[00:02:29] Shawn O’Malley: So today I’m covering VeriSign, ticker VRSN. I can hardly think of any businesses with such high profit margins that aren’t widely known about already. And yet VeriSign, a company that simply offers domain registry and internet infrastructure services, It’s by no means a household name, but billions of internet users and trillions of dollars of commerce rely on it each year.

[00:02:52] Shawn O’Malley: For every dollar that Verisign collects, more than 55 cents fall to the bottom line as profit, and over the last decade, its net income has grown steadily at just over 9 percent per year. That’s enough to make it the fifth most profitable company in the entire S& P 500 in terms of profit margins. The company recently came across my radar when Berkshire Hathaway started aggressively purchasing his stock, snapping up millions of shares over 12 consecutive trading days to establish a 2.7 billion stake at the time of recording.

[00:03:20] Shawn O’Malley: I don’t know if Buffett would have explicitly given his blessing for these latest purchases of stock. Since he leaves stock investments that are less than 3 billion to his portfolio managers, Ted Weschler and Todd Combs. But still, that was enough to get a lot of Buffett trackers to peek at the name.

[00:03:38] Shawn O’Malley: Berkshire is now Verisign’s largest shareholder, and Buffett was presumably the one behind the decision to initially invest in it back in 2012. Given that this is such a highly profitable and enduring, yet also boring business, it has Buffett’s fingerprints all over it. The extra attention from Buffett trackers recently gave the stock a 10 percent bump, which actually isn’t as much as I was expecting and isn’t enough of a move to make me feel late to the party.

[00:04:04] Shawn O’Malley: But before we get into its valuation and whether it would make for a good addition to the intrinsic value portfolio, let’s talk about what Verisign actually does. Fair warning, this is not the sexiest business in the world, but hot stocks get all the attention anyway. A highly predictable, highly profitable company that’s still growing and trading at a reasonable multiple of earnings is more than enough excitement for me.

[00:04:27] Shawn O’Malley: Incorporated in 1995 and headquartered in Reston, Virginia, VeriSign’s home is a fitting one for an internet infrastructure company, given that roughly 70 percent of global internet traffic is routed through Northern Virginia’s data centers. From growing up in Northern Virginia and doing a commercial real estate internship there, I can attest to the proliferation of data centers here that make up the backbone of the internet.

[00:04:50] Shawn O’Malley: I’ve actually toured a few of these data centers and they’re pretty unique properties. They’re effectively massive warehouses for sprawling arrays of industrial grade computers. Imagine huge climate controlled fortresses housing rows upon rows of humming servers. They are the unsung heroes keeping our digital lives running, storing everything from cat memes to critical bank transactions.

[00:05:13] Shawn O’Malley: Data centers are what make this all possible, and VeriSign does operate some data centers, but it’s what it does with those data centers that’s so important. VeriSign’s role in internet infrastructure is like a regulated monopoly, similar to the monopolies granted to utility companies that oversee the U.S’ electric grid but with web domain registries. The company has essentially been granted exclusive permission to register websites under the com and net domain names. And they’re permitted to do this by a non profit group known as the Internet Corporation for Assigned Names and Numbers. Not exactly a compelling name for marketing purposes, but the group is nonetheless quite important.

[00:05:51] Shawn O’Malley: Since their acronym is spelled out as I-C-A-N-N, I’ll call it ICANN. And we’ll need to do a quick tangent on ICANN first to understand VeriSign. ICANN has the humble responsibility of basically regulating much of the world’s internet. ICANN. com And in conjunction with the U. S. Department of Commerce, it grants VeriSign the exclusive right to register websites under certain domains.

[00:06:15] Shawn O’Malley: So long as the obligations under its previous contract were upheld, VeriSign’s contract with ICANN has a built in right to renewal, meaning this authority will keep getting rolled forward with automatic contracts. ICANN has provided uninterrupted service for over 25 years. For its part, ICANN’s service boils down to facilitating access to websites via a database that connects web address queries with the server that houses the data and functionality of said website.

[00:06:43] Shawn O’Malley: It’s a mouthful to say, but to simplify a bit, the idea is that ICANN ensures that when you search for a website, the domain you search for directs you to the correct place. To this end, the organization ensures that only one version of each domain exists, and that domains are clearly identifiable and can be accessed via a web browser.

[00:07:02] Shawn O’Malley: The organization, however, does not actively authorize web addresses. Its primary task is to ensure that every domain that exists is tied to a valid IP address. They kind of manage a gigantic address book for the internet. And on top of that, they also help to moderate disputes over domains, so their role is multifaceted.

[00:07:22] Shawn O’Malley: ICANN’s responsibility ultimately is to set policies and rules for domain management, delegate tasks to various organizations that are necessary to preserve the functioning of the internet, and also to ensure the stability and security of the Global Domain Name System, which I’ll refer to by the acronym DNS.

[00:07:40] Shawn O’Malley: So, lots of acronyms already. Again, DNS refers to the Global Domain Name System, while ICANN is the non profit group that has been tasked with overseeing the system. for listening. DNS is a worldwide network of servers that act as a massive directory, translating domain names like google. com from being readable to humans into machine readable IP addresses, allowing users to access websites by typing in their names instead of having to type out complex numerical addresses.

[00:08:06] Shawn O’Malley: Put differently, DNS is the reason that you can just input a website name into your browser, followed by com, and your computer knows where to take you. Okay, so we’ve mentioned DNS and ICANN so far. If you’re feeling a bit lost, that’s okay. You’ll not be an expert on internet infrastructure by the end of the episode, because I’m certainly not an expert.

[00:08:26] Shawn O’Malley: But as long as you have some general idea of what’s going on, you can hopefully follow along enough to understand the thesis for Verisign. Speaking of VeriSign, you’re probably wondering how this all relates to our company of interest. VeriSign is a domain registry. Each top level domain, that is, the part of the end of a web domain like com or net, is managed by a single registry.

