Tucows Podcast on Its NetIdentity Acquisition - Transcript

| About: Tucows Inc (TCX)
This article is now exclusive for PRO subscribers.

Tucows Completes Acquisition of NetIdentity: Transcript of Podcast With Tucows CEO Elliot Ness
June 15, 2006

[intro music]

Host: Welcome to this Tucows podcast, featuring an interview with Tucows CEO Elliot Noss, on the NetIdentity acquisition.

[music fades out]

Host: I am speaking with Tucows CEO Elliot Noss about the recent acquisition of NetIdentity.

Elliot, what exactly are you buying?

Elliot Noss: We're buying a few different things.

First, we're buying an existing customer base, of retail Internet service as clients. These are customers who receive email services, Web hosting services, blogging services from NetIdentity.

Most importantly here, we're buying a collection of domain names that are surnames, and they represent a very large number of popular surnames throughout North America, Europe, and frankly around the world. The reason that we're so excited about those surname domain names is that we believe that that is an excellent way to allow primarily end users, individuals but also small businesses especially solo with the opportunity to personalize their Internet services.

So imagine now, the ability to have an email address like "Jeff@Smith.net", "Ken@Schafer.org". As anybody who's tried to acquire a domain name for personal reasons over the last two, three four years now knows it is next to impossible to acquire the surname unless your name happens to be something so completely obscure that it's still available. And for most people it's still the case that rather than rely on some of the alternative top level domains, their preference would strongly be in com, net and org.

So in terms of what we bought, the single most important thing is a domain name portfolio of surnames that we believe is the largest in the world of its kind.

Host: I see that on the NetIdentity web site there's a claim that in their portfolio they represent 70 percent of US and European surnames. Is that true?

Elliot Noss: Well, I'll tell you what we found out on diligence as we dug into that claim. What we discovered was that the basis for that was that five or six years ago that they had undertaken an investigation that looked at their surnames relative to US census data, and some sampling that they did. And I think that they came up with coverage in that 68 - 69 percent range. So obviously very close to that 70 percent.

And you know I'll tell you two things, certainly nothing that we've looked at has made us think that that's far from where that us but we will be clear, first of all we haven't done our own independent investigation using that census data in either the U.S. or Europe. Second, we'll certainly be going forward, you know, engaging in some of that investigation ourselves to see exactly where it is. You know I will tell you that certainly from our serving of the landscape, it was by far the best coverage of any such portfolio that we've been able to find or identify.

And, that just in a little sampling, and when I say that I mean you know when I have looked through it for my friends names, or I have looked through it for employees names, it always tends to be you know somewhere in that 50, 60, 70, 80 percent range. If I'm looking for six people, I'll find for, and if I am looking for you know ten people I'll find six or seven. So, you know that's what they did, you know we're not quite making that claim yet ourselves, but you know, we think it's probably not miles from where it actually is.

Host: That's a pretty interesting acquisition for Tucows. It seems pretty sudden, no warning. Was this deal built up quickly?

Elliot Noss: No, in fact it's been a long time in the making. We've known the folks at NetIdentity for a number of years now; in fact we supply them with some of the services that they currently use. So they've been a customer for some period of time. In fact, the principal of NetIdentity, the chairman, is the fellow that introduced me years ago to Mark Cuban for the first time. A lot of you certainly on the investment side know that Mark Cuban is a shareholder at Tucows. Mark also happens to be a shareholder in NetIdentity. So for years both sides of this deal, both NetIdentity folks us on the Tucows side have thought that the best place in the world to take advantage of that domain name portfolio was inside of Tucows.

In fact, we spent years trying to figure out a way that we could actually simply offer services against their domain name portfolio at the time. We kept running into complications, there were real challenges in that if we didn't own the portfolio ourselves, how would we deal with things like constraining their ability to you know perhaps sell or dispose of names, things like that. And both parties after a fair period of time you know realized that the best way to make this happen was to try and do a transaction.

