Are Domain Names Recession-Proof? Probably Not, Next Question?

By Mark Jeftovic
Mark Jeftovic

I didn't see the Fortune article Are domain names recession proof until the weekend, and being the author of the now infamous Domain aftermarket overdue for an asset repricing last year I feel somewhat obligated to comment on it.

There can be no doubt now that the recession is here. I went on record nearly a year ago that it was coming, so I nearly gagged when I saw Jim Cramer say something along the lines of "I told you all this was coming" over the Christmas holidays. So now it's ok to say "recession" in polite company although the politicians and the pundits still try to soften it up by making sure they modify it with words like "maybe", "slight", "mild" and "possible". Make no mistake, it's underway and I think we're far closer to the beginning of it than the end.

So, how will domain names fare in a recession? The Fortune article was upbeat:

"Global markets are in a state of panic. Credit markets are all but closed. And recession fears are everywhere. But at the conference I attended in Hollywood this week, called DomainFest, you'd have little clue that the financial world was melting down.

The domain world — the people that buy and sell names and make money from pay-per-click ads on their websites — is booming. Downturn? Bring it on..."

While the rest of the article is little more than a layman's intro to the domainer business model, the question is timely. Now that the recession is here and, to paraphrase the old detergent commercial "we're soaking in it", are domain names as an asset class a "safe haven"? Will they in general terms produce "above average" returns compared with other places to put one's money such as stocks, bonds, commodities or inflation protected t-bills?

The difficulty of treating domains as an asset class per se

One of the troubles with examining domains names as an asset class is the short amount of time they've been around: compared to mainstream assets and financial instruments, domain names and the DNS have been around a few microseconds. Thus, we don't have a lot of historical data to make inferences from. In the history of the commercial internet (say since 1994 or so), there's been one recession/bear market (2000-2002) and it's almost a stretch to call it a meaningful one.

One domain broker I know related that "aftermarket values tanked" after the Nasdaq bubble burst. I know that prior to the crash, one of my clients paid $90,000 USD for a domain and he didn't even bother renewing its DNS last year. It's sitting right now on our "DNS expired" pages so I even have insight into it's traffic and PPC value. It gets a steady 20 to 40 "type-ins" per day, but at current PPC revenues the domain will break even in 4,500 years.

So on one hand, we don't have much of a past track record to give us insight into how domains as an asset will perform through various stages of economic cycles, the other problem is to the future: will there even be domain names in 5, 10, 50 or 100 years? We can, with some confidence, assert that in 100 years time people will still eat, wear clothes and sleep indoors, putting some kind of a demand based floor under things like real estate, textiles and commodities.

Domains on the other hand, work because of "DNS", and even though my personal livelihood depends on "long live DNS", I am not fool enough to think that in 10 or 20 years some completely different method will be employed that enables computers and network services to uniquely identify and locate each other across disparate networks. I called this future protocol "quantum foam" once as a placeholder. Let's for our purposes just label it "QNL" for "Quantum Network Locator" and wonder if some kid in a garage is going to invent it at some point. Even if that event is 50 years out, paying 100X on a domain may not work out so well.

What is recession-proof?

Warren Buffet loves recessions because they enable him to pick up undervalued assets on the cheap. He's parlayed $100,000 into a personal fortune worth over $30 Billion doing just that. What attracts Buffet to investments are what he calls "durable competitive advantages", or what his mentor Benjamin Graham termed "moats". In tech land we often equate this with "barriers to entry" but they are not exactly the same thing. The phrase I personally identify with it is "the ability to defend". How defensible are domain names?

The problem there as I see it is that there are two pillars holding up domain values: PPC and direct navigation.

On the PPC side, there is very nearly a single-point-of-failure for the entire industry and that is Google. As Jay Westerdal pointed out, Google may very well have single-handedly killed the domain tasting industry last week, which is significant. The registrars' constituency tried to hammer out a consensus, the registries themselves have been scratching their heads over how to best deal with perceived abuses of the AGP and along comes Google, from completely outside the inner circle and toasts the entire sector in one edict: no more monetization of domains less than 5 days old. End of story, end of the AGP carry trade.

So GOOG has the power to kill an entire slice if the domain pie, what would happen to the rest of it if they failed completely? It doesn't matter how far-fetched that sounds, the point is that there is a lot of capital pouring into the domain monetization game and the entire domain monetization game is dependent on a single external entity. What if GOOG says "no more parked pages" next? They won't...but they could.

