Why One Short-Seller Wound Up Buying -- Not Shorting -- Network Solutions
By Herb Greenberg
Senior Columnist
6/28/99 6:30 AM ET
For those who think this column never writes anything positive: The buzz in the short-selling community in recent months has been that Network Solutions (NSOL:Nasdaq) is a goner. This is the company that until recently had the exclusive license from the U.S. government to register domain names on the Internet. Earlier this year, however, the business was swung open to competitors, which was a big part of the bear bashing: more competition, lower prices and, therefore, lower profits for high-flying and no-longer-monopolistic Network Solutions.
Considering the ludicrous valuation of so many Internet stocks that don't have earnings, one short-seller decided to take a look at Network Solutions. Even though the company was making money, the stock looked like a short slam dunk, with a market value on Friday of $2.3 billion and sales of just $115 million. (That's 20 times sales, which is high by any standard.) He sent one of his most cynical analysts -- when it comes to Internet valuations -- to work on the job.
After a few weeks of research and financial modeling, his conclusion: "These guys really have a model to make money."
So, instead of shorting Network Solutions, our short-selling source bought it!
"What happened," he explained, "is that my analyst came back to me with this model. It showed that all of the analysts were estimating 14 cents in the second quarter. But based on our assumptions, which were based on the most conservative assumptions, our model came up with 17 cents. And we asked ourselves, 'Is that the model of a stock that goes up or goes down?'" (Since that time, the Street has raised its estimate to 16 cents.)
Considering the stock has already lost half its value, even the short's cynical analyst knew the answer. (Okay: up.)
Network Solutions, meanwhile, charges $35 a year for two years, but it also remains the official Internet registry. That means if you register with another company (and right now there's only one -- Register.com), that company must pay $9 per year to Network Solutions to keep the name registered. That number is likely to go lower, but right now it's not. And the company has to pay Network Solutions two years up front, to boot.
"So, we broke those numbers down and made assumptions on market share that I think were generous."
Worst case, he figured, was that by the second quarter of next year every Internet name that will be registered has been registered, or there's so much competition that Network Solutions loses most of its original business. Even so, the short declares, "It's still a stock to own because you'll still have to pay them $9 per year to keep your name."
But what about that $2.3 billion valuation? "I can't defend Internet valuations," the short-turned-long says.
Then, why own the stock? "Because there's a misperception about what this company does and what its earnings power is."
He adds: "I would argue that there are 210 Internet companies that don't have earnings that have massive valuations that you could make a good argument against before you could argue against a company that has earnings and a business plan and a model that shows earnings will grow."
He forecasts that Network Solutions will earn 83 cents per share this year, leaping to $1.40 next year. "And that's considering a business model that looks at its current, static business: people registering domain names. Network Solutions has said it hopes to leverage this database into something else. That potential isn't even considered in this model."
Sounds great, but remember: Sometimes the worst long ideas come from short-sellers. What makes this story so compelling, though, is that this short originally wanted to bet against Network Solutions. How often does something like this happen?
"It's very rare," he says. "You can figure out in a day, 10 minutes or three days into your research that something isn't a short and isn't worth your time. But this one was different. I said, 'Build me a model and show me these assumptions with the price declining.' I told my analyst to show me these guys are going out of business. He had to go through the whole exercise, and when all was said and done he found out that it was a good company."
In the words of Ricky Ricardo: How 'boud dat.
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