the left of the last dot.
There are two types of TLDs. Country code TLDs (ccTLDs) are only assigned to countries and territories for instance like .uk (United Kingdom) and .de (Germany) and have only two characters. Generic top level domains (gTLDs) are always at least three characters long, such as .com, .travel and .biz. ccTLDs and gTLDs can be in Latin script as well as non-Latin scripts.
At the end of the second quarter 2014, there were over 280 m domain names world-wide of which approximately 55% are accounted for by gTLDs, with the remainder being mainly ccTLDs.
The domain name system has been coordinated by the Internet Internet Corporation for Assigned Names and Numbers (ICANN), a not-for-profit corporation that has been responsible for the technical coordination of the domain name system (DNS) since November 1998.
In June 2008, the Board of ICANN adopted a policy to open up the DNS and created a programme through which any entity could apply for and be delegated a new gTLD if it met a number of criteria established by ICANN. After five years of consultation with the different stakeholders ICANN introduced a new gTLD application programme, which began accepting applications in January 2012.
ICANN received 1,930 applications. The majority were uncontested applications for a unique gTLD, while 751 applications were in competition for 233 same or similar new gTLDs. Most of the applications comprised ordinary gTLDs (61%), followed by brand names (36%) and gTLDs (3%) with a geographic reference.
For uncontested new gTLDs, the applicant can enter into a registry agreement with ICANN. The initial term of the registry agreement is 10 years, with a presumptive perpetual renewal for successive 10 year periods. Hence, the applicant (registry) has the presumptive right to run the gTLD forever. During the term of the agreement the registry has to pay a certain quarterly fee (USD 6,250) and a fee per user (USD 0.25).
Applicants for a contested new gTLD must either reach agreement with the other applicants for the contested new gTLD, or participate in a private auction. If the applicants for a new gTLD fail to resolve ownership privately, ICANN holds a public auction to determine the single successful applicant for the contested gTLD. In a private auction, the winning auction bid is divided equally and paid to the losing applicants, whereas in an ICANN public auction, the losing applicants do not receive any of the winning auction bid, though ICANN refunds 20 % of a losing applicant’s USD 185,000 new gTLD application fee. As a consequence, most contested applications are resolved privately rather than through ICANN public auctions.
ICANN public auction results can be found here. For instance, .app has been the most expensive one achieving a public auction result of USD 25 m sold to Google.
As of today, out of the 1,930 applications, 551 were withdrawn or not approved and 593 have already been introduced as new gTLDs to the internet with the remainder still pending. It is difficult to predict how many new gTLDs will have entered the internet after the first application round. Based on the overview of applications from this site, I assume that there will be roughly 900 new gTLDs at the end of the process. Assuming that one third concerns trademarks, this leaves roughly 600 new gTLDs available to the public.
After successful application and delegation to the internet, the registries are wholesaling domain names to registrars (e.g. GoDaddy, enom, web.com, DNS), which are retailers of second level domain names to consumers. Currently, there are more than 900 registrars offering their services in the internet. Before the domains are sold on a first come first serve basis (general availability), trademarks is given the opportunity to register (sunshine period) followed by an application period, where auctions are held if there is more than one interested party for a domain name (landrush period). Apart from that, the registry can identify premium domain names which are sold at premium prices irrespective of the sales period.
Given that the time period from the application to the introduction is so long, ICANN has not announced yet when the next application round for new gTLDs will start.
Minds+Machines is a pure play bet on the success of new gTLDs
Minds+Machines (MMX) is the fourth largest applicant for new gTLDs after Donuts Inc., Google and Amazon (excluding third party clients). MMX submitted a total of 92 new gTLD applications. Thereof 20 were on behalf of its clients.
Currently MMX owns 20 uncontested gTLDs of which 13 have been introduced to the internet. In addition to that, MMX owns and/or operates 5 geographic gTLDs from which it shares revenues with the relevant government, 3 of which have been launched to date. Moreover, the company is partnering on a further 4 uncontested top-level domains of which 1 has so far been launched.
Apart from that, MMX is the back end registry service provider for a further 5 clients, of which 2 have launched to date. Registry service providers provide the technological infrastructure (e.g. software, equipment and bandwidth) and services required to operate a TLD at the performance and security levels required by ICANN to new gTLD applicants. Clients choose this service, either because they do not have the technological know how or do not want to incur the substantial costs of building and operating their own registry. MMX receives a yearly per second level domain name fee for each second level domain name sold or renewed by a client registry.