The other aspect of domain monetization is, of course, direct navigation and again, this is where the rest of the domainer world and myself agree to disagree. Once again, there is the ability for entities outside the domainer's sphere of influence to have a huge impact on type-in. What if Google (them again) releases Gbrowser (or Gfox, or G-zilla) puts the search box where the location box is, puts the location box under Shift-Ctrl-F-L and grabs 20% or 30% of the market over the next few years? What if IE (who already has 20% on IE7 and another 30% on IE6) did it tomorrow?

Future input devices (the stuff we haven't thought of yet), likely won't interface with the computer using keywords with ".com" appended to it. When you think of it, typing that into your browser's location bar is a quite antiquated, not to mention uninformed method of getting around the internet. Future UI will succeed on the basis of infusing the user's known preferences with relevant search queries and agents. I don't know what it'll be or what it'll look like, but I know innovations will happen in UI and they will probably obsolete or at least end-run type-in.

So if you listen to me (don't worry, very few do), there are two gaping holes in the ability for domain names to defend or construct moats of safety around their current revenue models. The common factor in both is that too much crucial underpinnings of the PPC model are subject to control outside of the PPC/domainer industry. Unless Oversee can buy Google in the next few years.

Neither of these scenarios ever need happen to impact our assessment of domains as an investment vehicle and to ponder their value through a recession. If there's one thing I've taken away from my studies of value investing it's "margin of safety". All business is in a word, risk. So we want our entry points into our investments to offset the risks. At current levels, I think if any technical analysts existed in the domain aftermarket, they would call them "overbought". Hence no "margin of safety" against these risks.

What are safe havens?

During times of trouble, people flock to "safe havens". These havens have certain characteristics, including being dull, boring and thus (hopefully) safe. Such times are often eventful, tumultuous and are often by definition, not boring, so whatever people flee to during a crisis, they aren't looking for more excitement. Gold is a good example. We may not really understand exactly why a polished metal out of the ground holds it's "value" perpetually but we are hard pressed to find a tailor anywhere in the world who won't sell you a suit for an ounce of it.

Everybody has to eat, everybody has to sleep, everybody needs shelter. Nobody must surf the net or send email. If you find yourself in tough economic times deflation or hyperinflation, typified by scarcity, fear, uncertainty and financial chaos and you have an ounce of gold in one pocket and the auth code for food.com the other, I doubt you'll be able to feed your family with the latter. While we all hope times don't get that dire, that is the thought process at the root of all flights to safety among the asset classes: "How useful will this be if the crap really hits the fan?" and "How much value will this hold in all dire circumstances?" (deflation, hyperinflation, stagflation, etc)

Some factors that favour of domain names relative to other asset classes.

I'm saving some optimistic thoughts for the true believers and I'll outline why "domains-as-asset" class have a few favorable factors going into a recession which may help them become a lagging casualty (meaning the damage will occur later, and may not be as deep).

So our examination of the question "Are domain names recession proof?" can be summarized, I would say that the lack of track record (domains haven't existed long enough to gain insight on how they will react under differing economic climates), means domains won't qualify as a safe haven asset during a recession or an economic storm.

I would go on to say that at current overbought, overheated aftermarket pricing, there is no "margin-of-safety" on buying domain names as an investment (either by PPC at inflated multiples, trying to flip into a cooling market, or just thinking generic .com's are the "real estate of the future" — real estate has bubbles too)

The good news is there is no pronounced leverage in the sector generally. Jay Westerdal may wish banks would "get it" and finance domain names, but going into this recession it may be a benefit to the domainers that there isn't a lot of debt overhanging the industry. Most domains are (assumed) to be owned outright, so if PPC revenues fall, there isn't the spectre of being underwater on debt service looming.

While I don't consider domains "recession proof", I will be looking for signs of a bottom on this one, and for those of us who are still solvent (hopefully you and me included), there should be some bargains to be had.

I think part of the fallout against my "Aftermarket Overvalued" article last year was people thought I was saying "domain names suck", and that wasn't my intent. I've always loved domain names, I'm a geek and I'm in the DNS business and I was collecting domain names before I ended up being a registrar. I just called an overbought aftermarket as I see it.

What happens during recessions? Overreactions to the downside. I'm not a permabear so stay tuned for my someday-in-the-future article "Domain name aftermarket screaming BUY". Hopefully it won't be 10 years from now.

By Mark Jeftovic, Co-Founder, easyDNS Technlogies Inc.. Visit the blog maintained by Mark Jeftovic here.

Related topics: DNS, Domain Names, New TLDs

Comments

Re: Are Domain Names Recession-Proof? Probably Not, Next Question? Adam Strong  –  Jan 31, 2008 10:56 PM PST

BTW Mark Google is still monetizing domains that are < 5 days old still. . . Instead of proliferating rumors, a statement of fact from Google PR can be seen at DomainNameNews