VeriSign's Pain Falls Mainly in Domain Names

Before VeriSign (VRSN Quote) shares fell off a cliff Friday to a new 52-week low, a pack of analysts downgraded the company, citing its ailing domain name business.

While troubles in the domain name world are nothing new, they look as if they are going to get worse before they get better. The crux of the problem: The domain name land grab of the dot-com days has been replaced by a greater number of registrars fighting each other with cutthroat tactics for a shrinking base of customers.

The total number of registered domain names has been declining monthly since October, according to SnapNames, a domain industry infrastructure provider that publishes a monthly count on domain names.

By contrast, an average 60,000 domain names were registered daily in the fall of 2000, the heyday of domain name registrations. Part of the frenzy was fueled by speculators who bought any name they thought they could resell at a profit and companies that bought domain names defensively to prevent them from getting into the wrong hands.

At the beginning of 2001, the number of new registrations began growing more slowly and the number of names that expired began rising. One reason was one-year registration terms and $35 pricing were first introduced in January 2000, attracting more speculators, said SnapNames in its "Share of the Domain" report for the first quarter of 2001.

As their registrations came up for renewal a year later, though, many domain name holders preferred to hold on to their money and give up their addresses. Speculators realized it wasn't as easy to sell their property as they thought, and cybersquatters changed their ways in the aftermath of Congress' passage of the Anti-Cybersquatting Consumer Protection Act, according to SnapNames. In addition, as domain name ownership became more ubiquitous, it became common for owners to forget to renew registrations, the firm said.

Shrinking Domain The number of Web site names has been falling

Source: SnapNames

Meanwhile, a growing number of companies began selling domain names in a market that VeriSign's predecessor, Network Solutions, once enjoyed as a virtual monopoly. Prices declined to as low as $6.75 for renewals and registrars became notorious for what SnapNames politely calls "cross-renewal campaign tactics." Also called slamming, registrants solicit competitors' customers to renew and transfer their domain names to them, often confusing customers about who is soliciting the renewal.

Fast forward to October, the first month ever in which domain name expirations exceeded new name registrations. During the fourth quarter of 2001, VeriSign, the largest domain name registrar, and Register.com, ranked No. 3, reported plans to unload a batch of roughly 1.5 million "promotional" domains that expired, according to SnapNames. These include names ending in .net and .org that the companies gave away free with .com registrations, and which were not renewed when it came time to renew the .com property.

An Outright Decline

Registrars continued the flushing this year, and the number of registered domain names consequently continued declining.

Overall, total registered .com, .net and .org domain names declined 4.2% to 29.3 million at the end of the first quarter compared to the end of the fourth quarter of 2001, according to SnapNames.

On Thursday, VeriSign said its total registered domain names fell even further, by 12%, to 12 million at the end of the first quarter from 13.6 million at the end of the fourth quarter. And VeriSign's renewal rates for domain names dropped to the 40% range, from 54% in the fourth quarter. (SnapNames does not track industrywide renewal rates.)

Shares of VeriSign plummeted Friday, closing down $8.35, or 45.8%, at $9.89. Shares of competitor Register.com, set to report earnings after markets close today, also fell 10.9% to $7.55. Shares of NetNation Communications remained flat Friday at $1.50, but have lost 50% of their value since the beginning of the year.

Part of the reason VeriSign's numbers declined more than the overall market was the company's continued flushing of promotional names early in the first quarter and then in the final week of March, according to SnapNames.

Unaware of VeriSign's plans to unload 622,000 names at the end of March, SnapNames and analysts had expected registrations to stabilize during the month.

"We thought the promotional name flush would be over," said SnapNames spokesman Mason Cole. "But that wasn't the end of the it."

Analysts echoed those sentiments. In a note Friday, UBS Warburg analyst Jordan Klein said he had expected VeriSign's first quarter to be weak when he downgraded the company to hold from buy a week earlier, but not nearly as weak as VeriSign reported. "Conditions seem to have materially worsened even beyond our wildest imagination, especially in the domain name business that VRSN depends upon for profitability and cash flow," Klein said. His firm hasn't done any banking business with VeriSign.

In recent weeks, Wall Street analysts and industry CEOs have been asking whether the domain name business is collapsing altogether, SnapNames said in its first-quarter 2002 report released last week.

"The show isn't over yet," SnapNames CEO Rob Wiener wrote. While past purges were heavy in the .net and .org names, more recent expired names fall into the .com category. And early April counts show an even more dramatic plunge.

But in an interview, Cole points out that domain names aren't going away. "Come on, be reasonable," he says. "You have to have these things. That's a service I would be hard-pressed to figure out how it would go away."

Rather, SnapNames characterizes the recent declines as a "long-needed market correction." And the firm even found a positive side: When the purge is over, the quality of the average customer will be higher and recurring renewals will be more predictable.