Communicate.com and the Rising Value of Domain Names (CMNN.ob)

Is Communicate.com (ticker: CMNN) an undiscovered and attractive micro-cap play on e-commerce? So argued James Altucher in an article in the Financial Times:

Communicate.com is quietly transforming [sic] from a seller of domain names like Karate.com and Body.com to using those domain names to generate e-commerce sales, particularly in its sites Perfume.com and FrequentTraveller.com. The site just had its 10th consecutive profitable quarter and increased revenues 43 per cent year-over-year. The stock trades for $1.

Communicate's strategic decision to keep domain names for its own use instead of selling them illustrates an important Internet trend: Advertising and e-commerce are now more profitable than the domain name registration business. And single-word domain names have become valuable due to the natural traffic they attract versus the cost of paid search ads.

The key question for investors in CMNN is how profitable those businesses can be. CMNN's current focus is its e-commerce sites. Its largest e-commerce site is Perfume.com, which currently accounts for more than 50 percent of revenues (according to info supplied to me by the company). Karate.com and Cologne.com are smaller, and Body.com is due to launch in 2006. (Presumably the latter will sell health or beauty products rather than slaves.) In Q3, e-commerce accounted for $761 thousand in sales out of total revenue of $1.017 million.

But e-commerce is a lower margin and riskier business than ad sales. E-commerce companies risk getting lumped with inventory they haven't sold; they have to handle returns; and they have a responsibility to provide customer service. On top of that, it makes no difference where you buy perfume from (as long as its genuine), so price competition in that market could be fierce.

Which brings us to Communicate's advertising business. CMNN owns single-word domains including boxing.com, stereos.com and mouse.com. It monetizes the traffic they receive with pay-per-click home-page and search ads, splitting the revenue roughly 50/50 with Yahoo! (formerly Overture). CMNN also receives some advertising revenue in the form of membership fees from Importers.com, its B2B trade portal. Advertising accounted for about 25% of Q3 sales.

The remaining revenues come from the sale of travel at Malaysia.com, Indonesia.com and Vietnam.com, operated by Communicate's majority-owned travel subsidiary, FrequentTraveller.com. The company plans to launch Brazil.com as a travel site in 2006.

Communicate's enterprise value is roughly $19 million (16.1 million fully diluted shares outstanding multiplied by its current stock price of about $1.20 minus about $1 million of net cash on its balance sheet). It generated $117,000 of net income in Q3, but $53,000 of that came wasn't operating income -- it came from a one time gain on a debt settlement.

So is CMNN an attractive micro-cap play on e-commerce? If it can grow its e-commerce businesses fast enough with reasonable margins and continue to monetize its other domains with those infuriating search ads, perhaps it could make enough profit to justify that enterprise value.

But it seems to me the most interesting point is this. Even if Communicate's e-commerce efforts fail to generate meaningful profits, those single-word domain names just seem to be getting more and more valuable over time. Why?

1. The Internet's market share as a sales channel is rising over time.
2. As e-commerce web sites become more efficient, conversion-to-sale ratios rise and the value of a good domain name increases.
3. As online advertising becomes more targeted (for example through Google's site-specific advertising), it's easier to monetize good domain names.

Communicate.com itself seems to recognize the value of these domain names, and structures its deals accordingly. From the 10-Q (my italics):

...Registrant became a majority shareholder of FrequentTraveller which has developed and is operating travel sale websites utilizing non-exclusive access to Registrant’s domain names Vietnam.com, Malaysia.com, Indonesia.com, Brazil.com and Canadian.com. Registrant will continue to own the aforementioned domain names...

So what is the value of Communicate's domain names -- such as Malaysia.com, Indonesia.com, Vietnam.com, Brazil.com, Body.com, Boxing.com and Mouse.com -- today, and what will it be in five years' time? I'd be interested to hear readers' estimates.

Stock chart above (click to enlarge); company web site here; company blog here (highly recommended); and excerpts from the company's 10-Q below (for those wanting more detail). Caution: this is a highly volatile "penny stock".

