GoDaddy (GDDY)

****Summary**** I am recommending going long GoDaddy (GDDY) with a $106 2021 price target, which offers 53% upside and a 23% IRR. The company has emerged as a leader in web services, boasting nearly 20 million subscribers paying an average of $160/year. Customers generally increase their services, and therefore ARPU, over time. GoDaddy’s deep product offering enables it to be a seamless, one-stop shop for SMBs looking to increase their digital presence. My long thesis is predicated on 1) multiple expansion (especially relative to adjacent peers with similar growth profiles like Intuit), 2) acceleration in Hosting & Presence revenue, 3) continued mix enhancement from higher growth in higher gross margin segments (Hosting & Presence and Business Applications) and 4) further margin expansion from operating leverage, with sales growth outpacing growth in G&A and Customer Care. Separately – but not central to the thesis or a driver in the model – is my expectation that net new customer adds inflect next year to nearly 1 million after experiencing transitory issues unrelated to core retention trends in 2019. Taken together, this should result in double-digit top-line growth (modeling +12%/11% in FY20/FY21), mid to high-teens unlevered FCF (uFCF) growth and ~140-150bps of annual uFCF margin expansion, all of which are above consensus. More broadly, GDDY checks the boxes of high visibility into revenue growth/cash flow generation, quality business with strong competitive positioning, well-regarded management team and compelling valuation. ****Company Overview**** GoDaddy is a leading web services platform with global reach. Its business is stable and predictable, with high visibility into revenue and earnings. 90% of revenues are generated from prior cohorts in a given year, with first-year retention remaining remarkably stable at 85% (plus “10s of basis points”) since the company IPO’d in 2015. Although this retention rate may seem a bit low for a customer-centric software business, it is actually high relative to competitors and in relation to the failure rate of its small business customer base. Its LTV/CAC of over 8x is best-in-class and provides a sound argument for the company continuing to invest aggressively behind marketing. On management, I am intrigued by the fresh strategic vision under new CEO Aman Bhutani, who was formerly President of Expedia Brands. Mr. Bhutani has committed to remaining disciplined around costs (“will be prudent and diligent stewards of P&L”) while more rapidly scaling into a platform-based software business. I believe this will translate, over time, into better-than-expected margin expansion, strong ARPU growth and acceleration in the company’s increasingly core Hosting & Presence business. On a product level, GoDaddy sells an integrated solution to any novice or professional looking to build and manage a website and offers products across three segments: Domains, Hosting & Presence and Business Applications. ****Domains ($1.46B 2019E revenue)**** GoDaddy is the global leader in domain name registrations. Its current 80 million domains under management is more than 6x that of its next largest competitor, Endurance Group (EIGI). With over 92% of its total customers having purchased a domain from GoDaddy, this represents the top of the funnel for customer acquisition. The segment derives revenue from three offerings: Primary Registrations (buy and register new domain), Domain Name Add-Ons (i.e. privacy products) and Aftermarket Domains (secondary market). Future domain growth is underpinned by ~3% growth (higher end of underlying industry) in domains under management and mid-single digit % growth in average revenue per domain. **** **** ****Hosting & Presence ($1.27B 2019E Revenue)**** This is GoDaddy’s second largest segment which caters to individuals looking to not just register a domain but host it on a server, build a website and manage their web presence. In 2017, GDDY disclosed that 1/3rd of its customers had a Hosting & Presence product, a number which has continued to grow. The Hosting side of the segment relates to sites hosted on GoDaddy’s servers and includes the ‘Managed WordPress’ product targeting web pros. The Presence side is faster growing and relates to the company’s website builder, marketing platform and eCommerce tools (falling under the ‘Websites + Marketing’ umbrella). Together, the company has commented that ‘Managed WordPress’ and ‘Websites + Marketing’ are experiencing unit growth rates of 40%+ off of a sizable base. This, combined with the recently disclosed data point indicating ‘Websites + Marketing’ has added 1 million subs in less than two years, implies room for top-line acceleration (modeling +12% in FY20, from 11% in FY19). ****Business Applications ($610M 2019E Revenue)**** This is the company’s smallest yet fastest-growing segment, offering business-enhancement tools for its SMB customers, including both re-selling third-party applications and products developed in-house. The segment’s biggest revenue contributor is its Office 365 package, which was born out of a 2014 agreement with Microsoft and includes file-sharing capabilities, productivity tools and personalized