Yesterday, a short seller posted a critical analysis of Tucows (NASDAQ: TCX). Shares in the company dropped before quickly recovering and ending the day in positive territory.
It’s not the first time a short seller has targeted Tucows with a report. But this one is more level-headed, avoiding the extreme hyperbole and anonymity of the prior report.
Kerrisdale Capital Management titled its report published on SeekingAlpha “Tucows: 3 Terrible Businesses In 1.”
Tucows’ three businesses are domain names, mobile service and fiber internet service.
I know the most about domain names, so let’s start there.
Domain Names
Kerrisdale writes:
Tucows’ Domains business is suffering similar stagnation. Industry-wide, growth is abysmal. GoDaddy (NYSE:GDDY) and VeriSign (NASDAQ:VRSN) have been suffering low single-digit growth, while TCX’s own revenue CAGR has been 1% over the last 3 years as it’s been losing market share. The business is highly commoditized, with little to differentiate any individual firm other than price. TCX has been boosting prices to inflate growth metrics, but this will simply accelerate churn and share loss.
This is a reasonable assessment of the domain name market right now. Domains Under Management (DUM) metrics are just barely inching upward at large registrars. There’s some differentiation beyond price, but price is a critical factor. And Tucows did raise prices on domains, which will undoubtedly lead to some customer loss. How much? I’m not sure, but I suspect the domain business’ overall margin contribution will remain the same or better.
The author notes that another challenge on the margin side is potential wholesale .com price increases. Tucows has previously pointed out that the company earns basically the same amount on .com no matter what the wholesale price is. The registrar market is competitive and all registrars will pass the price increases on to customers.
Where Tucows (and some other registrars) might have exposure is if prices for .com get so dear that domain investors drop their marginal names.
Tucows isn’t the only reseller-model registrar facing industry-wide challenges, and the company has made smart acquisitions of its competitors in recent years.
Despite slow organic growth, domains deliver great free cash flow.
A significant milestone for the company will be rolling out a new backend platform for Enom and OpenSRS. Enom has some major issues, and this platform upgrade can’t come soon enough.
Mobile
Tucows did something smart when it realized the high-growth days of domain registration were coming to an end. It looked for other opportunities and expanded into mobile service as a Mobile Virtual Network Operator (MVNO).
Called Ting Mobile, the original idea was to leverage Tucows’ reseller network and expertise to sell mobile service. That didn’t work out, but Tucows understood that one of its core strengths was missing in the mobile business: customer service. People hate their major-brand mobile companies, so Tucows doubled-down on a simplified pricing structure and great customer service in which someone actually picks up the phone when you call (imagine!).
As Kerrisdale points out, Ting is facing headwinds. It depends on the major carriers for the network and resells their service. A Sprint/T-Mobile combination could hurt.
When I look at the Ting Mobile model, a few things worry me. I draw parallels to the domain business.
Tucows depends on a small number of prominent mobile operators. It reminds me of when domain parkers relied on just Google and Yahoo for ads.
It also reminds me of the reseller domain business. As mentioned earlier, Tucows raised the prices it charges domain resellers. Some will leave, but there aren’t that many options for other reseller platforms these days. Tucows has gobbled many of them up. It might be hard for Tucows to negotiate better deals with the few remaining megacarriers, just like it can be difficult for domain resellers to negotiate better deals with the few remaining reseller platforms.
Fiber
Ting Internet makes big outlays to light up fiber and bring service to customers. It then recoups that over time through monthly internet service fees.
This is a long term business. The further out your projections, the harder it is to target. I also worry about how changes in wireless technology could change the fixed-line internet market.
Kerrisdale makes some comparisons that I don’t think are particularly helpful, though. For example, it uses cost numbers from Verizon. But Ting is cherry-picking its locales because of their economics. That makes a big difference in the numbers.
I think one of the commenters sums it up nicely:
The Ting Fiber business is likely going to decide how investors fare. You make a strong case for the risks. And those risks are real. It takes a huge investment of capital to put in place the infrastructure. That results in a business that can be very sensitive to the adoption rate. If adoption rates turn out to be below Ting’s expectations, and more in line with yours, will greatly harm long term returns. The profitability for each new marginal customer is large so if there are surprises on the upside the returns could be very large.
Final Thoughts
There are lots of things about Tucows’ business to like. Its domain business its fairly predictable and throws off cash.
Whether the mobile and fiber businesses ultimately deliver is an open question. The business is relatively easy to model, and everyone can plug in their assumptions to figure out what they think the company is worth.
Tucows’ share price has soared from $12.47 five years ago to almost $90 before pulling back this year. It closed yesterday at about $60.
I don’t know if it is fairly valued or not. But I do know that Tucows CEO Elliot Noss is all in. He has more than 100% of his net worth in the company’s stock; he has borrowed against his stock holdings to exercise options and cover his taxes on them. That’s a good sign for investors.
I do not hold shares in individual publicly-traded domain name companies.
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