[00:08:51] Shawn O’Malley: For example, the Public Interest Registry oversees the top level domain org, and VeriSign manages multiple top level domains, including com, net, edu, gov, and tv. Here’s how the company describes what they do. Quote, Our infrastructure includes an advanced registration system, which reliably updates and maintains an accurate record of all registered.

[00:09:15] Shawn O’Malley: com domain names on a continuous basis, ensuring that millions of registry transactions are processed correctly and millions of daily changes are distributed within seconds. This system ensures that users around the world maintain continuous, round the clock access to com domain names. Each day, VeriSign processes more than 320 billion search queries.

[00:09:37] Shawn O’Malley: Which is essentially the number of times globally that people try to access websites ending in com or net. To make this all more tangible, let’s go through an example of what happens when you want to register your own web address for a website. For starters, you have to come up with a website name to make sure your desired domain is actually available to use and not owned by someone else.

[00:09:59] Shawn O’Malley: You might use a domain registrar like Squarespace or Wix to check for you. Assuming your novel domain name is available, the domain registrar, again think Squarespace, Wix, or GoDaddy, would provide you with a form to specify the domain you’d like for your website, along with some personal identification information so the domain can be registered to you as the owner.

[00:10:21] Shawn O’Malley: Assuming you want to use com at the end of your domain, since this is a top level domain overseen by VeriSign, all of that information would then get relayed from the domain registrar to VeriSign. The registrar handles checking domain availability and registering domains, and VeriSign stores that registry of domains.

[00:10:39] Shawn O’Malley: The domain name you have selected will then be entered into VeriSign’s database, and the domain name is then assigned a corresponding IP address by ICANN. Once ICANN enters the domain you have chosen into the DNS, it will be activated. Upon activation, then your domain can be used anywhere in the world.

[00:10:58] Shawn O’Malley: And voila, anyone can access your website by simply typing in your full domain into a search bar. So that’s how it looks in practice. This stuff can make your head spin, or at least for someone as un tech savvy as I am, it did for me. I do find it interesting though to get a rough idea of how this stuff works.

[00:11:17] Shawn O’Malley: We completely take for granted that we just type in a website name and suddenly we are on that page. But there’s an oppressive infrastructure network underpinning all of that, obviously. I’ll add that clearly the world doesn’t just run on English. Verisign converts website names into a hundred different native languages.

[00:11:33] Shawn O’Malley: And we can see this in action by looking at how VeriSign breaks out its revenues by geography, since this is based on where the registrar is located. So for example, someone from England could use a US based registrar to create the website and the revenue would be listed as being from the US.

[00:11:47] Shawn O’Malley: Correspondingly, about two thirds of the company’s revenue comes from the US and then the rest is from a scattering of all over the world. Over the years, ICANN has added several different top level domain options, aka different options for website endings. But overwhelmingly the dot com domain continues to be the most commonly used and most widely recognized by far with more than 63 percent of website registrations ending in.

[00:12:11] Shawn O’Malley: com. We’ve gotten through the weeds of internet infrastructure and I’ll try not to bore you anymore. And we’ve covered what I can does and managing the DNS, how the DNS allows you to search for a website and then actually access that website. And how VeriSign acts as a domain registry. Now, let’s talk about the economics of this unique business.

[00:12:33] Shawn O’Malley: VeriSign certainly doesn’t offer its services for free. Domain owners must pay to keep their domain registered so that their website remains accessible. If you fail to pay that fee, your website will become inaccessible. You lose your spot in search results and open yourself to the risk that someone else can take control of your domain, which can be especially detrimental if your domain is key to your brand identity.

[00:12:55] Shawn O’Malley: VeriSign. So the 10. 26 that Verisign charges for renewals of domains ending in com seems like a small price to pay. For net domains, the annual cost is a bit steeper at 12. 99. And I’m being tongue in cheek to emphasize that domain renewals are extremely important, but also very cheap. Yet when you extrapolate that across literally every website that ends in com or net, you’ve got a heck of a business.

[00:13:20] Shawn O’Malley: No wonder it caught Berkshire’s attention. Domains are renewed about 75 percent of the time, and for each domain registration, a small 0. 25 fee is paid to ICANN, which again is not a very large cost of doing business. It’s not confirmed, but given that GoDaddy has become such a market leader in domain registration, this is likely VeriSign’s top customer, making up roughly one third of their revenues.

[00:13:44] Shawn O’Malley: I will say there’s a cottage industry around investing in domains as a form of digital real estate. People will basically buy domains, speculating that they may be valuable to someone else one day, and then hold them until someone contacts them asking to buy it. It’s kind of like trying to flip a house by anticipating up and coming neighborhoods.

[00:14:02] Shawn O’Malley: That’s By buying enough domains and having some strategy for determining which domains to buy. There are people who make a living from doing that kind of thing. If you somehow knew that a major company was about to launch a new brand and you could secure domains related to that brand in advance. That could be a very lucrative strategy because you know, they really need that domain and can afford to pay for it too.

[00:14:24] Shawn O’Malley: Resellers very much help VeriSign though since they create a marketplace for domain names. If you buy a domain ending in com through GoDaddy for 15 per year, most of that payment gets paid out to VeriSign by GoDaddy. And VeriSign is mostly dependent on these companies to do marketing for them to try and attract more people to purchase website domains beyond some very modest marketing initiatives that they unveiled in 2024.

[00:14:49] Shawn O’Malley: This has its pros and cons. The obvious pro is that they’re outsourcing marketing costs and GoDaddy is the one spending on advertising, not them, which is great for VeriSign’s profitability. The con is that if domain registrars scale back their customer acquisition and instead focus on raising the prices they sell domains for, then that hurts VeriSign.

[00:15:08] Shawn O’Malley: They don’t reap any of the benefits of, say, GoDaddy selling domains at higher prices. And instead, since they have a fixed fee they charge per domain, they benefit more from higher volumes of domain registrations. To an extent then, whether the number of registered domains is growing or declining is at the whim of domain registration companies who may either decide to invest aggressively in advertising website domains or may choose to focus on selling domains at higher prices to existing customers.

