Endurance, GoDaddy, Wix, And Web.com: Choosing Growth Or Leverage

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Includes: EIGI, GDDY, WEB, WIX
by: Techonoclast

Summary

The web hosting space is largely commoditized due to low barriers to entry, so each player must survive either through delivering returns to scale or differentiated technology sets.

Web.com has management buying stock and is maintaining a strategy of profitability and low growth while Wix.com is spending aggressively to achieve returns to scale.

Endurance and GoDaddy have both scale and impressive growth, Endurance through acquiring growth and technology and GoDaddy through a high R&D & S&M spend.

It remains a question how much leverage both Endurance and GoDaddy can achieve in their model while maintaining their high growth rates, to be explored further later.

Endurance's CEO's aggressive selling of stock raises questions, although it does not provide conclusive evidence of a short case.

Battle of the Web Hosting Tycoons

Web Hosting is the 'Wild West' of the Internet industry. There are no barriers to entry - all that is required to get started is for an aspiring entrepreneur to set up servers and find customers. Trust fund kids, high school dropouts, and part-time-college students all found success in the market, building up their own hosting services startups. With such a commoditized product, the race was on for companies to acquire scale and product features that allow them to drive margin expansion and differentiation. Out of this mix has emerged a few winners, most notably Endurance International Group Holdings (NASDAQ:EIGI) which made its public debut in October 2013, and GoDaddy (Pending:GDDY) which is about to enter public markets. Wix.com (NASDAQ:WIX) and Web.com (WWWW) have also found niches in the market

What are the Margins? How do they maintain them?

GAAP Financial Metrics

  GoDaddy Endurance Web.com Wix.com
  GDDY EIGI WWWW WIX
Revenues 1387.3 629.8 543.9 141.8
y/y growth 22.7% 28.4% 10.9% 76.3%
Gross Margins 62.6% 39.4% 64.8% 81.6%
% of Revs:        
S&M 25.7% 23.1% 27.4% 67.1%
R&D 18.3% 2.8% 5.5% 36.1%
G&A 12.1% 9.0% 10.9% 8.0%
EBITDA 90.9 14.8 114.5 -52.8
EBITDA Margins 6.6% 2.3% 21.1% -37.2%
Interest Expense 85 126.1 15.5 2.1
Debt 1418.9 1095 718.9 0
         
EV 4288.9 3665 1435.1 625.9
Market Cap 2870 2412 950.3 711.9
EV/Sales 3.09 5.82 2.64 4.41
EV/EBITDA 47.18 247.64 12.53 -11.85

All four seem to indicate that they sell websites to businesses and also insist that they are differentiated from one another.

Web.com claims to serve the higher end of the market, with high price customized websites calibrated to drive leads for customers, adopting a marketing spin. It seems that marketing is their highest cost cutting into their margins, but their low growth is matched with low R&D and G&A spending. This particular business model is the result of their history. Founded as Micron Electronics in 1997, the company sold PCs to the government until a series of acquisitions made them the largest web hosting company, resulting in them changing their name to Web.com. However, written into the company's strategy is the experience of the market downturn in 2000 along with the evaporation of cheap capital that accompanied the crash. This seems to be evident in their DNA as they are the only one of the web hosting companies not deep in debt, content to pursue a conservative strategy of organic growth.

Wix serves a role as a publishing platform and technology to design websites, providing tools that allows individuals and businesses to design their own sites. Wix is attempting to expand their presence from the web to applications, creating an App Market which includes applications developed by Google, Instagram, and Shopify. Whereas others are attempting to consolidate the hosting space, Wix is making a play for the next generation of online presence. Consequently, their R&D and S&M are both well above any of the other companies in this space, but so is their growth, at 76.3%. Their strategy appears to be one of accelerating growth until they reach the kind of scale that would allow greater leverage in their model off of a large revenue base.

GoDaddy and Endurance seem to offer a different approach altogether, bringing on businesses with discounted services and then charging them for add-on services. What's interesting is that their customer acquisition strategies are quite different. GoDaddy has relied on a variation of lewd, bizarre, or absurd commercials that have catapulted the name recognition of the brand. Their S&M seems to reflect this, at 25.7% of revenues. Their acquisitions have been few and mostly oriented around technology sets that expand the capability of the core brand. In addition, GoDaddy invests the most in R&D outside of Wix, developing technology cross-sells for their customer base.