You know I would note, I think also that both of us are felt, and I think this is a very important point, that Tucows is really the company in the best position to take unique advantage of the value of this asset. You know, one of the things that I've talked about on a couple of the recent conference calls, is the value of a domain name being greatest to a strategic buyer. It's my belief that when it comes to this portfolio of surname domain names, that Tucows is the strategic buyer.

And I think one of the great things about it is you know we are pretty unique in our position, so therefore you know the folks that we were bidding against, and this was a competitive process, were financial buyers in the main. And so as a strategic buyer we had to really just try and tuck in above you know the highest price financial bar.

Host: What are some of the financial details of the acquisition?

Elliot Noss: Well, we paid in total roughly 18 million dollars in consideration, that's seven million in cash, roughly eight million dollars in a promissory note provided by the vendor, and roughly three million dollars in equity. In you know, in terms of performance around the assets we bought, this was a deal that was primarily driven by the cash flow generation up front.

Now NetIdentity generates their cash flow primarily from two sources: first from the retail revenue around internet services that I spoke about earlier, you know, there's a little bit less than a hundred thousand customers. It's in the ninety thousand plus range, who have email services, hosting services etc. And the second place is with pay per click revenue around domain parking. So there's a fair chunk of pay per click revenue in there as well. Now the predominant revenue stream that exists today is certainly that retail revenue. There is in the high threes, nearly four million dollars in revenue, but you know one of the things that we certainly put out in the press release was that you know, we expect this transaction to generate between three and four million dollars in cash flow for Tucows next year, and I'll talk a little bit more about synergies, but I will note that by the very nature of the businesses they're in, you know, we were able to deal with a lot of the costs.

In terms of revenue, it won't add much more than four million dollars on a current run rate, but in terms of cash flow it's going to be in excess of three million. A couple other notes there, the deal because of the actual accounting, the gap accounting, is not likely to be accretive from an earnings per share perspective, from a gap earnings per share prospective until 2008. We certainly expect it to be to have a negative impact on earnings per share, again at a gap level, at an accounting level in 2006 and probably in 2007 then it will turn positive in 2008, but the deal will generate a fairly significant cash flow. One of the things that you know we've talked about in the past is that we like to do acquisitions in the range of five to seven times cash flow, and we think in this transaction we'll comfortably land in that range.

Host: So it sounds almost like you're giving guidance?

Elliot Noss: Well, as you know, historically we have not given guidance. And we're not at this point instituting a standardized practice of giving guidance, but we've now made two acquisitions in the last six months. It's certainly our view when we looked at the limited market response to our critical path acquisition, which you know we thought was a great move for the company. And given this acquisition, we wanted the investment community to be completely clear about where these two transactions left the Tucows business.

So you know we said in the press release not only that we expect cash flow in 2007 from the NetIdentity acquisition to be in the three of four million range, we also wanted to very clearly level set. We wanted to be clear that where this left the business was for 2006, we effectively expected, and expect now to deliver between seven and eight million dollars in cash flow in 2006 and between 10 and 12 million dollars in cash flow for 2007. We, you know, didn't want people to have to sift through a number of press releases and have to make difficult assumptions as to where this left us.

You know, we're quite conscious of the fact that as a public company, we're relatively small, we're relatively uncovered, and we're relatively unknown. And so we think we do have to you know take some greater efforts to you know be really specific about things like that. In addition, we want to be able to talk about those numbers. You know, we think that they are quite strong, and we are going to want to talk about them we better put them out there very clearly.

Host: Well, with NetIdentity that makes two acquisitions in less than six months, should we expect to see future acquisitions at this rate?

Elliot Noss: No, I think this is quite situational. You know, one of the things that we've talked about in the past is that we always look for, you know that we are very picky in acquisitions, that we consider integration a real task. And that we only want to buy things that are right. You know, both of the acquisitions we did in the last six months were very circumstanced, they were very right on their circumstances. We didn't pick the timing, and in both cases to varying degrees they were assets that we'd had our eyes on for a number of years. So we don't expect this you know to indicate a rollup strategy of any sort on the part of Tucows.