MMXs 19 new gTLDs in the general availability sales period received 165,364 registrations as of April 20th 2015. Since January 1st 2015, the Company’s portfolio has achieved over 63,000 registrations. To put this into perspective, overall 593 TLDs have been introduced to the internet so far with roughly 5.2 m of domain names registered since February 2014.
The following table provides an overview of the owned gTLDs as of April 20th 2015:
|gTLDs||Launch date||Registrations to date||Back end provider|
|COOKING||Sep-14||1,491||Minds + Machines|
|FISHING||Sep-14||1,297||Minds + Machines|
|HORSE||Sep-14||1,755||Minds + Machines|
|RODEO||Sep-14||322||Minds + Machines|
|VODKA||Sep-14||1,415||Minds + Machines|
|BEER||Sep-14||6,957||Minds + Machines|
|SURF||Sep-14||2,080||Minds + Machines|
|CASA||Feb-15||2,919||Minds + Machines|
|WORK||Feb-15||20,605||Minds + Machines|
|YOGA||Feb-15||3,272||Minds + Machines|
|WEDDING||Apr-15||1,783||Minds + Machines|
|FASHION||Apr-15||2,205||Minds + Machines|
|GARDEN||Apr-15||400||Minds + Machines|
|FIT||Apr-15||-||Minds + Machines|
|ABOGADO||Q3 ’15||-||Minds + Machines|
|LAW||Q3 ’15||-||Minds + Machines|
|DDS||TBD||-||Minds + Machines|
|LUXE||TBD||-||Minds + Machines|
|VIP||TBD||-||Minds + Machines|
|购物 (shop – IDN)||TBD||-||Neustar|
Demand for geographic new gTLDs has been the strongest so far:
|gTLDs||Launch date||Registrations to date||Back end provider|
|LONDON||Sep-14||62,143||Minds + Machines|
|BAYERN||Sep-14||29,351||Minds + Machines|
|NRW||Mar-15||7,701||Knipp (Note 1)|
|BUDAPEST||Q3 ’15||-||Minds + Machines|
|MIAMI||Q3 ’15||-||Minds + Machines|
Note 1: MMX earns revenue as the registry owner, selling domain names at wholesale prices to registrars. Knipp is paid a per domain fee to manage the registry platform out of the State of North-Rhine Westphalia.
These are the new gTLDs which are managed for clients:
|gTLDs||Launch date||Registrations to date||Back end provider|
|KIWI||Apr-14||11,406||Minds + Machines|
|GOP||Jul-14||2,940||Minds + Machines|
|BRADESCO||TBD||-||Minds + Machines|
|BROADWAY||TBD||-||Minds + Machines|
|TUBE||TBD||-||Minds + Machines|
The following table provides an overview of the currently contested gTLDs:
|gTLDs||Type||Back end provider|
|ART||Wholly-owned||Minds + Machines|
|CPA||Wholly-owned||Minds + Machines|
|DATA||Wholly-owned||Minds + Machines|
|GAY||Wholly-owned||Minds + Machines|
|HOME||Wholly-owned||Minds + Machines|
|HOTEL||Wholly-owned||Minds + Machines|
|INC||Wholly-owned||Minds + Machines|
|LLC||Wholly-owned||Minds + Machines|
|ECO||Partnership||Minds + Machines|
|MUSIC||Partnership||Minds + Machines|
|RADIO||Client||Minds + Machines|
Management’s goal is to generate revenue from three different sources:
The registry business will be responsible for the majority of sales. MMX is wholesaling domain names to registrars for sale to consumers. The Company expects that the average price of a domain name will be approx. USD 20. According to the company, pricing for each second level domain name plus new gTLD is based on management’s determination of whether it concerns a geographical new gTLD, a defined and restricted market (e.g. .abogado), a niche market (e.g. .horse), or a defined market (e.g. .cooking). Pricing is further adjusted by other factors such as the pricing of other SLDs in other new gTLDs that end users are likely to view as being comparable (e.g., .site vs. .web vs. .website). For instance .luxe focuses on the luxury market which demands premium prices. Premium prices are also charged for high value SLD names that are expected to generate more internet traffic. These high value domain names are expected to account for only 3% of registrations, but for 25% of revenues.
As already mentioned, the company is the registry service provider for clients who are not running the new gTLDs by themselves. Clients pay the greater of a minimum annual fee and/or a per domain name fee for standard registrations. An additional fee is paid for premium names. MMX is also generating revenues from consultancy services provided to new gTLD applicants.