email products. In 2017, the company disclosed that 15% of its customers had a Business Applications product, a number which has grown in the two years since. I see room for further revenue growth (modeling high-teens in FY’20 and FY’21) aided by higher attach rates, seat growth and continued up-selling. On the latter point, GoDaddy offers four pricing plans and typically acquires a customer through the lowest tier (Email Essentials) before upselling to higher tiers (Email Plus, Business Premium, Premium Security). Having aggressively acquired customers on the low-end over the past five years, GDDY has the ability to upsell higher-end tiers as the customer’s own business scales and needs evolve. ****Industry View/TAM**** GoDaddy operates in the growing web services industry with a sizable core TAM of $24B. This is calculated by taking the 60M small businesses (<20 employees) in the U.S. and EU and multiplying by a conservative $200 ARPU while multiplying the 116M small businesses across the rest of the world by a 50% lower ARPU ($100). With 540k new businesses starting up each month in the U.S., the vast majority of which are looking to set up a domain and website, GoDaddy has a consistent supply of new potential customers. Another way to look at the opportunity is to consider that the average customer spends $168/year on GoDaddy, but the average small business spends $1,000-$2,000/year on web services. Calculating a more expansive TAM off of $1,000 ARPU in EU/U.S. and $500 RoW yields $120B. ****Competitive Advantages (Company Quality)**** ****Unit Economics**** GDDY has favorable unit economics, allowing it to scale profitably. As seen in the table below, GDDY’s LTV to CAC is an industry high 8x. GDDY’s low annual churn of 15% accounts for its high LTV, while its lower-cost customer acquisition channel accounts for its $100/sub lower CAC relative to peers. Even when allocating 20% of GDDY’s customer care spend to the CAC calculation to be conservative, GDDY’s LTV to CAC remains above 6x. Part of this structural advantage relates to the company’s domain business, which serves as a cost-efficient beachhead for new customer acquisitions. A customer registering a domain with GoDaddy already has intent, which allows the company to upsell multiple offerings such as website building, hosting, email & office applications, security products, social media management and marketing services. ****Customer Care Network**** One of GoDaddy’s largest competitive advantages is its expansive and highly regarded Customer Care network, spanning 6,300 specialists across the globe. Unlike peers which have far more limited offerings, GoDaddy’s Customer Care staff is available 24/7/365. The Customer Care team is not only responsible for increasing customer satisfaction and reducing churn, but also plays a key role in generating revenues, accounting for 17%+ of bookings in each of the last three years. While assisting clients, the care professionals can “upsell” additional subscriptions for value-added products, helping to entrench a customer deeper into the GoDaddy ecosystem. ****Fundamental Movement Expectations**** ****Revenue/Bookings**** I expect revenue to remain strong in FY20 (+11.6% to $3.33B vs. $3.31B consensus) and FY21 (+10.9% to $3.70B vs. $3.65B consensus). Bookings should grow roughly in line (modeling +11.6%/11.3% in FY20 and FY21, above consensus of ~10%). The variance versus consensus is driven largely by faster Hosting & Presence growth (forecasting acceleration from 11% revenue growth in FY19 to 12% in FY20 followed by 11% growth in FY21). Although not a driver in the model, another variant view is that GoDaddy will post higher net new subscriber adds than expected (forecasting 981k in FY20 and 950k in FY21 vs. 840k/870k consensus). After posting ~1 million net new sub adds annually since 2014, the company experienced a deceleration this year (I am modeling 745k) due to transitory factors unrelated to changes in underlying cohort retention, which is actually improving, or industry growth. Simply, GoDaddy promoted a high mix of two-year domain contract terms in 2017 and one-year terms in 2018. This resulted in a significant amount of both 2017 (two-year) and 2018 (one-year) contracts expiring in 2019. The coterminous effect led to higher churn from an optics perspective, but had no impact on core churn or LTV. This normalizes in 2020, which should lead to a solid acceleration in net adds. ****Gross Margins**** I expect GM expansion to be driven by mix enhancement, as revenue growth across the higher gross margin segments – Hosting & Presence and Business Applications – outpaces the much lower margin Domain segment. Although the company does not disclose segment-level margins, historical commentary, peer-based inference and conversations with IR suggest Hosting & Presence GMs trend around 80% (comparable to, though slightly below, Wix), Business Applications a touch lower and Domains around 50%. With Hosting & Presence and Business Applications growing low double digits and high-teens, respectively, compared to high-single digit Domain growth, I see a natural mix enhancement opportunity. Specifically, I am modeling +25bps of GM expansion in FY20 