This Once Unstoppable Industry Is Starting To Shrink

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Includes: GDDY, VRSN, XLF, XLY
by: StreetAuthority

Summary

A new study by Adobe suggests that internet growth has slowed considerably or even stopped altogether.

Companies with a large share of revenue based off of internet growth in North America and Europe are likely to be negatively affected by this trend.

Retailers and Finance & Insurance are two sectors that could stand to gain from lowered ad prices - invest in XLY and XLF to capture potential growth.

By Joseph Hogue

The internet turned 47 years old this year. That's if you count from the first computer-to-computer linkup on ARPANET in 1969. Even counting from the creation of the world wide web in 1989, the online revolution would be getting close to its 30s.

While few companies are trading at the dizzying heights of the dot-com bubble, there are still quite a few names that trade as 'growth' stocks on the assumption of years left to internet growth.

But what if the internet stops growing?

Nearly everyone in the United States (89%) is connected and internet penetration is as high as 94% of the population in the United Kingdom. What happens when the growth that investors are assuming to drive internet-related companies just isn't there?

Turns out it may already be happening.

A new study by Adobe suggests that internet growth has slowed considerably or even stopped altogether and it could be disastrous for a few tech names.

The Internet Is Dead, Long Live The Internet
A report by Adobe suggests that internet traffic may have reached its peak as fewer net new people come online every year. The company's first Advertising Demand Report was compiled from more than 1.1 trillion visits to North American and European websites over the 41 months to June 2016.

Just over half (six of ten) of the websites were growing, increasing traffic by an average 51% per year but the remaining 40% of sites were seeing a rapid decline in traffic. Websites growing traffic reported an average of $0.17 in revenue per visit while declining sites booked $0.159 in sales per visitor.

The total number of new websites has been flashing red for a couple of years. The number of internet sites reached one billion in 2014 before falling and only hit that mark again in March of 2016. The number of active sites has been stable around 1.085 billion for growth of under 4.2% annually over the last two years.

Who Will Lose As The Internet Matures?
Internet usage is still growing in emerging markets but the total number of websites seems to have reached a natural cap. While companies exposed to growth in developing nations may still be able to eke out gains, those with a large share of revenue from North America and Europe could see expectations come down significantly.

GoDaddy (NYSE:GDDY) is the world's largest domain name registrar and trades just 4% off its 52-week high. The company provides website registration and hosting services. Earnings missed estimates widely last quarter and the company has lost $0.27 per share over the last year. GoDaddy acquired its 17th company late September, buying a Serbian WordPress management site that allows users to manage multiple sites from one dashboard.

Sales growth has slowed every year since the company started reporting in 2011. Not only will slower growth hit sales to domain registrations but competition for hosting could increase as companies fight for market share.

VeriSign (NASDAQ:VRSN) has sole authority to register several top-level domains like .com and .net and operates two of the world's 13 root servers used to route internet traffic. Not only is growth limited on peak internet but the company may lose its protected exclusivity to register domains with ICANN.

Senators Cruz, Lee and Duffy sent a letter to the Department of Justice in August expressing concern over the government's renewal of Verisign's exclusivity with ICANN to operate the global .com registry. While the company will keep its monopoly for the next couple of years, it may not have exclusivity for much longer.

Sales growth has slowed to an average of just 4.8% over the last two years versus an average of 11.8% over the two prior years. The company's .com and .net top-level domains command nearly 50% of the internet but other domains like .tv and .org are growing in influence.

Potential Winners In the Space
Against the potential for falling sales at companies reliant on domain registration and web services, there are two sectors that could benefit as the internet reaches maturity. While ecommerce sales should continue to rise, the cost of advertising has already been falling for some time as competition increases for advertising dollars. Per click advertising rates on Google Adwords have fallen for 17-consecutive quarters.

Retailers stand to benefit as ad rates decline on an estimated $23 billion in sector advertising from the sector by 2020, up from an estimate of $15.1 billion in 2016 according to eMarketer. On an average operating margin of just 15% and with marketing accounting for the majority of expenses, companies in the consumer discretionary sector may be able to boost profitability as ad rates fall. This sets the Consumer Discretionary Select Sector SPDR ETF (XLY) up to gain on lower ad rates and higher consumer spending on a recovering economy.

Finance & Insurance also stands to benefit as one of the largest spenders by sector on Google Adwords, with the sector spending as much as $4 billion on Google in 2015 alone. The Financial Select Sector SPDR (XLF) has underperformed the S&P 500 by 8.3% over the last year on a shrinking net interest spread but may be able to improve profitability on lower ad rates.

Risks To Consider: While overall internet growth may slow or stop, there will still be individual companies that are able to buck the trend for faster growth.

Action To Take: Avoid companies with revenue tied directly to overall internet growth like domain registrars while positioning in companies that could benefit from decreasing advertising costs.

This article originally appeared on StreetAuthority.com.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.