Wednesday, December 31, 2008

Virtual real estate (domain names)

Over the past couple of years, while plying me with sardines and onions, my buddy Igal has been educating me about the domain name space. Arguing that domain names, due to their uniqueness ('Charlie, there are 4 corners on 42nd and 5th, but only one domain name 42nd and 5th') have more potential value, and far less holding costs than physical real estate; he's had me intrigued enough to bring the family together and build a modest (er, tiny) portfolio. Other folk with interest in this market include the multi-billion dollar PE fund Oak Investment Partners, with their large investment in Demand Media and Summit Partners and Highland Capital leading the investment in Name Media (mentioned later).

Rather than hiring folk to design the sites, build the graphics and sell the advertising, I parked them with a couple of companies where you contract with them (easily terminated at any time) to put up content and sell advertising on my behalf, and splitting revenues. It's really a no hassle arrangement and we anxiously sit back as the various checks, some as much as $1.28 :-) come rolling in. Each of the parked domains have a 'for sale' sign on them and we did sell two that netted enough returns to pay for the entire portfolio.

Looking at the current state of the domain parking business, it will come as no surprise that, consistent with the downturn in advertising rates for display advertising and PPC rates, many participants are reporting revenue declines, on a same property basis, in the 30% range. Expectations are that Q1 '09 will continue the downward trend, though 'premium'/high traffic names should fare far better than generic names which only qualify for 'remainder' revenues.

Similar to physical real estate, but with a far lower cost of entry, domain names have intrinsic 'location' value, as well as a more tangible value based on a function of cash flows. This market has seen its share of speculation driving prices to levels only justified by intrinsic value (e.g. hopes and prayers). I suspect we are now beginning to see the whiplash in valuations as domain current income plummets and intrinsic value clouds. It's always difficult to measure intrinsic value as its beauty is in the value of the beholder. DN Journal is one of the leading trade magazines covering the space. In the two links below, you will find a summary of the valuations for the top 100 domain sales for 2007 and 2008.

2008

2007

As businesses are only as healthy as their customers, we should expect that the scores of domain parking and optimization companies that comprise the heretofore growing ecosystem will also be negatively affected. One quality company, NameMedia has withdrawn its IPO (probably due to a combination of market conditions as well as a softening P&L outlook), and already public, Marchex has seen its market cap plummet 45% in the past 60 days.

Due to the scarcity value of physical real estate, as well as the intrinsic value of many names that are not yet developed (e.g. can't you see intrinsic value for J&J owning the parked, and obviously not optimized sneeze.com?) all supported by innovation in the ecosystem, I have no doubts about the long-term health of domain names and their supporting cast (see Sendori as an example.

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