Summary of Communicate.com's business from most recent 10-Q:

REVENUES AND COSTS OF REVENUES

Domain Name Leasing and Advertising. In the third quarter of 2005, Registrant generated domain name leasing and advertising revenue of $256,705 as compared to $171,885 in the third quarter of 2004, an increase of 49.4%. Management is satisfied with the current result as it surpasses Management’s growth target of 40% year-over-year. Management is continuing its effort to add to its domain portfolio to enhance revenue generation and is maintaining its growth target while certain domain names, such as body.com, are slated for development into ecommerce retailing sites. As more domain names are converted to retailing sites, domain name leasing and advertising growth will be curtailed while eCommerce sales will increase.

Domain Name Sales. In the third quarter of 2005, the Registrant did not sell any domain names. Management has concluded its strategy to recapitalize the Registrant through the selling of non-strategic domain names. Proceeds from the prior sales in 2003 and 2004 were used to repay a note payable and to enhance the Registrant’s financial ratios and liquidity. Management has begun acquiring new domain names both individually and as a portfolio to replenish its asset base and to increase its advertising revenue. While Registrant has no immediate plans to sell any domain names in the near future, it will evaluate opportunities as they arise.

eCommerce Sales. Registrant began converting Internet traffic into customers by directly marketing and selling consumable goods. Beginning in May 2003, Registrant launched its cologne.com and perfume.com Internet retail sites and karate.com Internet retail site in 2004. In the third quarter of 2005, the combined retail sites generated sales of $583,933 (2004 Q3 - $339,604), or approximately $6,347 per day (2004 Q3 - $3,691 per day), with cost of purchases and shipping totaling $456,071 (2004 Q3 - $268,890) resulting in gross profit of $127,862 and gross profit margin of approximately 21.9% (2004 Q3 - 20.8%). Comparable quarterly sales have increased by 72.0% and gross profit margin in percentage term has increased by 5.3%. The improvement to current gross margin percentage over the previous quarter’s gross margin percentage of 17.1% reflected a more stringent fragrance vendor selection process based on analyzing a vendor’s stock selection, quoted margin, past service history and shipping costs. Also, with respect to karate.com, management improved on the sporting goods product mix and profit margin by eliminating items which involve high shipping costs. Management is continuously monitoring its overall product offerings and profit margins to maintain an acceptable gross profit margin of between 20% to 22% and to add growth to overall eCommerce sales. One disappointment is that the launch of body.com has been delayed to 2006 as management will instead focus on the holiday shopping period occurring in the fourth quarter of 2005.

In the third quarter of 2005, Registrant through its travel business subsidiary generated product sales of $172,337 at a cost of $146,577 as compared to sales of $105,603 at a cost of $87,636 in the third quarter of 2004. The travel operation incurred a net loss of $35,629 in the third quarter of 2005 and an accumulated deficit of $317,192 since inception in October 2002. During the third quarter of 2005, the subsidiary incurred accounting and legal fees of $13,168 related to its Form SB-2 filing. By excluding such fees, the loss would have been reduced to $22,461, an increase over the previous quarter’s loss of $15,787. While Management has reduced the monthly overhead by consolidating its base of operation it has not reached its revenue target of $150,000 per month and will continue to work to meet this goal. Management continues to build its travel business by forming affiliations with partners in Southeast Asia and in Brazil and estimates that the travel business will break-even when sales approach $150,000 per month and believes the goal is achievable within twelve months.

MARKETING. Registrant has begun to advertise online by paying-for-clicks and search-engine-placements and other media in 2004 and has continued its effort into 2005. In the third quarter of 2005, Registrant recorded marketing expenses of $43,295 or 7.4% of eCommerce sales as compared to $24,274 or 7.2% of comparable third quarter sales in 2004. Marketing expense is in line with expectation, and Management expects marketing expenses to increase as sales increase and has planned to use up to 10% of gross product sales for marketing in 2005.

