09:25am EDT 7-Apr-99 Prudential Securities (P.MERENBLOOM 212-778-7328) NSOL
NSOL-FORGET THE SHORTS & CHECK THE FACTS-ICANN NEEDS NSOL'S BLESSING TO PROCEED
NSOL-FORGET THE SHORTS & CHECK THE FACTS-ICANN NEEDS NSOL'S BLESSING TO PROCEED
& TECHNOLOGY DELAYS LIE AHEAD FOR POTENTIAL COMPETITORS; STRONG BUY
(Part 4 of 4)
R E S E A R C H N O T E S April 7, 1999
Subject: Network Solutions (NSOL- 115)-OTC
OPINION
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Current: Strong Buy
Analysts: Paul L. Merenbloom (212) 778-7328
Aydin O. Tuncer (212) 778-6764 Risk: High
12-Month Target Price: $188
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Ind. Div.: - Yield: - Shares: 34.2 mil. 52-Wk.Range: 153 3/4 - 10 1/2
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EPS FY Year P/E 1Q 2Q 3Q 4Q
Actual 12/98 $ 0.38 NM $ 0.13 $ 0.13 $ 0.18 $ 0.22
Current 12/99 $ 0.62E 185X $ 0.11E $ 0.13E $ 0.17E $ 0.21E
Current 12/00 $ 1.24E 92.8X
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And, Of The Matter Of Registry Fees? The Street has paid great attention to the
matter(s) of registrar fees to be paid to NSOL following the onset of
competition. First, we wish to point out that NSOL's recent proposition of $16
per domain name registered is substantially above the fees we had initially
projected into our models. For the purposes of our initial model, we estimated
that there would be a revenue split of the $35 per domain name per year, in the
order of 70% to the registrar and 30% to the registry. This would place the
fee to NSOL, for each domain name, in the range of $10 per domain registered,
well below the company's proposed fee.
Further, we note that Amendment 11 stipulates that NSOL will agree to the
following language:
"Commencing upon the Phase 1 deployment of the Shared Registration System, and
for the term of this agreement, NSI's prices for registry services through the
Shared Registration System in the gTLDs for which NSI now acts as the registry,
will be no more than a dollar amount per registration/year to be specified in a
further amendment reflecting NSI's costs and a reasonable return on its
investment.
This price cap will be adjusted via an amendment to the Cooperative Agreement to
reflect demonstrated changed costs of NSI arising from newly enacted
legislation, NewCo fees, inflation, regulations, standards, costs of new
litigation (including settlements and judgments) in excess of NSI's operating
plan or changes in the operation of the registry, or to fund specific additional
activities in the event such activities are reflected in an amendment to the
Cooperative Agreement."
The language in this agreement has been widely taken to mean that NSOL, as the
registry owner/operator, is entitled to establish the pricing schedule for
domain name registration (registrar and registry) fees. As is the current
practice, and one we believe supportable in the future by way of current
practices (serving as precedent), NSOL may likely enjoy the ability to establish
a 'base' pricing scenario that resellers and other registrars may elect to
increase for their respective value-add services. Given the language contained
in Amendment 11 (above) we find it difficult to believe that NSOL would be
remanded to leave registrar pricing a fully open matter lacking any guidelines
or controls.
Further, we point out that several registrars may, over time, elect to discount
to their potential subscribers the fees levied by NSOL as the registry. Such
action could conceivably be employed to garner market share and brand awareness,
however, we would expect that the base registry fees, established under
schedule through currently in-progress negotiations between NSOL and USG would
stand firm.
Put another way, to engage in price gouging, prospective competitors would have
to potentially commit to 'buying' business-paying NSOL the full registry amount
and absorbing any other ongoing costs of operations. We expect that this
strategy, while attractive to some private investors, could lead to a lower
quality service and higher churn rates for providers inclined to employing such
a pricing strategy.
While Some Analysts Suggest Domain Name Price Erosion, We Believe That DNS Entry
Pricing Could Actually Increase. Noting that this is an area of considerable
controversy, we note that NSOL, and other resellers, have consistently
demonstrated the ability to capture revenues in the range of $60 per year (as
evidenced by the $119 for two-year product's sales levels). This represents
an increase from the official InterNIC pricing of $35 per year structure. Given
the value-point that a domain name enjoys on the 'Net at large (which is
considerable and increasing each day) we note that NSI and other registrars are
likely to enjoy the willingness of individuals and organizations to spend a wee
bit more to simplify the process for acquiring or maintaining their online
identity. While we could foresee short-term price competition amongst
registrars to effect market share capture, we view this as limited in time.
Further we note that the proposed initial structure of five competing registrars
closely resembles an oligopoly. Oligopolies typically do not compete directly
on price and tend to reach a relatively benign pricing environment where all
players earn a comfortable return. We suspect that the initial introduction of
five new registrars, expected to last four to five months, will not put downward
pressure on pricing. Further, as new competitors are introduced, we expect NSI
and the five initial testbed registrants will continue to provide pricing
leadership and will maintain an oligopoly framework.
