The web hosting and domain registration sector — while decidedly not fun to say — seems to be sizzling hot right now.
Maybe that’s why GoDaddy (GDDY) needed a little cooling off.
GoDaddy (GDDY) has reported yet another strong quarter, the second since the company went public in April, and a few days removed from its chief rival Web.com’s (WWWW) second-quarter beat. However, GoDaddy stock was off some 5% in early Thursday trading.
What’s Wall Street’s issue?
GoDaddy’s top-line growth of 16.5% was fueled by an 8.6% growth in annual average revenue per customer, or ARPU, and a 9.1% increase in the number of customers. GDDY registered $394.5 million in revenues, which just edged out the consensus estimate for $392.9 million. The company also expanded its net loss, from $43.3 million to $71.3 million, and the per-share loss of 46 cents was far worse than the 17-cent loss expected by Wall Street analysts.
With so many competitors in the space, GoDaddy’s strong top-line growth helps to allay fears that the market could be close to hitting saturation point. But even more importantly, it helps to reinforce the notion that GoDaddy’s brand equity is as strong as ever.
We can deduce this much by looking at Web.com’s ARPU, which has been on a decline for several quarters now — down 6.6% during the last quarter, which implies customers are spending less and less on the company’s products. Strong brand recognition can be a powerful weapon in a highly competitive environment, and can help a company to continue growing its market share, or maintain it at the very least.
But GoDaddy’s more flexible business model seems to be the real reason its finding room for growth.
On the surface, GoDaddy’s and Web.com’s revenue models look amazingly similar — they host all websites and register domain names for a fee. But a deeper peek at how things really work behind the scenes suggests that GoDaddy’s approach to doing business might be superior to Web.com’s.
Web.com prides itself in serving the higher end of the market. Its high-priced customized websites are calibrated to help drive leads for customers. But selling pricey products often means you have to push them harder, and in the process end up incurring high sales and marketing costs.
This is exactly what has been happening with Web.com — the company’s S&M expenses equal 26% of revenue, double GoDaddy’s 13%.
But even more worryingly, trying to push overpriced products down customers’ throats is a bad business strategy when everybody is engaged in a race to the bottom. Consequently, Web.com’s ARPU of $13.91 compares poorly with GoDaddy’s $118.
So what’s GoDaddy’s secret?
Unlike Web.com, GDDY offers highly discounted services to lure customers, then makes a lot of money on the side by charging for add-on services. The company also pursues highly strategic acquisitions that revolve around technology sets that directly expand its core brand. GoDaddy has a business segment known as Business Applications; those applications are mainly Microsoft’s (MSFT) Office 365 products, as GDDY is one of the largest resellers of Office 365. During the last quarter, the business application segment brought in 10.3% of the company’s revenue after growing 51.4% — by far the company’s fastest growth.
GoDaddy’s business model allows the company to create a lot of cross-selling opportunities for its different products, hence its high ARPU compared to Web.com.
GDDY is notorious for all those lewd and bizarre marketing campaigns, but those have been left in the past — and in fact, GoDaddy in general isn’t spending as much money on marketing expenses. GoDaddy instead invests more heavily on R&D as it continues to look for new product lines to add to its ever-growing portfolio. GoDaddy’s R&D spend is among the highest in the industry, but this appears to be money well-spent.
For all its success, there are some significant risks that come with investing in GoDaddy stock over the long-term.
The company’s operating expense grew at 20% year-over-year — 350 basis points faster than top line growth. This was caused by a large 77% increase in administrative expenses. Administrative expense is the company’s largest line item, and the huge increase was responsible for GoDaddy’s 29-cent EPS miss — the likely catalyst for the 5% drop in GoDaddy stock on Thursday. This also reversed first-quarter gains, when the company losses shrunk by a big margin.
This is not an encouraging trend. Investors are usually willing to tolerate poor bottom line growth as long as a company’s top line is expanding at a healthy clip. However, they tend to be very unforgiving if a company’s revenue growth starts to slow down pretty dramatically.
Throw in the fact that GoDaddy’s shares are hardly cheap — GDDY trades at 370 times forward estimates for earnings, and 3 times sales — and the risk is magnified. While this is not likely to hurt the shares in the near-term, it’s something worth pondering for investors who would like to build a long-term position in GoDaddy stock.
As of this writing, Brian Wu did not own a position in any of the aforementioned securities.
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