[00:15:36] Shawn O’Malley: As I’ve already said, not really being able to control whether it’s customer base of domain registration is expanding or contracting leaves VeriSign as a profitable, but also sort of vulnerable middleman, which is maybe an unusual combination. Normally, highly profitable companies control their destiny to some extent, but that’s not really true in the same way for Verisign.

[00:15:57] Shawn O’Malley: Between relying on domain registrars to drive more domain renewals and their dependence on the broader macroeconomic environment, since if the economy is growing, you’d expect more websites to pop up, the result is a company that acts as a profitable toll road, but like a toll road, doesn’t have a huge amount of say over who and how many people drive on its roads beyond the prices it charges.

[00:16:18] Shawn O’Malley: And as we’ll cover a bit later, even in pricing, VeriSign doesn’t have all that much discretion. To get a better feeling for the industry though, I took a closer look at GoDaddy to see what its economics look like as a domain registrar relative to VeriSign. The 41 percent net profit margin, that’s not as good as VeriSign, so that’s still very high.

[00:16:37] Shawn O’Malley: And GoDaddy is actually growing much faster too, with sales climbing by double digit rates on average over the last decade. Even though the stock has doubled over the last year, it still trades at a price to earnings ratio of less than 16, so we may have actually stumbled onto a pretty interesting business to cover in another week.

[00:16:53] Shawn O’Malley: In market cap terms, GoDaddy is actually a modestly bigger company than Verisign too, so clearly all of the economic value of domains isn’t concentrated solely in the hands of registries like Verisign. There’s apparently more than enough meat on the bone to generously feed companies at multiple levels of the domain registration industry.

[00:17:11] Shawn O’Malley: GoDaddy is about more than just domains, though. They offer a range of website related services. I also went through GoDaddy’s website, pretending to shop for web domains, just to see what the process is like. It’s kind of funny to shop for domain endings for your website in the same way you might shop for deodorant on Amazon, but you basically scroll through a range of domain options with different price points and marketing pitches.

[00:17:33] Shawn O’Malley: The NET domain has a promotional offer where if you commit to registering for three years, then the first year only costs one cent. And then to continue using the domain, the price renews at 25 per year. The pitch is simply, quote, the domain for entrepreneurs to have dot shop at the end of your web domain costs 1.

[00:17:50] Shawn O’Malley: 49 for the first year and then renews at 48 per year over the next two years and the pitch for it is, quote, satisfy the world’s buyers with dot shop and then dot X Y Z is marketed toward creatives and innovative types at a price of 22 per year. Well, dot art is made for well, quote, Artists and runs for 40 a year.

[00:18:09] Shawn O’Malley: I was very surprised to learn that dot Inc is apparently the gold standard of domain names who have dot Inc. At the end of your website costs a pretty penny of 4, 000 per year. That is several orders of magnitude more than the other domains clearly, but it’s just so interesting to me how these things are marketed and priced.

[00:18:28] Shawn O’Malley: I’m not sure why art should be twice as expensive as xyz, but that’s how it is. I would never have thought paying a hundred times the cost of other domains to use ink would appeal to anyone, yet clearly it does. From life to club to store, shop, solutions, org, or com, it’s a surprisingly vast number of words or letters to end your website with, each with its own unique connotation, branding, and prestige.

[00:18:52] Shawn O’Malley: I also learned that GoDaddy offers an interesting service where they basically act as a broker, enabling you to work through them to contact the owner of a domain you’re interested in purchasing. And they take a 20 percent commission of the sale price. So if you have a company called cool stuff and want the domain cool stuff.

[00:19:07] Shawn O’Malley: com, assuming someone else already owns it, go daddy will contact the domain owner on your behalf and then try to negotiate a sale. And this all goes to show what I talked about earlier when I mentioned that Verisign sales ultimately go through registrars like GoDaddy. How GoDaddy goes about selling domains matters a ton for VeriSign, and whether they’re focused on selling novel domains or offering bundles and discounts on well known domains can shape not only the number of domain registrations occurring each year, but also whether the domains being registered belong to VeriSign or not.

[00:19:37] Shawn O’Malley: In my search, I did see that VeriSign’s NET domain is presented front and center, but I didn’t see just an old fashioned com domain in their default promotions. Maybe com domains sell themselves so they don’t have to be promoted? But my takeaway was that GoDaddy was naturally focused on pitching more exciting domains that they could sell for higher prices and higher margins.

[00:19:57] Shawn O’Malley: Yet again, that doesn’t reap any benefits for VeriSign. Selling more ink domains does nothing for them. Unless people are buying com or net domains, nothing else moves the needle for VeriSign. Turning back to VeriSign, another unique service it offers is related to internet root servers. Again, exciting stuff.

[00:20:18] Shawn O’Malley: There are 13 internet root servers in the world, and VeriSign operates two of them, making it the only institution to operate more than one. The other operators include a range of governmental organizations, non profits, and universities. Not to drag us too deeply back into the conversation around technical internet infrastructure, but internet root servers are crucial components of the DNS infrastructure, and VeriSign has been performing this critical DNS function since 1993, initially on behalf of the National Science Foundation and the Department of Commerce.

[00:20:52] Shawn O’Malley: And now for ICANN. Simply put, when you type a website address, your request goes first to a root server, which then directs it to the right place to find more specific information about the website’s location. So, root servers store information about top level domains, like com, org, and net. When asked about a website, root servers don’t give the final answer, but point to the next server that might know.

[00:21:16] Shawn O’Malley: And this process continues down the line until your computer gets the correct IP address for the website you want to visit. It’s not critical that you understand technically what’s going on, besides knowing that this process is very important. While it’s not clear how much, if anything, VeriSign makes from supporting these root servers, it does show how deeply integrated VeriSign is to the backend processes supporting the internet and search browsers.

[00:21:39] Shawn O’Malley: This service is not how VeriSign makes its money, But I do think it builds goodwill with the public and regulators, and that it helps with contract negotiations and how tolerant ICANN and the Department of Commerce might be in providing more room for price increases for domain registrations. In this wonky world of internet infrastructure, it’s natural to wonder who VeriSign competes with.