Our Current Pricing Model Assumes Approximately 44% Of CY2000 Registrations Are
NSOL Direct; 41% Are VAR Sourced; And 15% Are Derived From Competitive
Registrars. Our current revenue figures are based on the following assumptions:
(1) Registration revenues will 'baseline' at $35 per domain name per year; (2)
NSOL resellers will account for approximately $21.00 per domain name per year;
(3) and competitive registrars will account for $10.50 per domain name per year
(30% of the $35 fee). While we are currently revising the timing and
distribution of the fees to the company, assessing the likelihood that CY2000
registry fees could account for as much as 25-35% of total domain name generated
income to NSOL, we believe that clarifications of the timing and implementation
issues raised above must first be addressed in order to assess the revenue mix
and potential in a reasonably complete context.
We also note, and underscore, that our working pro-forma figures, based on
NSOL's recent domain name registration rates, suggest that total domains
registered could exceed one million, per quarter, on a net basis (vs. gross
domain name registrations) as soon as 2Q, 1999. We believe that this figure
could grow by 50% one year out, reaching nearly 1.5 million net domain
additions, or more, in 2Q, 2000. Moreover, we note that our pro-forma figures
do not include any material contributions from the RealNamesT service from
Centraal Corp. due to begin significant roll-out in 3Q, 1999.
In conjunction with the Centraal efforts and the introduction of additional
registrars, we believe that our domain name figures could be conservative by a
factor of 20%-40% or more for the CY 2000 period. Keeping in mind that the
firm's operating leverage increases substantially with increases in domain name
registration and the use of pre-paid, higher-margin 'reservation' revenues (the
$60 per domain per year fee structure), it is our belief that our currently
published $0.61 in EPS for CY 1999 and $1.14 CY 2000 EPS figures (on revenues of
$188 and $353 million, respectively, could prove very conservative.
Clearly NSOL will find themselves facing volume and competitive pricing issues.
We turn first the agreement(s) between NSOL and the US Government to establish
the guidelines and framework for the pricing structure(s) to be employed. It is
our expectation that NSOL will wind-up with a three-tier pricing system. In
the first tier (retail) the firm will likely capture $60/year per domain name
registered/reserved. The second tier, offered to wholesale providers, and
premier-class partners will likely enjoy a $20-$25 price structure, scaleable
with volume and indexed against a willingness by the partner to assume financial
responsibility for 100% of issued domain names. Finally, a third tier fee,
assessed to registrars, in the $10-$16 range is likely as described above.
Reviewing The Valuation. We continue to believe in the use of the discounted
cash flow model for NSOL shares, which yield a per-share value of $188 per share
based on our consolidated Discounted Cash Flow (DCF) model. This model assumes
a discount rate of 20.5%, a risk free rate of 5.5%, a 7.5% risk premium, a Beta
(obtained from Bloomberg) of 2.0, and a derived terminal multiple of 15.4.
Based on the company's closing price of $115 per share, the DCF driven price
objective, yields upside of 63% from current levels. We note that our
assumptions for the distribution of revenue according to channels (NSOL direct;
Value Added Reseller/NSOL Partners Program, and via other registrars) is subject
to change, however on a preliminary basis, the incorporation of the RealNamesT
name and expansion of the Net will yield substantially higher registration
volumes. In addition, in CY2000, initial domain name registrations will come up
for renewal increasing the revenues and lowering the effective cost of sales
thereby offering the potential for even greater leverage in the company's
operating model.
Finally, we note that NSOL shares, while likely to remain exceptionally volatile
over the near term, will, we expect, continue to appreciate in advance of the
broader markets as a primary reflection point for the Internet's growth
directly. Contrary to some analyst's comments, we believe that the success of
the secondary registrars, at such time as these organizations become effective
players in the Internet domain space, will only serve to increase NSOL's
visibility, traffic and revenue streams. We continue to rate shares of Network
Solutions (NSOL) a 'Strong Buy' for aggressive, long-term investors.
Investment Thesis. Network Solutions (NSOL) enjoys an effective monopoly in the
creation, maintenance and stewardship of the central database that contains the
names and corresponding numerical addresses for the Internet. NSOL enjoys
interminable annuity revenues from 'licensing' the 'slots' in which unique names
are made available in the .COM, .NET and .ORG databases (registries). The
company enjoys the 'keystone' role in the Internet. Without their database, the
Internet and incumbent/affiliated commerce would cease to function as it does
today. While competitive access to this database is an endorsed event, and
will, we expect promote additional domestic and international near-term the
process of deregulation and the introduction of competition has furthered
confusion in political, business and Wall Street contexts. We do not expect the
confusion to abate any time soon. While there will be claims of threats to
the NSOL franchise, the US Courts have affirmed NSOL's rights and position.
We expect the company will enjoy significant time advantages in developing their
brand, franchise, market, products and relationships with distributors and
end-users alike. Accordingly, we expect NSOL will embody a full E-Commerce
company, similar in certain regards to America Online (AOL, $168, rated Strong
Buy) enjoying the annuity revenues of domain name registrations (which are
growing by 75% per year), consulting revenues, 'layered' revenues associated
with advertising and E-Commerce enablement roles, and high-margin revenue shares
affiliated with the company's position to broker business between vendors and
buyers (corporate and individual).
Accordingly, we rate shares of NSOL a 'Strong Buy' and are raising our near-term
price objective to $188. Further, we fully expect that this figure will
increase in forward quarters and years.
Prudential Securities Incorporated makes a primary over-the-counter market
shares of Network Solutions.
Prudential Securities Incorporated (or one of its affiliates) or their officers,
directors, analysts, or employees may have positions in securities or
commodities referred to herein, and may, as principal or agent, buy and sell
such securities or commodities.
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