CentralNic offers both growth and value

Domains are a key infrastructure component of the internet and the market is currently estimated to be growing at about 3 per cent a year. Currently more than 45m domain names use at least one of CentralNic’s platforms. That’s around 12 per cent of the market.

Selling subscriptions made up 45 per cent of the business during the first six months of 2021. The other 55 per cent of revenue came from marketing, an activity that made a near-zero contribution as recently as 2019. The marketing operation makes use of CentralNic's visibility of all the traffic heading to its domain names and then employs AI software to match up the buyers and sellers of advertising. As the company already has relationships with lots of businesses, marketing services can easily be sold to existing customers.

Recurring revenues

Once customers subscribe with CentralNic, they are unlikely to leave because it is difficult to switch suppliers in the domain industry. Being a sticky subscription business comes with a dual benefit. Almost 99 per cent of its revenue is recurring so it is unlikely that its revenue will fall dramatically in any given year. The company also doesn’t have to spend lots of money to market to its current customers to convince them to stay loyal. The moat this creates makes it problematic for new competitors to enter the market.  

The flipside of this story is that because customers are so sticky, it is hard for CentralNic to take them from competitors. To grow the customer base it has to be acquisitive. In January 2021, it acquired French corporate registrar SafeBrands for $4.4m, which was 0.9 times its revenue at the time. This was a low price for a deal that gave the business a new portfolio of French websites.  

In September, it announced the acquisition of a publishing network of revenue-generating websites from White and Case for $6.5m. This purchase is expected to generate $1.5m in annualised cash profit. Buying at just four times its future profits is a very affordable deal.

The reason these acquisitions seem relatively cheap is that CentralNic immediately has the capability to sell acquired customers its advertising services. The companies it is acquiring from don’t have the means to do this.

Growth of the marketing business

The $48m acquisition of online advertising business Team Internet at the end of 2019 launched the marketing business. This gave CentalNic the proprietary technology that allows the matching of domain names with the highest-paying advertisers. Since then, it has purchased Codewise for $36m in 2020 and Wando for $6.5m in February this year.

During 2020 around $400bn was spent by online marketers acquiring new traffic to their websites and demand is growing at over 20 per cent a year.

But while online advertising is a growing industry, many of the big players are plagued by changes to protect user privacy. Earlier this year, Google announced that third-party cookies will no longer be used on its Chrome browser, meaning ad companies will no longer be able to collect data on users' habits. Apple has similarly started asking its users in the App Store if they would like to receive targeted advertising. The majority have chosen not to, which has knocked huge amounts of value off Snapchat (US:SNAP) and Facebook (US:FB), which have both seen advertising revenue drop significantly.

CentalNic’s marketing technology, however, doesn’t rely on cookies or collecting individuals' search data. It uses “contextual marketing principles, not requiring the collection of personal data for retargeting purposes”. Covid-19 has accelerated the demand for digital advertising and CentralNic can provide it without facing the risks associated with tightening privacy rules.

Organic growth picking up

Sales grew by over eight times from £24.3m (or $31.4m for consistency with CentralNic's switch to dollar reporting) to $241m in the three years to 2020. Adjusted cash profits (Ebitda) were up almost six times in the same period from £4.3m ($5.4m) to $30.6m. However, most of this growth was driven by acquisitions. Organic revenue growth tends to be valued more highly. So it was big news that in its last trading update CentralNic showed strong evidence of organic expansion. For the nine months to 30 September 2021, organic growth was 29 per cent.

Broker Stifel said the company had now “broken free from the domain-related growth rate”. Its US peers have been growing slower in their most recent quarterly earnings, with GoDaddy’s sales increasing 13.8 per cent, while Verisign and United Internet were up 5 per cent and 4.7 per cent, respectively. 

The forecast is revenue of $280m and cash profits of $32m for the nine months to September. That is an increase of 66 per cent and 45 per cent, respectively. Cash generation is also very impressive because CentralNic is an asset-light business. In the first half of the year, adjusted operating cash conversion was 126 per cent. The cash balance is now $54m compared with $28.7m in December and net debt is down to $79m from $85m, despite spending $13m on the acquisitions of Safebrands and Wando.

Analysts are expecting revenue and cash profits of up to $355m and $42m, respectively, for the full year. Free cash flow is forecast to be $29.5m, which gives it a handsome free cash flow yield of 6.3 per cent based on its enterprise value. CentralNic is now in an unusual position of generating significant organic growth and still generating enough cash to internally finance its acquisition strategy while trading at a relatively low valuation. It looks to be both a growth and value play.

Still good value relative to peers

Since the beginning of October investors seem to have started to cotton on to the fact that something special may be on offer. Its share price has risen by around 30 per cent since it posted those impressive organic growth numbers last month. 

There are currently no listed competitors in the UK, but compared with its US listed peers, GoDaddy and Verisign, it still looks very affordable even after the strong rise. GoDaddy and Verisign have 2023 PE ratios of 28 and 30, respectively. Compare that with CentralNic shares on just 15 times 2023 forecasts.

The UK markets seem to be waking up to the potential of domain name businesses but, based on its US peer valuations, there is still some way to go. And in a rapidly consolidating market, CentralNic, with its relatively low rating, could go from the hunter to the hunted. It's possible that GoDaddy could decide to acquire it. Last year, GoDaddy had free cash flow of $698m and has a very acquisitive track record. A deciding factor could be the view of near-25 per cent shareholder Kestrel Partners. The boutique investment firm has exited many of its other large positions when the companies it held stakes in were acquired. Either way, there is a lot of potential for shareholders.