[00:22:01] Shawn O’Malley: They’re basically competing with other types of website endings and the registry companies who own these top level domains. So, the non profit group I mentioned earlier that oversees the org domain is a direct competitor because, in a sense, a org domain is an alternative to the com or net domains that VeriSign owns.

[00:22:19] Shawn O’Malley: And if someone chooses to put org on the end of their website, then that’s lost business for VeriSign. The same is true for other domain operators like Donuts, which is a registry company, and Radix, an Indian domain registry. And in theory, if for some reason VeriSign didn’t fulfill their obligations to upholding the fabric of the internet, ICANN could auction off the rights to the com and net domains, and VeriSign would have to bid against some of these companies to reclaim them.

[00:22:44] Shawn O’Malley: This happened back in 2005 after VeriSign’s first contract for the NET domain expired, and the company had to outbid five other competitors to retain its right to the NET domain. But after that, the right of presumptive renewal was added to VeriSign’s contracts, making it almost certain that they’ll continue to control these popular domains.

[00:23:03] Shawn O’Malley: To protect its obligations to internet infrastructure, VeriSign doesn’t rely on any public cloud computing services. Instead, it runs its own private data centers that give it complete control over its network, reducing its dependence on other companies infrastructure and cybersecurity vulnerabilities.

[00:23:20] Shawn O’Malley: With a spotless track record of 100 percent uptime, VeriSign has never compromised on that core mission. Interestingly though, one of the biggest threats to VeriSign is the use of apps. When you use an app, there is no com registration, or if we all live in the metaverse as Mark Zuckerberg has imagined, there would be a new version of the internet that makes the com domain obsolete.

[00:23:41] Shawn O’Malley: So, you know, there is a chance that eventually the way we interact with the internet will change and the emergence of apps as an alternative to websites is one example of how that could happen. But I also don’t think Amazon is getting rid of the amazon. com domain anytime soon, simply because their app is popular.

[00:23:58] Shawn O’Malley: It’s not like Verizon gets paid based on how many times a domain is visited. They get paid by domain owners continuing to renew their domains. And as long as there’s a good reason to continue having a website, even if your company’s app is more popular, I’m sure website publishers will continue to stick with the medium.

[00:24:15] Shawn O’Malley: On the margins, reliance more on apps, especially for smaller publishers, will contribute to lower rates of new domain registrations and renewals for existing domains. 100 years from now, maybe we won’t have com domains anymore, we’ll have a new way to interact with the internet, but calling this a near term rest for VeriSign is sort of a stretch.

[00:24:33] Shawn O’Malley: Realistically, the use of com and net domains is not fading away anytime soon. So, Verizon probably isn’t going anywhere, but is it growing? Being monopoly can be a tricky thing. On the one hand, you don’t really have direct competition. On the other hand, regulators aren’t exactly keen to let you expand that monopoly power beyond the carve out they’ve already granted you.

[00:24:54] Shawn O’Malley: Perhaps it comes as little surprise then that VeriSign hasn’t made an acquisition in well over 15 years. Now, before I go in any further into VeriSign’s growth prospects, I Let me say that the company does not agree with the classification of being a monopoly. For complete journalistic integrity, let me go ahead and read their statement from a 2024 blog article on why accusations of monopoly are unfair.

[00:25:16] Shawn O’Malley: They write, quote, There are nearly 1, 200 top level domains and more than 250 country code top level domains operating today. Each of these top level domains offer the same core functionality. Allowing users to establish and maintain an online presence, establish websites, and create email addresses. We continue, saying, Globally, there are over 362 million registered domain names, the majority of which are registered in top level domains not operated by VeriSign.

[00:25:45] Shawn O’Malley: The number of domain names registered not with VeriSign has grown consistently as those top level domains have grown their share of the marketplace. In addition to this competition at the wholesale level, there are more than 2, 800 ICANN accredited registrars and thousands more resellers offering domain names at a range of prices and a range of packages to consumers.

[00:26:06] Shawn O’Malley: Finally, they add, quote, further from a practical perspective, the technical nature of domain registries requires that they each be run by a single operator, but with so many operators in the marketplace, consumers have a broad and diverse array of choices at a range of prices. Thanks. Other top level domains like org, shop, ai, and uk are not monopolies, and neither is com.

[00:26:31] Shawn O’Malley: Alright, so there you have it. The case for why VeriSign isn’t a monopoly in the domain market generally. Fair enough. It’s indisputable, though, that they do have monopoly like control over the world’s most common domain, ending with com. And that is at the core of their business’s success. The fact that Verisign is so keen to play down their power in the market is, at least according to Peter Thiel, a telltale sign that they actually do have very deep moats around their business.

[00:26:58] Shawn O’Malley: As he wrote in his iconic book, Zero to One, quote, anyone that has a monopoly will pretend that they’re in incredible competition. So you know, I can’t help but read that statement from Verisign and think of Thiel’s comments on how true monopolies want to understate their power and weaker companies want to overstate their power to make themselves look better to investors.

[00:27:18] Shawn O’Malley: When you have as good of a business as VeriSign, you probably don’t want to brag about it and risk drawing scrutiny from regulators. It’s better than to just let investors realize on their own how good of a business VeriSign is. Turning back to how VeriSign can grow, this largely comes from a few fairly intuitive things.

[00:27:35] Shawn O’Malley: Raising prices for domain registrations and an increase in the number of domains being registered. For years, com domain registrations have consistently grown by a few percentage points a year, so this isn’t blistering growth, but it’s also not complete stagnation or decline either. You can also acquire new domains like it has tried to do with web, though that has been tied up by disputes with competitors for the rights to it.

[00:27:59] Shawn O’Malley: And as another illustration of how VeriSign operates implicitly as a legal monopoly, there are strict limits on its vertical integration. The company is not permitted, under its agreements with the Department of Commerce, to own more than a 15 percent interest in domain registrars, because doing so would give them control over not just domain registration, but also the distribution of those domains.