You know, in addition, we really do think that as a very general statement, it's a seller's market when it comes to transactions. You know, we've talked about, and I mentioned earlier, that we like transactions to be able to come in in the five to seven times cash flow range. You know, in this transaction we were able to get there, but that's subject to a lot of the synergies that we bring to the acquisition. And you know, it's tough to find good value out there these days. So you know we'll always be looking, we're always talking, but no I don't think you should have this signal any sort of grand rollup strategy.

Host: So how is the balance sheet after these two acquisitions?

Elliot Noss: Well, we've certainly spent a fair bit of money in the last six months making these acquisitions. There's probably a couple of things that I would call out. First, you know, it was certainly the case that towards the end of last year our cash pile was starting to become fairly significant, and that does make us a little more wide-eyed when looking for opportunities. Now, you know, we've taken our cash to a place where I would suggest, you know, unless it was something that completely blew our socks off tomorrow, we probably wouldn't be looking to spend any more cash. You know, we've got great luxury in this business in a couple of ways.

One, it's an incredibly predictable business. Because of the nature of our subscription revenue, we've got very good strong visibility to what our financial results will be tomorrow, next month, next quarter, frankly, to a great degree, next year.

Two, it's a business that has been cash flow positive now for the last three or four years. You know, so it's not like we have any breaking out to do, we just have to continue to do what we've been doing. And the business really is an amazingly consistent business. I'd also probably take the opportunity to provide a little bit more specificity, you know, we did, I talked earlier about there being a promissory note in this transaction. In fact there's two separate notes, one of which for a couple million dollars or so in the range of two million dollars has a six-month term, and that was really very situational in the context of this deal, and one that we'll have no problem satisfying out of you know out of cash flow and out of normal operations. The second note for six million dollars is interest only at seven percent and therefore does not come due you know, and there's no payment against it for a couple of years. So again as it, just as it relates to you know, our need for cash and our ability to generate cash, we think that despite the fact that we've written a couple of big checks in the last six months, we're still in an extremely comfortable place.

Host: With acquisitions like this, there's always the issue of integration costs and other issues. Could you tell us about those?

Elliot Noss: Well, because this is a relatively simple operation, there really is very very little by way of integration costs. You know, when we have talked about the critical path transaction, you know, there was material integration costs, you know, and we disclosed those. You know, here there's very very little here by way of integration, all of the operations are today in Boulder Colorado, all the operations will be integrated into our Toronto operation almost immediately. And there will be sort of less than a hundred thousand dollars effectively in integration costs.

You know, I think it's worth noting on our last conference call that when it comes to integration, you know, I talked about the fact that we were looking to reinvent our retail business, our domain direct business. And looking to use that as a little bit more of a test tube, or a petri dish to study excellence in Internet services retailing, and to use those lessons broadly across our wholesale customers. You know, we think that this acquisition and these specific customers and this retail operation will first of all greatly facilitate those goals, and additionally we think this customer base will greatly benefit from a lot of the work that we are about to engage in there. So we're pretty e xcited about it, we think that you know from a timing perspective, and you can never pick your timing with these things, from a timing perspective really came about at just the right time for us.

Host: Are there any synergies worth noting?

Elliot Noss: Well there's lots of synergies. Certainly you know, I had gone on at some length earlier about the benefits that we think a crew to Tucows and to all of its' wholesale customers from this portfolio of surname domain names. One of the great things about that is you know today we provide hosted email for hundreds of customers and across millions of email boxes, obviously if you are a hosted email customer of ours you will get the greatest benefit around these surnames. You know, we'll, that'll be deeply integrated into our hosted email offering. But it's worth noting that all of our customers, whether they are hosted email customers of Tucows today or not, will be able to avail themselves of these surnames, of these surname domain names.

So this really will expose the benefits of these domain name assets, you know, to our thousands of customers in hundred of countries around the world, and again, you know, those assets are unique. So any service provider who understands the benefit of being the primary email provider to their customers. Any service provider who understands the benefit of personalized services, and easy to find and remember services, you know, email in particular. Any service provider who wants to take advantage of this unique asset will be able to do so and in a fairly simple way operationally, and in a fairly inexpensive way.