The third pillar of revenue generation comes from the company owned registrar business. Currently MMX is selling roughly 10% of the registered domains directly to customers without the usage of third party registrars. The Company plans to expand its registrar service offerings to include value added services, such as e-commerce enablement tools, webhosting and email (like many other registrars already do). One of the most important product launches will be the introduction of a new software tool called Mozart. Mozart is a web building tool that is expected to be launched in the first half of 2015 and will be packaged with the registrar option. By using this software, it takes just a couple minutes to set up a webpage. There is also an app available for mobile phones using Android.
As far as I understand, Mozart is owned by Needly, another venture of the founder of MMX. MMX went into an exclusive agreement with Needly regarding the marketing of Mozart. According to management, MMX will own the customer billing relationship and associated revenues, both where MMX’s customers adopt Mozart and where customers are referred to MMX for a domain address by Mozart. I could not find any information, what amount MMX is going to pay to Needly for the license. In addition, I could not find Needly’s web presence, but only the information that Wellington Partners invested in Needly in 2010 and a brief summary of Mozart’s advantages compared to other tools available.
An overview of the industry players
Verisign, the target of disruption?
Currently, the dominant player in the registry business is Verisign, which has a monopoly for the registry in the .com and .net TLDs. Revenues are primarily derived from registrations for these gTLDs. They charge an annual fee for a . net domain name registration of USD 6.79 (compared to USD 5.11 in 2013). The annual fee for a .com domain name registration is fixed at USD 7.85 for the duration of the current registry agreement with ICANN expiring in 2018. Verisign recorded revenues of USD 1.0 bn in 2014 and an operating income of USD 0.6 bn. Verisign generated an operating profit margin of 56%. During 2014, domain names registered under the . com and . net TLDs increased by 3.4 million to 130.6 m and renewal rates for gTLDs were roughly 70%.
Obviously, Verisign has been opposed to the introduction of new gTLDs. They only applied for 14 new gTLDs. In the risk section of their 10K, management mentions that the introduction of new gTLDs under the current ICANN programme is a potential threat to their business model and outlines their concerns about the programme:
“Increased competition from these new TLDs could have a material effect on our business, results of operations, financial condition and cash flows. As set forth in the Verisign Labs Technical Report #1130007 version 2.2: New gTLD Security and Stability Considerations released on March 28, 2013, and reiterated in our further publications since then, we continue to believe there are issues regarding the deployment of the new gTLDs that should have been addressed before any new gTLDs were delegated, and despite our and others’ efforts, some of these issues have not been addressed by ICANN sufficiently, if at all. For example, there has been an increase in domain name collisions in 2014 which have resulted in network interruptions for enterprises as well as confusion and usability issues that have led to phishing attacks. We do not yet know the impact, if any, that these new gTLDs may have on our business, including if or how the introduction of these new gTLDs will affect registrations for .com and .net and therefore have a material adverse effect on our business, results of operations, financial condition and cash flows. …
… In addition, under the .com , .net and . name Registry Agreements with ICANN, as well as the Cooperative Agreement with the DOC, we are not permitted to acquire, directly or indirectly, control of, or a greater than 15% ownership interest in, any ICANN-accredited registrar. Historically, all gTLD registry operators were subject to this vertical integration prohibition. However, ICANN has established a process whereby these registry operators may seek ICANN’s approval to remove this restriction, and ICANN has approved such removal in some instances. Additionally, ICANN’s registry agreement for new gTLDs generally permits such vertical integration, with certain limitations including ICANN’s right, but not the obligation, to refer such vertical integration activities to competition authorities. Furthermore, unless prohibited by ICANN as noted above, such vertical integration restrictions do not generally apply to other ccTLD operators if at all.
If Verisign were to seek removal of the vertical integration restrictions contained in our agreements with respect to existing gTLDs, or in the future with respect to new gTLDs, it is uncertain whether ICANN and/or the DOC approval would be obtained; without such changes, we may be at a competitive disadvantage.”
I am not an expert, but I believe that the technical issues Verisign mentions can be resolved relatively quickly. Apart from that, it is interesting that Verisign is not allowed to run their own registrar business, while MMX got the permission from ICANN to go ahead with their own registrar.
I believe that the new gTLDs will reduce Verisign’s market share to a certain extent, but that it will take quite a while until Verisign will feel the real pain of losing their de facto monopoly position.