[00:28:18] Shawn O’Malley: It would be like owning the farms that produce most of the country’s food, and then owning the grocery stores that sell food to people. That sort of vertical consolidation of business power is not something regulators want to tacitly endorse. It crosses just about every boundary for regulating competition that’s been set over the last decade.

[00:28:37] Shawn O’Malley: On pricing, it’s important to note that VeriSign doesn’t control its destiny here. They cannot raise prices at their own discretion. 2018, VeriSign and the Department of Commerce added an amendment to their contract specifying the terms of price increases, and the company was granted the right to raise prices by a maximum of 7 percent per year in the last four years of its six year contracts for com domains.

[00:29:00] Shawn O’Malley: For its NET domain, it could raise prices by 10 percent per year. And the ability to raise prices at all is a big deal, given that VeriSign’s previous contract did not allow for any explicit price hikes. VeriSign has to get approval to raise prices, and to do so, they have to convince the government that their costs are increasing, there’s some competition impacting them, or that some investment is needed, like building out new security systems to protect the registry system.

[00:29:27] Shawn O’Malley: Or at least, that’s how things used to work. In many ways, the U. S. government has passed along its oversight of VeriSign to ICANN in recent years. In an ICANN’s charter, they express that their mission is to ensure the internet runs fairly, but they aren’t a price regulator and prefer to let the market set prices.

[00:29:44] Shawn O’Malley: Thus, ICANN has removed pricing restrictions entirely from some of its renewal contracts with other domain registry companies. To me, this represents the most favorable regulatory environment for Verisign in a long while because ICANN is, generally speaking, going to be more flexible and tolerant than the government is.

[00:30:02] Shawn O’Malley: For newer domains, as mentioned, ICANN has moved away from price caps entirely, while some legacy domain contracts, like Verisign’s com and net domains, have seemingly only retained price caps since those were set by the U. S. government before it handed off regulatory powers to ICANN. The beauty of price increases is that those incremental revenues will fall almost entirely to the bottom line.

[00:30:24] Shawn O’Malley: At a retailer, when you sell more units of merchandise, you still have the incremental costs to acquire and sell those items to account for, but with Verisign, if they raise prices by 10%, there’s no corresponding incremental cost increase. Almost all of that will become profit, and that is some pretty favorable business economics if you ask me.

[00:30:42] Shawn O’Malley: And yet for a long time, they’ve often chosen not to raise prices or were not permitted to do so for certain domains. Let me share some timely worldly wisdom from the great Charlie Munger on pricing power. He says, quote, there are actually businesses that you will find a few times in a lifetime where any manager could raise the return enormously just by raising prices and yet they haven’t done it.

[00:31:06] Shawn O’Malley: So they have huge untapped pricing power that they’re not using. That is the ultimate no brainer. VeriSign is one of the clearest cases of this that I’ve ever seen, given how valuable website domains are and the modest sum charged to ensure they remain accessible. Now there is some debate over how you would classify VeriSign’s pricing power.

[00:31:26] Shawn O’Malley: Like we’ve discussed, at times it’d be more accurate to say that VeriSign has pricing permission, maybe not pricing power. They could only raise prices by as much as ICANN and the Department of Commerce would allow them. And from 2012 to 2020, they weren’t really allowed to raise prices at all. It doesn’t sound like pricing power.

[00:31:43] Shawn O’Malley: That dynamic has changed, and VeriSign is permitted to raise prices by 7 to 10 percent per year, depending on the domain, from 2020 through 2024. And the outlook has increasingly tilted from needing permission to being implied that VeriSign has its own pricing power. At 10. 26 for com domain, that is cheaper than 87 percent of the cost of other top level domains, so the pricing for com domains is by no means aggressive.

[00:32:08] Shawn O’Malley: Domains like biz and info cost 50 percent or more, and domains like store cost 40 per year, or four times as much as VeriSign charges for com. There’s a pretty strong case for VeriSign charging much higher prices, and if that comes to fruition That would be a huge boon for returns. The biggest risk factors for a company like Verisign, beyond the lack of control over pricing and the low but still possible chance of losing out on contract renewals for its domains, stem from cyber security.

[00:32:38] Shawn O’Malley: Since Verisign underpins the functioning of the internet, which is really not exaggerating at all. There is no shortage of actors who would like to compromise its systems, from sophisticated individual hackers to nation states. This puts a substantial burden on them to remain at the cutting edge of cyber security, fending off the most advanced attacks there are.

[00:32:59] Shawn O’Malley: Ransomware, social engineering, attempts to physically break into its data centers worldwide, and just about anything else that can be conjured up by nefarious characters, are all on the table for Verisign to deal with daily. Besides the cost of maintaining robust defense systems and investing considerably in training employees on how to mitigate these threats, there’s the potential reputational risk of Verisign having a critical failure.

[00:33:22] Shawn O’Malley: I’m sure CrowdStrike had what they thought was a robust set of systems in place, until suddenly they didn’t in July 2024, sparking outages worldwide and causing millions of Windows devices to crash. After the stock initially collapsed 40%, it still hasn’t recovered from that debacle. A similar incident at VeriSign would probably have equally grave implications, if not more so.

[00:33:44] Shawn O’Malley: Such a failure, if egregious enough, could spur ICANN and the Department of Commerce to look for someone else to maintain the com registry, dealing a crippling blow to VeriSign’s core business model. On the bright side though, if there is a so called extraordinary expense tied to dealing with the fallout of a cyber attack, for example, VeriSign is permitted under its contracts to raise prices to account for these higher costs.

[00:34:07] Shawn O’Malley: Thanks. This is all well beyond my area of expertise, and while I do find the constant risk of cyber attacks concerning, I suppose that this is the price to be paid for having one of the world’s most profitable businesses legally protected by recurring contracts. With any company, really, you could draw up a worst case scenario that scares you out of investing.

[00:34:25] Shawn O’Malley: These kinds of idiosyncratic risks are the exact reason why diversification is such an important concept in investing. If we like the business enough, all we can really do is trust that VeriSign’s nearly spotless track record will persist and size the position accordingly in our portfolio to further protect from black swan events.

