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Tucows - Has a deferred problem

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Tucows (AMEX:TCX) has lost 50% of its market value since July 2007. Yes it has dropped from $1.26 to $0.63 a share, a 50% drop over the last six months.The Company just released it’s year end financial statement, so now is a good time for a quick review of the basics:-    Annual revenues were $74.6 M vs. $65 M for the previous year – up 14%, nothing wrong there.-    Net Income $2.6 M vs. $2.1 M – up 24% -- direction is good.-    EBITDA $8.7 M vs. $5.8 M – up 50% -- something to write home about.Tucows has a market cap of $46.5 million. The overall value could be stated as:-    5.3X EBITDA-    .62X trailing revenues.-    PE Ratio 18.68So why is Tucows trading so low? Why has it dropped a whopping 50%? As a high tech firm it deserves at least a 40 P/E ratio. It should be trading at a 1X revenue range, frankly more. That would take it back the July stock price.The problem is the Tucows balance sheet. The Company has $80 million in liabilities. How is Tucows going to make it? Given current EBITDA one could take almost 10 years to pay it back, not including interest. The game is over; tank the deal, time to trade out. WRONG WRONG WRONG ---- Tucows needs more liabilities, I think liabilities should go through the roof. They should be the master of liabilities; the street just doesn’t get it. Financially speaking there are not many firms like Tucows. They sell millions of little things, sort of like Coca Cola. However those little things are domain names, selling for lets say $12.  Since they are paid “up front” for a specific period, usually one year, the revenues for these are recognized at $1 per month, not the $12 when the transaction occurred. Sort of like cash vs. accrual accounting.

The bulk of the liabilities time out in one year, when hopefully, they start all over again. Look at it as millions of itsy bitsy revolving loans.

Of the $80 million in liabilities, $50 million (63%) is tied to deferred revenues resulting from domain registration sales. Domain name registrations account for 73% of revenues. Usually I hate deferred revenues (which is a topic for a separate writing). However for Tucows it is the business model.

I might be naive, but I don't think many people drive up to Tucows and say..."I stopped using my domain name...I want my $3 back". I have a hard time rationalizing how GAAP, in the practical world, should apply here.

Tucows – Has a deferred problem. One the street does not understand, and one I think is holding the stock price down.

========== MORE ABOUT TOM ==========

New Commerce Communications

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Tom Millitzer provides merger and acquisition services to Internet service firms including Web Hosting, Data Centers and similar sectors. In 1994 he founded and is President of  NCC - New Commerce Communications, Inc. He has been involved in almost 200 mergers and acquisitions , finance an... (Read full bio)

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Comment by Anonymous on Tuesday, February 12, 2008

What is EBITDA?

Comment by Anonymous on Wednesday, February 13, 2008

I have written two blogs specific to EBITDA: “The Ultimate EBITDA” dated Oct. 2, 2007 and “EBITDA is only easy in a vacuum” dated Oct. 3, 2007. If you go back through the history of my blogs you should be able to find them. Thanks - Tom

Comment by Anonymous on Thursday, February 14, 2008

That is an interesting analysis Tom. However I don't follow the deferred revenue part. Tucows only sells domain names to resellers such as ISPs and web hosts, quote:

"Tucows is a wholesaler of domain names and other Internet services to ISPs and web hosting companies worldwide."

I have never seen a domain registration company where you pay on a monthly basis, only annual. I looked at Tucows' service agreement here

http://services.tucows.com/signup/contracts/master_services_v1-6.pdf

Appendix A page 1 shows the fees, they are all on an annual basis. Also I don't think they are extending credit to web hosts:

"Prior to registering domains, purchasing digital certificates or email boxes using OpenSRS, the Reseller must deposit funds into their reseller account. We recommend pre-paying at least one month worth of credit in advance."

http://services.tucows.com/signup/contracts/payment.php

So, whats the story here?

Comment by Anonymous on Friday, February 15, 2008

Your question was about deferred revenue, and how it would apply since Tucows since they do not sell to the end user, ala wholeseller.

Actually Tucows provides services to each end user and it could be debated if wholesale is the correct term, but who cares,if I were Tucows I would use that term also, but only as a convenience.

The important part is they have "Reseller(s)", the term used in the Master Services Agreement (MSA). The Reseller sells Tucows services to those millions of domain holders on behalf of Tucows. Tucows is selling a service, individually, one at a time, via their reseller network.

Definition - “Deferred revenue is not yet revenue. It is an amount that was received by a company in advance of earning it.”

As the registrar of record, Tucows has to perform various services. These services relate to each individual domain for a fixed period, for example one year. The fact that services are “non-refundable” does not relieve Tucows of it’s responsibility to perform the services during the term. Ah-ha - creating a liability, one that is deferred.

What happens: Take a $12 domain name, with a one year term. The Tucows accountant moves $1 (each month) from the balance sheet and to the P&L statement, “recognize the revenue”.

So getting back to Tucows --- While there are $80 million of liabilities, only $12.8 million appears to be related to real loans, $50 million relate to deferred revenues…I think the Tucows stock price is being hurt by the deferred revenue liability, basically people not taking the extra step to see what kind of liabilities are included on the balance sheet. I think the stock price should be higher.

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