For instance, if I had been the owner of a shop selling yoga mattresses, I would register for .yoga immediately. However, many customers might be reluctant to change the TLD as it takes some effort to do so. Maybe, there are registrars who will offer the service to change the TLD of a domain name. Still, visitors might then face the problem that they do not find the web page anymore. Interestingly, Google recently changed the search algorithmic, now using the real-world name of the web site instead of the domain name. This might be a big help for the spread of new gTLDs. For some businesses it might also make sense to just keep the old TLD and redirect the traffic to a domain name with a new gTLD.
Interests of many new gTLDs applicants seem to be aligned to a large degree
Like MMX, some of the applicants for new gTLDs have been founded for the sole purpose of getting an interest in the new gTLD sector. The largest one is Donuts Inc, which is backed by a number of private equity investors and has so far raised between USD 100 m and USD 200 m of equity. Donuts applied for 307 new gTLDs.
Between these new registries there will be competition with respect to certain new gTLDs. For instance, there will be .law, .laywer and .abogado all competing for the same group of customers.
At the same time, these companies have an aligned interest in increasing the public awareness of the new gTLDs and therefore each dollar spent for marketing and lobbying by one player should benefit the whole new gTLD industry.
An interesting conversation between the CEOs of MMX and Donuts Inc. can be found here.
The role of Google and Amazon remains unclear
Google and Amazon are the second and third largest applicants for new gTLDs. It is still unclear what they are planning to do with their new gTLDs. Although acquiring new gTLDs makes up for only a small part of their budget, their involvement seems to validate the reason for new gTLDs at least to some degree.
Estimating the market size for new gTLDs and MMX’s piece of the action
The following is just a back of the envelope calculation including rough estimates of the variables:
Now there are roughly 300 m domain name registrations across all TLDs. Currently, new gTLDs have a market share of less than 2% with roughly 5 m registrations since February 2014. Awareness for new gTLDs is still low and only 65% of the new gTLDs have been introduced to the internet so far.
Let’s assume for example, new gTLDs can grab a 15% market share over the next two years. This will lead to roughly 50 m domain name registrations across all new gTLDs (taking into account a 10% market growth over that period). With a renewal rate of let’s say 70%, this means that roughly 15 m new gTLDs have to be added each year to keep that level constant.
Management believes that the average yearly price for a gTLD will be USD 20 for the time being. MMX reported some numbers for the second half of 2014. During this period the registry business generated noteworthy revenue for the first time. From September (the start of the registry business) to December 2014, MMX received USD 3.7 m in cash revenue for the registration of 107,000 new gTLDs leading to an average price paid of USD 35 per domain name. Prices for .work and .casa start at USD 1 per year, but prices for less generic new gTLDs like .beer, .fishing and .rodeo are priced much higher than that.
Hence, with an average price of USD 20 per new gTLD and 50 m annual registrations the new gTLD registry market could grow to USD 1 bn over the next two years. This is roughly equal to Verisign’s current revenue.
Excluding brand names, which amount to roughly one third of new gTLD applications, I assume that there will be roughly 600 new gTLDs delivered to the internet.
MMX has currently a portfolio of 25 new gTLDs ignoring the outstanding 10 contested new gTLDs (excluding one application for a client). It is important to note, that 5 new gTLDs in the portfolio have a geographic relation like .london and .bayern. In total there are only 66 geographic new gTLDs to be introduced to the internet. These geographic new gTLDs are expected to reach relatively high prices and registration numbers. It is difficult to predict how MMX’s new gTLD portfolio will perform in terms of demand relative to all the other new gTLDs. Overall, I believe that MMX accumulated a relatively good portfolio of new gTLDs and can therefore retain at least a 4% market share.
This results into a potential revenue for MMX from the registry business excluding services for clients and the registrar segment of USD 40 m.
This is a rough forecast for the next two to three years. Thereafter, more new gTLDs will enter the market, with the completion of the next application round for new gTLDs. I believe that the number of applications at the next round will be many times larger than in the first round as many potential applicants were not aware of this opportunity or preferred to watch from the sideline.
As a consequence of the expected increase in supply 3 years from now, prices for new gTLDs in general should go down. However, there might also be new gTLDs from the first round which stay successful due to their inherent uniqueness.
The question is how the development will be regarding personal adoption of websites, innovation in using names and whether the number of domain names per person or business will increase. For instance, in the future personal webpages could be comparable to Instagram or even Facebook. At the same time, personal data could be better protected. If consumers follow MMX’s vision, the number of domain names will increase rapidly. In addition, customers might pay less for domain name registration, but might be willing to pay more for services, if they can manage many different tasks by using their webpages.
