The first tipping point will occur when the global advertising dollars per unique user flattens off and begins to decline. In my opinion this will be inevitable as the value of a user in an emerging economy such as India is much less than that of a first world nation. The rapid adoption of the Internet by vast numbers of users from emerging economies will cause this first tipping point to be reached within the next couple of years. It would be quite interesting to conduct some analysis to work out a more precise time frame for when this is likely to occur - maybe next time.
The second tipping point will occur when it becomes more worthwhile for Google to apply capital to purchase the traffic outright rather than share revenue with partners. Google is currently making 39% from its own traffic and only 11.9% off network partners. This differential of 27.1% is the margin that could be applied to any acquisitions.
Assuming that Google is currently paying out 11.9% to the domain channel then this would mean that Google could earn an additional $61.4m per quarter ($245.6m per year) from the $219m (ie. $219m x 27.1%) if they purchased all of the domains. This is definitely a feasible option for them to consider and much of the financing could be funded via the increase in their margin.
About two years ago the domain industry was awash with venture capitalists. You would go to conferences like TRAFFIC and bump into VCs continuously. I was almost convinced the Google, Microsoft or Yahoo was funding VCs to acquire huge domain portfolios and permanently secure the traffic for themselves. Surprisingly this still hasn't occurred.
Let's examine what it would take for Google to buy the domain industry. For a start we'll have to imagine that they wouldn't first squeeze the revenue line of every domain owner prior to an acquisition. I know that this is a big assumption but I think that for the purposes of the exercise let's imagine that they decided to not exercise their market power.
If the domain traffic industry (TM domains included) is currently on track to do about $1200m of parking revenue this year and is paid on average four times earnings then the entire industry would be worth $4800m. With $245.6m of additional cash flow gained from the additional margin if the acquired the whole industry Google could achieve a worst case payback in 19.54 years.
Since the number of Internet users is project to grow by 10.9% for 2008 and 9.8% for 2009 we'll use 10.4% which is the average of the two figures. Internet advertising is projected to grow in 2008 by 23.6% and 15.3% for 2009. We'll use the average of 19.5%. Combined this would provide Google with a yearly average revenue growth rate of 29.8% from the increasing size of both the number of Internet users and online advertising industry.
If the $4.8 billion dollars was borrowed at an interest rate of 5% the entire loan would be paid off purely from the increased margin Google would receive in 2015 plus leave $1.4 billion in the bank. That's a little over 7 years! Sure these are back of the envelope calculations but they would be in ball park. What I wouldn't give to put this strategy in place for a company with the will and determination to act on it!
Last year Google purchased DoubleClick for $3.1b and about 10 times earnings so it is likely that if the domain industry was really on Google's radar that they would seriously consider acquiring it. What was interesting about the DoubleClick deal was that Google was prepared to offer a substantial premium just keep archrival Microsoft out of the online advertising market. A possible exit option for the domain industry would be to position itself as a possible Microsoft target. After all it would make sense for the "Boardwalk" of the Internet to own the whole monopoly board.
What I'm surprised at is that a venture capital firm hasn't begun the aggregation process and pitched the deal to either Microsoft or Google.What domain owners need to monitor is the margin differential between Google's own properties and the margin they earn from their network partners. The larger the differential the more likely we are that we'll see a major acquisition in this space. Watch out for an increase in VC activity or private equity firms. These two groups may be working on behalf of one of the major corporates.
Is this bad for the domain industry? Depends if you're the one left on the deck of the Titanic as you suddenly discover that PPC no longer exists unless it's a Google or Microsoft owned property. It's a grim picture but a possibility that may be worth some consideration prior to making any 8 year deals.
Source: Posted on WhizzBangsBlog by Michael Gilmour -- Reprinted with permission -- May 22, 2008