Valuation and Financial Analysis
Web.com currently trades at a trailing twelve months price-to-sales ratio (P/S) of 2.1, trailing twelve months price-to-free cash flow (P/FCF) of 3.8. P/E and P/B ratios are not used in the valuation of Web.com, due to negative earnings and the large proportion of goodwill from acquisition respectively. Web.com has a dismal earnings track record with losses in five out of the past ten years and was only profitable in 2009 in the last five fiscal years. However, it generated positive free cash flow in every year since its listing in 2005. Web.com’s gross margin fell from its 2008 peak of 64% to 56% in fiscal 2010. It has since recovered to achieve gross margin of 60% for fiscal 2012. Web.com’s margins are expected to expand in future periods, as it reaps the benefits from the economies of scale as a result of its past acquisitions.
Web.com is highly geared with a gross debt-to-equity ratio of 428%. In October 2011, Web.com entered into debt financing arrangements totaling $800 million, of which $771 million of proceeds were used to pay off existing debt and to complete the acquisition of Network Solutions. As of Dec. 31, 2012, $701 million of the debt remained outstanding. On Feb. 12, 2013, Web.com announced that it planned to amend, increase and re-price its First Lien Credit Facility and use the proceeds of such increase to repay the remaining balance of its Second Lien Term Loan. It will seek improved terms on its First Lien Term Loan, which has a current interest rate of LIBOR plus 4.25%, with a LIBOR floor of 1.25%, and a balance of approximately $628 million at Dec. 31, 2012.
Competitor/Peer Analysis
Since there are no direct listed companies comparable with Web.com, I have used business software and services companies: Adobe Systems Incorporated (NASDAQ:ADBE), ValueClick Inc (NASDAQ:VCLK), and Oracle Corporation (NASDAQ:ORCL) for peer comparisons. Adobe and Oracle sell business and enterprise software to companies; while ValueClick is a digital marketing services company. All four companies trade at 14-15 times trailing twelve month P/FCF; while Web.com is undervalued on a trailing twelve month P/S basis (2.1 times P/S) relative to the other three stocks. ValueClick, Adobe Systems and Oracle are valued by the market at 3.1, 4.4 and 4.4 times P/S respectively. However, all three of them are profitable with strong balance sheets. Adobe Systems and Oracle have net cash financial positions; while Valueclick’s net gearing is only 10%.
Investment Risks
Web.com’s existing and target customers are SMBs, which are more likely to be adversely affected by economic downturns than larger and more established businesses. SMBs tend to behave more conservatively in light of a weak economic environment, and may choose to cut back on spending and resources to develop their online presences. The risk of business closure represents the greatest threat to lower than expected customer retention rates.
Web.com’s ARPU growth is dependent on the successful retention and upselling of products to Network Solutions’s acquired customer base, and its investments to drive growth. While Web.com was able to successfully increase ARPU from $15.39 in the four quarter of 2010 (post-acquisition of Register.com) to $17.38 in the fourth quarter of 2011, there is no guarantee that it can achieve the same level of success with Network Solution. Also, its new customer acquisition efforts through marketing activities such as the “Feet on the Street” direct sales initiative, a Direct Response Television campaign and a Tour Title sponsorship may or may not achieve the desired results.
Conclusion
Web.com is a proxy for the migration of SMBs online and is making efforts to reduce debt and lower effective interest rate, in addition to generating strong free cash flows to meet interest payments. Notwithstanding that it is cheaper relative to peers on a P/S basis; I will prefer to purchase Web.com when it shows signs of increased balance sheet strength and profitability.
The article Domain Names Help Web.com To Get A Foot In The Door of SMBs originally appeared on Fool.com and is written by Mark Lin.
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