Management and share capital
Frederick Krueger is the founder and Chairman of MMX. As an entrepreneur Mr. Krueger brings vast experience to the company. In the past, he successfully founded, developed and sold a number of internet ventures. He is holding 15.4% of the outstanding shares. He is also the founder and CEO of Needly, which provides the Mozart software to MMX. I do not know what Needly is currently worth and how Mr. Krueger’s economic interest in Needly looks like. Overall, I would prefer Needly to be part of MMX, so that his focus would be concentrated on just one entity.
The other members of the management team are only holding 0.4% of the company’s shares outstanding. In March 2015, they made a number of insider purchases. However, together this accounted for less than 0.1% of the outstanding shares.
MMX is listed on the AIM of the London Stock Exchange
but reporting in USD. The company has currently roughly 836 m shares outstanding. At the beginning of 2014 MMX issued 175 m new shares at a price of 12 pence (current stock price 8.4 pence) raising GBP 21 m (USD 30 m). Apart from that, dilution from the exercise of share options is quite substantial. Currently, there is a total of 76 m outstanding options representing 9.1% of the company’s issued share capital. Most of the options have exercise prices between 6 pence and 9 pence. Hence, while dilution from option exercises might be significant going forward, the exercise prices are close to the current stock price. This at least mitigates the negative effect from the issuance of new shares.
In 2014, total management remuneration was roughly GBP 0.8 m. As far as I understand, management is consisting of 7 members. Management compensation will increase substantially in 2015, as certain milestones have already been met (i.e. compensation increases automatically with the first revenue generation from either .london, .bayern or .miami).
Verisign was able to deliver operating margins of more than 50% over the last three years. From my perspective MMX’s cost structure should be comparable to Verisign once the release of the new gTLDs to the internet will be completed. As marginal cost per new gTLD registration approaches zero, the registry business has strong economies of scale. However, MMX might be less profitable due to relatively higher expenses for marketing and employee remuneration. In addition, Verisign’s profitability is based on a monopoly in the registry business which will no longer exist in the future. Consequently, I assume that MMX can achieve an operating margin of 30%.
Based on this assumption, MMX might be able to generate USD 12 m of operating profit. Using a 10 times multiple the business could be worth USD 120 m.
The current market cap of MMX is USD 105 m (GBP 70 m). Assuming that all the options outstanding get exercised, the market cap increases to USD 114 m (GBP 76 m). With proceeds from option exercises being USD 8 m (GBP 5 m) based on an estimated weighted average exercise price of 7 pence per share and USD 48 m in net cash, the business itself is currently valued with USD 58 m (GBP 39 m).
Hence, under the scenario outlined above, the share price has an upside potential of close to 50% over the next two years.
This is just one possible outcome. However, I do not think that it is totally unrealistic. It shows at least that the market is all but euphoric about this company.
The high cash balance results from private auction proceeds and the capital increase from last year. According to management, cash resources might be used for growing the portfolio of new gTLDs. Presumably, there will be another round of private and public auctions for the remaining contested new gTLDs later this year. These seem to be quite valuable to me (e.g. .hotel, .gay, .music). Upcoming private auctions could provide a nice boost to the cash position in case MMX does not win. Apart from that, management believes that there will be some registries for sale at a later point in time, which could be attractive acquisition targets.
On a different note, I believe that management wants to find a buyer for MMX not too far in the future. Members of the management have been involved in other ventures and sold them to large players in the industry. Whether this will happen, will obviously depend on the success of new gTLDs over the coming months.
My first impression of this company was, that it is just another stock promotion with limited intrinsic value. However, the more I got to know the industry the more I saw the opportunity and understood the reason why management prepared for the change in domain names five years ago. What needs to happen is, that some of MMX’s portfolio components convert to highly demanded new gTLDs. With high renewal rates these new gTLDs will provide the company with profitable recurring sales revenue. I do not see the probability for this potential outcome being fully reflected in the current stock price. Nevertheless, I want to emphasize that there are many obstacles to my investment case as this is a company entering undiscovered territory.
In my last post, I announced that I will accumulate a 2% position for the portfolio with a price limit of 9 pence per share. So far, I acquired a 1.5% position with an weighted average price of 8.3 pence assuming that I trade one third of daily volume.
The content contained on this site represents only the opinions of its author(s). I may hold a position in securities mentioned on this site. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. As always please do your own research!