and +20bps in FY21. ****Operating Margins**** I expect operating margins to expand solidly over the coming years (+190bps/+160bps in FY20/FY21) supported by both gross margin expansion and lower operating expenses as a percentage of revenues. On the opex side, while the company will likely grow marketing slightly faster than sales and R&D in line with sales, it should get some nice and meaningful leverage from the G&A and Customer Care lines. Investors have expressed fear that the new CEO will ramp R&D (which GoDaddy labels “Technology & Development”) spend given his deep product and technology experience most recently at Expedia and dating back to his days at JP Morgan. I believe this fear is misguided, and Mr. Bhutani will prove more disciplined and thoughtful around his expense allocation than feared. As such, I am forecasting R&D spend to grow with revenues over the next two years. ****Unlevered FCF (uFCF)**** This is an important metric for GoDaddy, one which it manages to internally and externally. Management has previously stated that it is targeting uFCF margins of 30%+ vs. 25% today, and I expect the company to reiterate this goal at its 2020 Investor Day. The combination of GM enhancement, opex leverage and continued deferred revenue growth should drive uFCF margins higher (I model +150bps/+140bps in FY’20 and FY’21) and annualized growth in the mid to high-teens (modeling +19%/17% in FY20/FY21). ****Valuation**** I believe GDDY is undervalued and expect its multiple to expand relative to Intuit as it delivers strong double-digit top line results, recommits to its 30% uFCF margin target and expands gross and operating margins at a meaningful clip. Wix is too early in its growth cycle to be a relevant trading peer, while Intuit makes sense as an SMB-facing software company with similar growth. EIGI is hardly a useful comp given significant company-specific issues and extremely high leverage. The primary way I am looking at valuation is on a P/FCF basis (EV/Sales is helpful as a temperature check but not core to my analysis). EV/EBITDA is not used as it discounts the company’s tax-advantaged status relative to peers (it is not expected to pay any taxes for the next two years) and doesn’t give them credit for deferred revenue. Since P/FCF has the opposite effect of capitalizing a base of earnings that will eventually be taxed, I am capitalizing GDDY’s FCF/share on a fully taxed basis before adding back the NPV of the tax savings benefit. I use a 20x P/FCF multiple to value GDDY shares which leads to an $87 valuation in 2020 (+25% upside) and $106 in 2021 (+53% upside). I believe GDDY should bridge its gap versus Intuit – trading at 29x/26x FY20/FY21 FCF – which faces a similar customer base (large part of biz sells through SMBs) with remarkably similar top-line growth rates. Further, Intuit appears to have less of a margin expansion opportunity than GDDY, resulting in the latter’s outsized EBITDA and FCF growth. ****Capital Deployment**** GoDaddy management has long committed to allocating capital in a balanced manner across three priorities: organic investments, accretive M&A and share repurchases. I do not expect that mentality to change under Mr. Bhutani. I would not be surprised to see management pursue an acquisition that aligns with a core strategic focus (likely related to ‘Presence’) but did not incorporate this into the model given the speculative nature of such an assumption. For purposes of the model, and to ensure cash doesn’t pile up on the balance sheet without earning a return, I have made the rough assumption that 80% of FCF is deployed towards share repurchases and 20% towards de-levering. ****Catalysts**** The two biggest catalysts are 2020 Guidance (to be provided on Q4 call) and an upcoming Investor Day (set to take place 1H’2020). The latter will be new CEO Bhutani’s opportunity to take his strategy to the public markets while unveiling fresh multi-year expectations. I expect revenue growth targets to remain in the double-digits while uFCF margins are targeted at 30%+ and growth in the mid-to high-teens. ****Risk Factors**** From a high level, my view is that the risks seem relatively baked into expectations, with shares 17% off their late April 2019 peak and 8% below post-3Q earnings pop. They also seem to be reflected in the multiple, which as discussed earlier is depressed relative to peers and has come down 3 turns on an EV/EBITDA basis since September of last year. All said, the story is not without risk. I have listed the most important factors to remain aware of below: * Domain growth, which has been supported by aftermarket in recent years, decelerates meaningfully * The Hosting side of the Hosting & Presence business drags down segment growth * Management steps up R&D investments to support new product cycle with low visibility * Domain customers fail to digest pass-through from Verisign price increase next year * Leverage continues to increase as company accelerates M&A strategy * Net new customer adds continue to decelerate and stabilize around ~700k clip * Competitive entrance/ramp into Domain space from larger internet players * Management pursues a large acquisition with murky return characteristics