Endurance, however, seems to have grown by acquiring other hosting companies at a breakneck pace, keeping them as independent brands and migrating their digital footprints onto their centralized platform, driving returns to scale for their efforts. Both seem to sacrifice margins in exchange for growth. Endurance does this by acquiring revenues, acquiring Hostgator and Homestead in 2012 and most recently international firm Directi and hosting companies BuyDomains, Webzai, and Arvixe. Their low 39.4% gross margin is due to this acquisition strategy. Deferred revenue from acquisitions is not counted while the cost of goods sold continues to count against them as they deliver services, lowering their margins. When this is normalized through their adjusted revenue metric, their gross margins are a healthy 64.6%. What's remarkable is how low their R&D is at 2.8%, likely because they are simply acquiring additional technology sets to sell to their base. Endurance presents an Adjusted EBITDA of $236 million which seems to point to more leverage in their long term model.

However, a quick look at debt shows that Endurance might be on less firm ground than first meets the eye due to this strategy. With about half the revenues of GoDaddy, they seem to have accumulated roughly 80% of the debt. Cheap capital has fueled easy growth in the technology space as a whole, and it will be interesting to explore if Endurance's model is stable as monetary tightening kicks into gear.

Who's Selling?

Another interesting way to look at these companies is to explore how management views the future of the company in the most tangible way possible: by seeing if they are willing to keep their net worth invested in that future.

Endurance presents cause for caution on this front. CEO Hari Ravichandran has aggressively jettisoned stock in this past quarter, selling $2.85 million of shares or 28.8% of his holdings. However, other members of the management team have exercised more restraint, but are selling as well, with Chief Accounting Officer Christina Lane selling $290,000, or 7.6% of her holdings, board member Thomas Gorny selling $480,000 worth of shares or 17% of his holdings, CFO Ellawala Tivanka selling only 1.5% of his holdings or $5,000 worth of shares, and COO Ron La Salvia selling $24,000worth of shares or 12.8% of his holdings. It makes you wonder what the CEO knows that others have yet to catch onto.

Web.com looks promising here. CEO David L. Brown and CFO Kevin Carney have both increased their holdings in the company, Brown by $173,000 or 19% and Carney by $34,000, an increase of 18%. COO Jason Teichman has, however, been selling stock, selling $11,000 worth of shares or 8.5% of his holdings. It seems that management there thinks the street has undervalued their company and have invested their own money in the belief that its future prospects are higher than the Wall Street chorus thinks it is.

Wix.com has had very little of recent buying or selling, with Co-founders Nadav Abrahami & Avishai Abrahami, and Giora Kaplan all maintaining their investment in the company. This seems promising.

GoDaddy, of course, is just about to IPO, so it will be a while before the lock-up allows management to sell shares, so we can't get a read on them quite yet.

Conclusions

This quick glance at the world of Web Hosting has yielded more questions than it has answers. At first glance, Endurance looked like an amazing story, with a high multiple justified by rapid growth and great EBITDA margins. However, a cursory look at management's recent activities should provide pause. I think before I make any judgment, I will have to offer a deeper look at their business.

Web.com has shown itself to be particularly interesting, with management investing their own net worth in the belief that the company will surprise the street in a positive way. I am interested to see how they approach the challenge of creating marketing tools for small businesses and looking more closely at how GoDaddy and Endurance have managed to outpace their growth by so much.

It will also be interesting to examine to what degree the trade-off between growth and margins is structural for both GoDaddy and Endurance. Can these companies turn off their massive spending on S&M and acquisitions respectively and drive leverage from their model or will the difficulties of growth in the SMB segment forever keep them from leveraging the scale that they have achieved through growth.

More to come regarding Web Hosting as I explore these new questions and try to find us some answers…

Disclosure: The author is short EIGI, WIX.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The author is exploring a larger short position in EIGI due to the insider selling and is exploring GDDY in anticipation of the IPO.