[00:34:44] Shawn O’Malley: Another risk worth mentioning though is VeriSign’s economic sensitivities. For example, a relatively weak Chinese economy over the past few years has resulted in fewer people paying for domain registrations. That, paired with regulations from the Chinese government making it more difficult to register and operate web domains has contributed to what the company has described as a quote, substantial worsening of their business in China.

[00:35:07] Shawn O’Malley: Since 2019, revenues from China have fallen over 30 percent from 119 million to 80 million. That 40 million headwind is only 2 percent to 3 percent of the company’s revenue. But that is still painful, especially for a company that isn’t growing quickly and doesn’t have many ways in the short term to grow either and offset that.

[00:35:26] Shawn O’Malley: I think another risk is the impact of AI. The way we search for information and interact with websites is definitely changing and Google is the most obvious illustration of that. Whereas all searches previously led you to some website. Now, some searches have AI explanations up top that make it unnecessary to ever visit a website.

[00:35:44] Shawn O’Malley: I have trouble seeing how this won’t eventually lead to there being fewer total websites because we’ll have alternative ways to access information. Making a number of websites today just redundant. Some researchers expect that, by 2026, a quarter of all searches will be displaced by chatbots and AI summaries.

[00:36:00] Shawn O’Malley: That would mean significantly less traffic for many websites, hurting their business models, and leading to a spike in domains not being renewed, as publishers opt to just close down their websites if they aren’t profitable anymore. The business is a cash cow, given the lack of investment needed for growth.

[00:36:17] Shawn O’Malley: I do have some data centers that they need to invest in maintaining, but for the most part they churn out a ton of cash flow. They can’t do much with from an operational perspective. While Verisign doesn’t pay a dividend, they do allocate roughly 100 percent of their free cash flows to share repurchases, meaning they buy back a lot of stock.

[00:36:35] Shawn O’Malley: Typically around 3 percent of their outstanding shares each year. Looking at the company’s Q3 results in that quarter alone, they spent over 300 million on share repurchases, which is more than a third of the free cash flow they generated in the previous 12 months. In the underlying business though, there have been some hiccups.

[00:36:52] Shawn O’Malley: In 2023, the rate at which domains were being renewed fell by a full percentage point. The number of new domain registrations declined from 9. 9 million to 9. 3 million. At the same time, the total number of registered com and net domains dropped by 1. 1 million to just under 170 million. During the frenzy of the pandemic years, domain registration was significantly pulled forward.

[00:37:17] Shawn O’Malley: VeriSign’s domain registrations jumped by 15 million during the pandemic, and that kind of double digit percentage leap in domains is not common. So there was a substantial increase in domains during the pandemic, which doesn’t surprise me. It seemed like everyone was starting a new business while they were stuck at home or some weird cryptocurrency, and there was a ton of money sloshing around to support companies, and all of that is a good recipe for more websites being built out.

[00:37:41] Shawn O’Malley: But as things have moderated and returned to a more normal environment, there’s been a hangover in domain registrations. Another explanation, which would be more concerning, is that the domain name market has matured significantly, and many of the most desirable com and net names have already been registered.

[00:37:58] Shawn O’Malley: Thus, make it harder for new entrants to find valuable, short, or relevant names, reducing the incentive for new registrations. This explanation makes some sense to me. While there’s an infinite number of possible domain names, there’s a finite number of ones that are actually useful and valuable. Nobody wants to domain name WMFF32400XYZ.

[00:38:19] Shawn O’Malley: com, obviously they made that up, and that’s the point. It’s possible, but it’s not claimed because it’s not useful. And domains that were once useful may become obsolete as part of a marketing stunt. It seems someone actually does own blockbuster. com, but that’s a good example of a domain that would otherwise no longer be relevant today.

[00:38:38] Shawn O’Malley: I’ll also mention that there are some trendier top level domains that have popped up in recent years like io, co, and xyz, which we mentioned earlier. I see this with a lot of tech companies, and they’re seen as flasher alternatives to just using com. On the margins, if you have more website publishers being attracted to those domains, then of course you’re going to see some declines in the number of com and net registered domains.

[00:39:02] Shawn O’Malley: Also, many of today’s startups might be more drawn to having a presence on social media or just using their app, and they may never even set up a formal website at all. It’s hard to say whether the decline in com and net domains will continue, but it has been a very tangible headwind and one explanation for why the stock’s returns have been flat since 2022.

[00:39:21] Shawn O’Malley: Despite weakness in domain registrations, sales have held up for VeriSign and Grown, rising by a few percent a year, totaling sales growth from 2020 to 2024. I attribute that mostly to Verisign raising prices to more than offset the declines in total domain registrations. While the stock has only delivered a return of just over 2 percent in total since 2020, it has grown free cashflow steadily at an average rate of more than 5.

[00:39:46] Shawn O’Malley: 5 percent per year. Given that the company generates around 850 million per year in free cashflow, I’d say the company is very conservatively leveraged with just 1. 1 billion in net debt. And that doesn’t surprise me at all. This is a company where caution and safety are foundational to its identity.

[00:40:04] Shawn O’Malley: They oversee the internet’s infrastructure and they take that responsibility extremely seriously as they should. So whether it’s with their cybersecurity efforts or financing, they tilt toward the old expression that it’s better to be safe than sorry. They could support considerably more debt, which could be used to more aggressively buy back stock and return capital to shareholders.

[00:40:22] Shawn O’Malley: That would be at odds with the company’s conservative ethos. First lines management knows that it has a very special financial asset in its hands and it doesn’t want to jeopardize that. They have what you might call a golden goose and their dot com registry business. This golden goose is so valuable that using the cash flows that produces to do just about anything else could dilute the overall quality of their business.

[00:40:44] Shawn O’Malley: They don’t want to take the cash from their golden goose and go buy a regular dairy cow with it. If they can’t find better uses for the profits being generated by their business, I have no issue with management consistently returning that money to shareholders. We have talked about this a fair bit with AutoZone last week, which has been as aggressive as anyone in buying back stock.