GENERAL AND ADMINISTRATIVE. Registrant’s general and administrative expenses consist of costs for general and corporate functions, including facility fees, travel, telecommunications and investor relations. In the third quarter of 2005, Registrant recorded general and administrative expense of $80,307 (7.9% of total sales) as compared to $67,922 in the third quarter of 2004, an increase of 18.2%. Overhead costs have increased in line with increased staff and related costs. The currency exchange rate between the Canadian dollar and the US dollar has increased by over 10% and has contributed to costs which were primarily invoiced in Canadian dollars. Management expects general and administrative expenses to increase as total revenue increases but will attempt to maintain general and administrative costs below 10% of total sales.

MANAGEMENT FEES AND SALARIES. In the third quarter of 2005, Registrant incurred management fees and staff salaries of $217,750, an increase of 30.6% over the third quarter of 2004 of $166,735. New hires, scheduled salary and wage increases, and the fluctuation in the Canadian dollar have all impacted this line of expenses. Management expects staff salaries to increase slightly in the coming quarters as hiring slows down while management assesses productivity returns.

PROFESSIONAL FEES. Professional fees include legal and auditing fees. During the third quarter of 2005, professional fees totaled $24,404 as compared to $2,782 in 2004, an increase of 777%. Both legal and auditing fees have increased because the Registrant’s travel services subsidiary has filed its Form SB-2 to offer up to 4,000,000 common shares at a price of $0.50 per share. Any funds received by the Registrant’s travel business subsidiary on this offering will be used for the development of its travel business. Other than professional fees related to the travel subsidiary’s Form SB-2 filing, Management is unaware of factors which are likely to increase professional fees in the fourth quarter of 2005.

Liquidity and Capital Resources

Registrant seeks to generate revenue from (i) leasing domain names to third parties to conduct on-line businesses; (ii) selling products and services of both company owned inventory and of inventory owned by third parties; (iii) fees resulting from Internet traffic click-throughs generated by company owned domain name assets; and (iv) trading of domain name assets.

Management’s previously stated goal of eliminating the working capital deficiency has been achieved in the third quarter of 2004 and maintained into the third quarter of 2005. At September 30, 2005 Registrant had current assets in excess of current liabilities resulting in a positive working capital of $1,042,463 as compared to a working capital of $411,397 at the fiscal year ending December 31, 2004. During the nine-months ended September 30, 2005 Registrant had net income of $365,751 and an increase in cash of $424,888, compared to net income of $303,352 and an increase in cash of $192,537 for the same nine-month period of last year. Operating activities generated cash inflows of $157,768 after primarily reducing accounts payable and excluding the non-cash dilution gains from the sale of equity in the Registrant’s travel subsidiary during the nine-month period ended September 30, 2005. During the nine months ended September 30, 2005, the Registrant raised a net of $297,100 through: i) the completion of a private placement of 275,000 common shares for $100,000 cash; ii) the exercise of stock purchase warrants into 2,000,000 common shares for $100,000; and iii) the net private placement to non-controlling interest of FT of $97,100. From the beginning of the fiscal year to September 30, 2005, Registrant has reduced its accumulated deficit to $834,497 from $1,200,248 and has stockholders’ equity of $2,620,020.

In October 2003, Registrant became a majority shareholder of FrequentTraveller which has developed and is operating travel sale websites utilizing non-exclusive access to Registrant’s domain names Vietnam.com, Malaysia.com, Indonesia.com, Brazil.com and Canadian.com. Registrant will continue to own the aforementioned domain names and to develop businesses other than travel sales for them. FrequentTraveller has two managers and is not expected to generate sufficient revenue to cover expenses for at least twelve months. Any fund shortfall, currently requiring $10,000 per month, will be covered by Registrant or by sourcing outside capital. During the first nine months of 2005, FT completed a private placement of $147,100 in new common share at a price of $0.05 per common share, including $50,000 invested by the Registrant. Since inception, FT has raised $338,926 in private placement equity, including $120,000 invested by the Registrant, and accumulated a deficit of $317,192 with total shareholders’ equity of $21,734. On July 19, 2005, FT filed a Form SB-2 offering up to 4,000,000 common shares at a price of $0.50 per share on a non-sponsored best effort basis. While the offering has been filed, it is not yet effective and may not become effective. FT plans to use any proceeds from this planned offering to expand its business and for working capital purposes.

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