So we're really most excited again about the synergies around that domain name portfolio. You know, at an operating level there's just some easy synergies in this deal. Obviously with a you know, with a large portfolio of domain names, they were paying a registrar every year, you know well for us that's just not an issue. In addition they were providing email for their ninety thousand plus existing customers, obviously for us there are some easy operational synergies there, things like that. We were their existing supplier of both blogging and web site building tools, and so there are some great synergies for us there. And simply in providing customer support, marketing etc. around a retail Internet services operation, great synergies for us there.

So you know, in the main, you know, it's an interesting deal, because as I've talked about the type of deals that we look to do in the past on conference calls, I've generally identified two types of deals: ones where we could find a bolt on customer base, that provided a creative cash flow. And ones where there was a strategic element usually technically. And in this deal, we think we actually get a pretty nice piece of both of those different approaches, you know, certainly the existing retail services operation, Internet services operation, bolts on customers in an easy way. And that portfolio of domain names again, you know, we think that's the greatest portfolio of surname domain names that's out there, certainly that we've been able to identify. We think that's a unique strategic asset that really differentiates our hosted email offering. And it differentiates it in a way that it's very very difficult for our competitors to replicate.

Host: So what does NetIdentity's existing customer base look like?

Elliot Noss: Well, it's again it's you know it's these ninety one thousand, ninety two, ninety plus thousand retail customers, primarily in the US. There's also a pretty significant portion of them that are in Europe, and again that matches up well with our existing coverage, because we've got a very very large European customer base. e were quite surprised on due diligence to see that these were very active users of these services. We expected to see a lot of passive use simply of the domain name, but these are people that are using these services.

One of the things that I've always identified, you know, I go to a lot of conferences in the industry, you know, obviously I've been doing this for you know, I'm in my tenth year now at Tucows, and twelfth in Internet services. You know, one of the things that I've certainly observed over the last three, four, five years, a lot of the Digirad, a lot of these sort of plugged in Internet savvy folk would have their surname as their domain name for email addresses. You know, I could rattle off, you know, a long list of you know, off the Web 2.0 walk of Fame who all have their surnames, but it's a next to impossible thing to do. You know, when I wanted to do that, you know, when I was a want to be and wanting to do that myself, you know, six or eight years ago, every variation of Noss, believe it or not, was already gone.

It's something that the more Internet savvy folks are, the more they have used the Internet, the more experienced they become with the Internet, the more they appreciate the value of personalizing and making it easy to remember the name and navigation ability associated with their Internet services. And I think that what we saw when we dug deeper into this Internet customer base, is that those folks really got that. We think it's a pretty Internet savvy group, and we are looking forward to dealing with them.

Host: And finally, this is the second podcast that we have done. Are you intending to do more?

Elliot Noss: Well, I think for us that's situational. We had very positive feedback from the first podcast; we certainly felt it positive enough and we were satisfied enough with the results that we felt very good about doing this again you know, in the context of this transaction. And I think I'd see what kind of feedback we get, you know I take the opportunity to be very specific: as we're coming up with the questions for the podcast, as we're thinking through the material for the podcast, or the FAQ that we put up on the web site for that matter, we are really trying to anticipate what investors want to know.

We would encourage both in relation to this podcast and this acquisition, and in general, we would really encourage investors whether they be large, small, institutional or otherwise, and analysts, to send us questions by email. You know, for instance, if we were to have a half a dozen questions or comments that we received by email that clearly seemed to indicate that there were a couple of other items that we should have covered off here, you know, we can be back here again in another week doing a podcast just to deal with some of the questions that came out of this one. So for me, you know, this is just something else that can and should be part of an ongoing dialogue with our investors.

Host: Thank you, Elliot.

Elliot Noss: Thanks very much.


Host: This has been a Tucows podcast featuring an interview with Tucows CEO Elliot Noss on the acquisition of NetIdentity. Thank you for listening.

[Ending music]