CentralNic CNIC
November 23, 2020 - 9:45am EST by
MrTwister
2020 2021
Price: 83.00 EPS 0.04 0.07
Shares Out. (in M): 232 P/E 27 17.2
Market Cap (in $M): 275 P/FCF 18.6 12
Net Debt (in $M): 76 EBIT 12 19
TEV ($): 351 TEV/EBIT 22.6 14.4

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Description

There’s a year old post on CentralNic, so I will try not to go over the same things, but i'll describe business in a little more detail.

 

CentralNic is a technology small-cap located in UK. CentralNic's core business is a centralized registry platform, where they have accumulated and integrated a lot of long tail, low volume country codes (think .uk but low volume). The accumulation phase took a long time, 5-10 years where they went from country to country, getting country specific level domains on their platform. They are a supplier to the likes of GoDaddy, Amazon WebHost and other retailer platforms, which use CentralNic centralized system to register domain names on behalf of businesses. They don’t own registries, as these are established cash cow companies usually not up for sale. Though they were able to buy SK Nic, Slovakian country code owner a couple years back, but that's the only one they own. Essentially they are the middle man with the technology who went around the world consolidating all of the registrars on one platform. Apart from working with retailers, they also have own direct domain selling business, which includes brand protection services for big corporates.

To illustrate how core domain business works:

1. .xyz domain costs $10. Whoever holds the right for .xyz (like VeriSign owns .com), gets full $10.
2. CentralNic pays $10 to .xyz holder.
3. Adds 20% margin.
4. GoDaddy buys .xyz from CentralNic for $12, adds whatever margin they want and sell it to end-customer (business owner).

Customers are sticky due to switching costs and recurring nature of the business. Renewal rates are in the 85-95% range for domains and provides for a secure, recurring revenue stream. 

Google tried to compete with CentralNic by building its own centralized domain platform but abandoned the plan after research and became a reseller for CentralNic instead. Which is a testament on the barriers to entry.

3 main segments. Indirect - distributing domain names and provides consultancy services to retailers. Basically, working with GoDaddy and such. Direct - domain names directly to end-users, brand protection (BrandShelter), technical assistance with domains. Monetisation is the newest segment, developed over 2 big acquisitions about which I talk below. 

CentralNic has excellent cash conversion, with OCF = management adjusted EBITDA. NWC is volatile, with outflows in 1H, and inflow in the 2H of the year, but overall a negative NWC business.

Gross margin is ~40%, with EBITDA margins ~15%, which is almost 100% converted into cash. CAPEX is low, 1-1.5% of revenues.

Realizing that domain name business is not scalable and low growth, management decided to expand into adjacent revenue streams and made 2 big (amid numerous smaller ones) acquisitions - Team Internet, which is a web monetization company. They were able to acquire at a rock bottom multiple of 3.9x EV/EBITDA from a distressed seller Manotamy (bond holders of Manotamy forced the sell). A tool to provide web monetization for domain investors. Helped with monetizing parked webs, generating traffic for them and placing ads. Company issued bond in 2019 to fund acquisition, which is publicly traded and has YTM of around 4%. Net debt/EBITDA is roughly 2x. 

Second big acquisition, done a month ago, where they acquired Polish based Codewise. Codewise was direct competitor of Team Internet, with a slightly different technology. Codewise was acquired at 4.9x EV/EBITDA. Primary reason is the owner, Polish tech wizkid, burning out and living the past year+ on a remote Caribbean Island. He was looking for a way out and CentralNic offered him a deal. Talks were going for quite some time, and thanks to COVID, CentralNic was able to renegotiate the deal and lower the contingent part of the deal to nil. Management issued equity to fund acquisition (22% dilution), and ~25% of the issue was subscribed by existing shareholder.

There are 370m domain names in existence globally, of which ~25% do not get renewed annually. These become available to domain name investors, who scoop up the most desirable ones. Domain investors can make profit 2 ways - generate traffic and sell ads on it or resell sell the domain name later to someone at a profit. 

These domain investors use services of Team Internet and Codewise to amplify/enhance profit generation on their domains. Services include delivering targeted ads on parked domains, acting as a supplier of ads (similar to AdWords, but for niche things), tracking software to optimize targeting and so on.

This adjacent, web monetization is a more volatile business, and in 1H20 has grown 38% after Team Internet was integrated into CentralNic. 

Even though not as recurring and sticky as foundation of CentralNic business, it provides value due to cheap acquisitions. 

Domain name, or core of CentralNic business, as mentioned is slowly growing ~5-6% p.a., while recently acquired monetization is a high beta horizontal. According to our conservative expectations, CentralNic is trading at 10.3x, 7.6x and 7.3x EV/EBITDA multiple and ~8% FCF yield on average going forward. 

Although CentralNic doesn’t have direct peers, Tucows is somewhat of a related peer, has traded on average at ~15x fwd EV/EBIT, meanwhile CentralNic's historic fwd EV/EBIT is around 9.5x, with currently trading at ~9x. 

For valuation, we use 5Y DCF, assuming 60% conversion rate of FCF/mgmt adj. EBITDA, growing at 6% after 2022. 8% WACC, 2% perp growth, and arrive at a valuation of GBp146/sh, 83% upside. Projected FCF yield is ~8%. 

We also believe that given that now monetization will constitute 50%+ of the business, higher growth rates will come through. But don't model it into our assumptions.

Management expects to further make value accretive deals in the space and are focused on key variables, such as:
1. Online
2. Recurring revenue
3. B2B
4. Similar cash conversion
5. CAPEX light
We believe stock is overlooked due to several factors. 

1. Messy P&L (integration costs, amortization of intangibles - 50% of acquired intangibles is allocated to GW, rest to intangibles), classic valuation metrics like EV/EBITDA, P/E and similar do not screen well. 

2. Complex business. Since they don't do one thing, rather a lot of different related things, investors aren't clear on the business model.

There is possibility of a ruinous M&A, but based on the historic acquisitions, believe management is shrewd, patient and has been a good steward of shareholders capital. And given the history, expect an option like upside from the capital allocation. In case there are no opportunities, management has signaled possible dividends, given strong FCF generation capacity. 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

There is no strong catalyst other than a very successful M&A. Rather the results on P&L will come through, which are currently distorted by the one-offs/non-cash expenses. Meanwhile CentralNic will provide investors with a very satisfactory ~8-10% FCF yield, solid organic growth and very stable, recurring revenue business.  

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