[00:41:02] Shawn O’Malley: But with AutoZone still, there was a template for growth, even if the company relies on it less than it used to. They know how to set up successful new stores, and when they see the chance to do so, they will. Otherwise, they return cash to shareholders by repurchasing stock. With Verisign, as we’ve covered today, there’s really no similar growth playbook.

[00:41:20] Shawn O’Malley: Verisign can’t just decide to start investing in more stores if it wants to grow its business like AutoZone can. See’s Candy comes to mind as a similar investment from Buffett previously. SEAS does not compete in every grocery store aisle with Hershey’s, yet I’m sure Buffett is fine with that because some businesses, like SEAS and Verisign, are only great at a certain size or in a very specific niche or geography.

[00:41:43] Shawn O’Malley: For these businesses, growth is actually destructive, and therefore the cash is better utilized elsewhere. That doesn’t mean Verisign isn’t compelling though. Highly profitable businesses with virtually no competition seldom come along. As Buffett once mused about, owning the one toll bridge from Michigan to Canada would be a great business.

[00:42:03] Shawn O’Malley: And I’d say VeriSign is the digital equivalent of such a business. VeriSign’s business is so predictable that it’s almost like a bond. I know Buffett has used the metaphor that all stocks are actually just bonds with unpredictable coupons. Still, I make the comparison specifically with VeriSign because there’s a high degree of certainty around its earnings.

[00:42:22] Shawn O’Malley: Just from reading their financial filings, I can tell you over the next six years when they can raise prices for the com or net domains and by how much. I can also tell you the number of registered domains. And given that this number doesn’t fluctuate much, I can tell you with much higher certainty, how much revenue VeriSign will earn in three years than I could for just about any other company out there.

[00:42:43] Shawn O’Malley: And I also know that VeriSign’s profit margins have hardly moved over time. So again, I can not only confidently predict a reasonable range of revenues, but also the company’s earnings by multiplying those revenues by the company’s average profit margin. Even if I like AutoZone long term, I couldn’t say with any confidence what will be happening with the company three years from now, and AutoZone is one of the more stable businesses out there.

[00:43:06] Shawn O’Malley: With dynamic and fast growing companies, knowing what the future looks like is even harder. I can’t imagine trying to anticipate what Tesla’s business will look like in 5 years with much confidence given how quickly things change with that company. But VeriSign is clearly the opposite, so predictable that it teeters on bond status since bonds have defined payments over a number of years.

[00:43:27] Shawn O’Malley: With companies like Tesla, you could pay a hefty premium for the stock today and get bailed out by fast growth and its underlying business over time. Modestly overpaying for a fast growing tech company is not necessarily a big deal. Yet with a bond like company such as Verisign, the price you pay for the stock is everything.

[00:43:46] Shawn O’Malley: Let me make the point with a bond example. I’ll keep the numbers super simple to follow along with. Let’s say there’s a corporate bond that pays 7 percent interest per year for 5 years and the bond costs 1, 000 to buy. At the end of those 5 years, you’ll get your 1, 000 back, but will have made a return of 7 percent per year in the meantime from 70 annual coupon payments.

[00:44:07] Shawn O’Malley: That sounds pretty great. A lot of other people will notice this deal too, though, and also wants to get paid 7 percent per year with little risk, and so the price of the bond will get bid up. Now, the same bond costs 1, 200, but still pays the same 70 interest. So instead of offering a 7 percent annual return, it now offers a current yield of only 5.

[00:44:27] Shawn O’Malley: 8%. By paying a higher amount upfront and getting the same interest payments, your return in percentage terms falls off. And then when you account for the fact that if you pay 1, 200 for a bond that pays you only 1, years, your return actually falls off even further to less than 3%. The point being simply that by paying 20 percent more for the same bond, your return drops off from 7 percent a year to less than 3 percent a year.

[00:44:52] Shawn O’Malley: With bond investing, price is everything. And the opposite is true too. By paying less than 1, 000 of the same bond, your annual return would jump up to greater than 7 percent a year. I’m taking you through the math to say that with Verisign, the share price is everything. More so than with other types of stocks that have more growth.

[00:45:11] Shawn O’Malley: And the price paid for the company’s steady future cash flows will largely determine whether VeriSign is a satisfactory or unsatisfactory investment. At this point, I’m now overstating the predictability of VeriSign’s business because it can of course fluctuate, domains can fall off or grow faster than expected, and the company may not make use of price increases that are legally available to it.

[00:45:33] Shawn O’Malley: That said, comparatively speaking, this is about as predictable of a business as it gets for a public company. Now, let’s actually look at Verisign’s valuation and decide whether the company is indeed attractively priced. Since 2018, the median price to earnings ratio that investors have been willing to pay for Verisign’s stock is 31, but today that number is down to 24, slightly above its lowest levels over the last decade.

[00:45:58] Shawn O’Malley: Even though it’s down, I still wouldn’t say 24 times earnings for a business with almost no growth is cheap. But yes, this does mean that, comparatively speaking, the price of owning a share of Verisign’s high quality business today is on the lower end of its normal spectrum. Assuming that we are through the worst of the weakness in Chinese domain registrations, and that domains will no longer keep declining and will instead grow by 0.

[00:46:20] Shawn O’Malley: 5 percent per year on average, alongside the assumption that the company will raise prices for its com and net domains in the coming years, Without completely maximizing price hikes to the full extent that they’re legally allowed to, while also continuing to use their cash flows to repurchase stock aggressively, I get an estimated growth rating for cash flow per share of almost 10 percent per year.

[00:46:40] Shawn O’Malley: Clearly, there are a few different assumptions baked in there. If we were to instead assume that demands continue to decline slowly each year, with Verisign making up for that by taking full advantage of the price hikes they’re legally allowed to do. Then the estimated annual return again comes out to over 9%.

