The mispricing of securities in the IPO process never ceases to amaze me. Despite reams of historical evidence that most IPOs are overpriced and represent poor medium-term investments, there is an almost-unending stream of retail punters who jump into the next ‘hot’ IPO at almost any price, often on the basis of name recognition alone, only to be sore disappointed in the months that follow. For the life of me I can’t figure out what it is about new merchandise that so excites the masses, but this element of bull market behavior seems immutable. GoDaddy (GDDY), the well-known domain name and internet hosting service (mostly for its raunchy Superbowl ads), is just the latest in a long line, coming public at $20 this week and closing the first day’s trade north of $26, for a cool 30% day one pop. As an example of how fundamentally wrong the market can be (for extended periods), it serves as a pretty fine example.
Before digging into the negatives, though, let’s acknowledge the positives (yes, unlike some IPOs, there are actually a few). GDDY has exhibited decent revenue and bookings growth in recent years, posting mid-teens CAGR growth rates in each in the 201–2014 period (somewhat supported by acquisitions, but we’ll leave that for now). While profitability on a GAAP basis remains elusive (mostly due to a large interest burden from the company’s substantial debt), Adjusted EBITDA has grown nicely from $174mm in 2012 to $275mm in 2014 (heavily adjusted, but still – let’s leave for now). More important than the numbers, perhaps, is the business and GDDY’s place in it: the core domain registry and hosting business (around 90% of group revs in 2014) is low-margin and maturing but still growing low double-digits (in lock step with the ongoing growth in shift to online); GDDY is one of the largest players with ~20-25% market share. Better for GDDY is their focus on small businesses – around 50% of which, in the US, remain offline (according to the company), offering further ample runway for growth. ARPU trends are favorable, growing ~10% a year the last two years, and, at ~$115/year, are still lower than their main competition, Web.com (WWWW), where ARPU is ~$165/year, suggesting scope for further growth there too.
Now for the bad. GDDY is not a new company: they have been around, in one form or another, since 1997, and according to the data offered in the prospectus, has not generated a GAAP profit once in the last five years. This is a massive problem for a company in a well-known industry and maturing market that is trying to convince the market to pay a premium multiple. Consider that despite the operational and scale improvements of the last two years, the company is still running solidly loss-making at the operating level; and given how fragmented the market, it is unlikely market share has much room to expand. And while GDDY claims to be a ‘cloud-based provider’ of value-added services, core domains/hosting still represents ~90% of revenues as of 2014 – which, since these markets are competitive and relatively low-margin, suggests overall market expansion could be difficult to achieve as well.
Somewhat ominously, GDDY had previously tried to IPO twice, but PE sponsors pulled the deal both times due to ‘market conditions’ – not exactly propitious for buyers now. Most all the use of proceeds of the offering (~$315mm out of ~$470mm raised) will go to debt paydown, meaning PE sponsors are not cashing out their stakes at the IPO. Normally, I would take this as a positive sign, but actually in this case it makes me think large PE secondary offerings are simply a matter of time, especially if the stock stays up here (mid-$20s).
I guess it all comes down to valuation in the end, and this is where the current price is mind-boggling. Consider, pro-forma for the IPO, the share count will consist of: 23mm class A shares issued in the IPO; 38.8mm other Class A shares already existing; 90.4mm class B shares (held by sponsors and exchangeable to Class A post-IPO); and up to 35mm more shares to be issued under existing incentive plans/stock options agreements (at least 27mm of which have strike prices in the $7-8.5 range). Let’s say pro-forma fully-diluted share count is 179.2mm shares (including just the stock with low-priced options from the above), suggesting a pro-forma market cap (at $26/share) of $4.66bn. (It’s important to note that only ~12.8% of the total share count is in the float (23mm/179.2mm), which – like many recent IPOs – provides a technical bid to the shares in the near-term but will likely pressure prices substantially once the majority of the float enters the market). Given the company also has ~$900mm of pro-forma net debt (even after the paydown post IPO), GDDY is sporting a cool ~$5.55bn EV – or 4x 2014 sales, and 20x FY14 ‘adjusted’ EBITDA.
20x EV/EBITDA – even assuming the EBITDA number is real, which it is not (heavily adjusted by deferred revenue changes and stock comp) – is expensive in a vacuum; but when you look at comps it really makes you wonder. Web.com (WWWW) is the best comp: it is smaller (~3.5mm customers vs 13mm for GDDY) but occupies the exact same niche (small business focused) in the exact same industry (domain name registry, hosting, and value-add web design services, etc). Sure, it is growing slightly slower (7-10% revs + bookings) and has perhaps less scale, but trades at just 10x EV/EBITDA and 2.5x EV/sales. Much larger, more diversified Verisign (VRSN) – which, by the way, has been consistently GAAP profitable and throws off a ton of cash – trades at 11x EV/EBITDA (admittedly the business model for Verisign is a bit different).
If GDDY was an early-stage growth company with an undefined ‘blue sky’ growth opportunity, these kinds of multiples and day-one enthusiasm would at least be explainable. But in response to the listing of a two-decades old business with a history of operating losses, a mostly mature (or at least maturing) market, a large majority of the share count yet to enter the float, the specter of numerous secondary offerings from motivated PE sellers; and, of course, listed comps trading at a fraction of the valuation, GDDY at $26 is beyond expensive. Look out below!
Disclosure: no position in GDDY (but may look to short once borrow becomes available)