[00:46:58] Shawn O’Malley: If ICANN eventually grants VeriSign the ability to do unrestricted price hikes, then returns could be dramatically higher. The same is true if the price to earnings ratio reverts back to its long term average. Both of those optimistic scenarios could easily generate double digit returns. Which would be wonderful outcomes considering that not much business risk is being taken to earn them.

[00:47:18] Shawn O’Malley: Even in scenarios where domain registrations fall off more dramatically, dropping by more than 15 million over the next 5 years, so long as VeriSign takes full advantage of the price hikes permitted by ICANN, I still get an estimated growth rate in earnings per share by nearly 8 percent per year. So, anticipated price hikes can pretty well absorb the negative effects of a scenario where declining domain registrations persist.

[00:47:43] Shawn O’Malley: As with any model I put together, the aim is to help me think through a range of plausible things that could happen in the coming years and consider how that would affect my returns. When even the pessimistic scenarios lend themselves to acceptable returns, with even more upside if a few things work out positively in your favor, then I definitely get interested.

[00:48:02] Shawn O’Malley: I want investments where I’m not at risk of losing much, but can potentially benefit substantially. My baseline scenario here is that free cashflow per share will grow by about 8 percent per year thanks to higher domain prices and share buybacks, and thus I’d expect to earn an 8 percent return correspondingly from current price levels.

[00:48:20] Shawn O’Malley: At the time of recording, according to Moody’s, the long term interest rate on investment grade corporate bonds is about 5. 6%. So if we really do see Verizon stock as being similar to a corporate bond with perhaps slightly more risk, then I get between 220 and 230 per share as my estimate of intrinsic value for the company.

[00:48:39] Shawn O’Malley: The expected return of 8 percent per year from that fair value isn’t going to deliver market beating returns, but you’re also not taking the same kind of risks as the broader stock market either. When you buy the S& P 500, you’re not getting a monopoly with a contractually protected business at the foundation of the internet.

[00:48:55] Shawn O’Malley: You’re getting a mix of high and low quality businesses facing a range of different competitors valued in aggregate well above historical levels. Not to discourage anyone from buying an S& P 500 index fund, my point is that the S& P 500 is not the perfect benchmark to use for a company like Verisign.

[00:49:13] Shawn O’Malley: Given these strong moats around Verisign’s business that make its operations so steady and profitable, and also provide a floor for the plausible worst case outcomes that could occur, I feel very good that on a risk adjusted basis, Verisign is a wonderfully simple, enduring, and attractive business to own.

[00:49:30] Shawn O’Malley: But if I wanted to get relatively low risk 6 8 percent returns, I’d just go out and actually buy corporate bonds. Sure, there’s some upside here, too, but there’s also a potential downside. For me to be really excited about Verisign, I need the share price to be lower. I think a fair value for the stock is about 220 per share as I mentioned a few moments ago, so to give myself a margin of safety, I’m not interested in owning at any price above 200 for the time being, and realistically, I probably don’t want to pay more than 190 per share.

[00:50:00] Shawn O’Malley: At those levels, though, I think a 12 percent or higher return is quite plausible. As such, at any price below 190 or 200 per share, I may add VeriSign to the intrinsic value portfolio. At the time of recording, the stock is above that threshold, so I’m not expecting to immediately build a position, but we’re close enough that Mr.

[00:50:18] Shawn O’Malley: Market may give me a chance to do so in the coming weeks or months. Unlike with Alphabet where I’m a bit more flexible on price, given how much that business can still grow with Verisign, I need to be very strict on pricing. The next question then is on position sizing. Since Verisign isn’t a compounder that can substantially grow its business over time, I don’t expect to have more than 10 percent of the portfolio allocated to Verisign given the opportunity costs.

[00:50:43] Shawn O’Malley: It will probably be much less, if any at all, and its role in the portfolio would reflect that it offers more attractive returns in cash, than Verisign. We’ll also probably not being the type of home run that will single handedly carry the portfolio to double digit returns for many years. I hope to scale the position to be maybe three to 5 percent of the portfolio over time, but if it remains at current prices or higher, or if there are some changes to say how quickly its domain registrations fall off, then I’ll pass on the opportunity here and in our free intrinsic value newsletter going forward, I’ll keep you updated on what happens.

[00:51:15] Shawn O’Malley: In a way, you could argue that VeriSign is well beyond my circle of competence, since I know nothing about cybersecurity, or technically know what they’re doing, but at the same time, I think the business is pretty straightforward. Despite the jargon associated with talking about internet infrastructure, VeriSign really is basically just a toll road company, and once you get a grip on how its contracts are structured and its relationships with domain registrars, you realize it’s not all that complicated of an opportunity.

[00:51:41] Shawn O’Malley: If some critical technical failure occurs, and yes, the investment would be in trouble, but you could say that about any company. Maybe I’m naive, but from everything I’ve read, Verisign is a well-respected operator and is seen as trustworthy in managing the infrastructure that it oversees. And I do feel that from a business perspective at least, I clearly understand what’s going on, even if I couldn’t explain the nuances of how the domain name system works technically.

[00:52:05] Shawn O’Malley: But I can recognize that Apple is an excellent business without knowing how to build iPhones. As always, let me send you off with a quote from the Oracle of Omaha himself. He says, time is the friend of the wonderful company. The enemy of the mediocre. I’d like to add that if you’ve enjoyed this conversation about Verisign today, you should check out our Q1 2025 mastermind episode discussion on We Study Billionaires, where I joined Tobias Carlisle and Stig Brodersen to discuss the merits of Verisign.

[00:52:36] Shawn O’Malley: Tobias actually is the one who pitched the company, but I gave him some feedback on basically the bear case. And I think you’ll get even more out of it after having the context of listening to this episode. That’s all for today. I’ll see you next time.

[00:52:50] Outro: Thank you for listening to TIP. Make sure to follow The Intrinsic Value Podcast on your favorite podcast app and never miss out on our episodes. To access our show notes and courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decisions, consult a professional. This show is copyrighted by The Investor’s Podcast Network. Written permissions must be granted before syndication or rebroadcasting.