Is This The Investment Cash Cow You’ve Been Looking For?
Tucows – A Powerful Business with Solid Capital Allocation Chops
Tucows: Will this bring in the mooney?
SUMMARY
- Tucows is a profitable small-cap operating in the internet domain registry and internet fiber business.
- It has a similar business model as Warren Buffett’s Berkshire Hathaway as it invests its cash flows from one segment of the business into a more profitable one.
- Ting Mobile continues to drive tremednous growth in revenue and cash flows.
- The company has solid financials and a greenfield opportunity ahead of it.
- Introduction
Much of the companies listed in the public markets have had a huge run-up lately. Most of them are well-known tech companies with names that we are probably familiar with. At this point in time, investors can take comfort in knowing that bargains can still be found – we just need to make sure that every stone has been overturned as we go hunting for them.
Tucows (NASDAQ: TCX) operates primarily in the tech space with businesses in internet domain registry, mobile phone networks and internet fiber networks. Yes, it is pronounced as “Two Cows”. Come to think of it, Tucows has similar traits to that of Warren Buffett’s Berkshire Hathaway – it takes the cash it generates from its internet domain registry business, the same way Berkshire takes its cash generated from the insurance business, and invests it in high-margin, low-risk internet and mobile phone network business.
The company is currently profitable with a market capitalisation under $400 million with plenty of room to grow and in the process, deliver market-crushing returns for investors who are patient enough to stick around.
- The Business
Over the years, this Canadian-based tech company has established itself as the leading player in the internet domain registry business. For the time being, CEO Elliot Noss seems comfortable with the domain registry business contributing to the lion’s share of the revenue which amounts to roughly 60% as of the latest financial quarter.
In order to get a sense of how powerful this segment of the business is, investors must be prepared to geek it out. The Internet Corporations for Assigned Names and Numbers (ICANN) is a non-profit organisation that manages and the global domain name system. Tucows is one of the largest ICANN-accredited domain registar in the world.
The service is distributed by Tucow’s Ting Domain Services through brands that some may be familiar with. OpenSRS and Hover distributes domain names and related internet services such as email services and customer service to wholesale and retail customers respectively. OpenSRS has almost 15 million domains under management with more than 13,000 reseller clients around the globe. The business handles almost 1 million domain transactions each month which includes new registrations and other renewal services. Ting Domain Services is stable and extremely profitable. On top of that, the recent buyout of eNom amounting to $83.5 million has boosted its domain services revenue by a whopping 120% as compared to the year-ago quarter.
Through this business, Tucows is able to generate a steady flow of cash flow that the management has been allocating into its mobile phone services and fiber networks segment.
- Pursuing High Margins and Growth
Clearly, Noss has far larger ambitions for this company than simply being the leading internet domain registar. Here is where Ting Mobile comes into the picture.
Ting Mobile is a mobile virtual network operator (MVNO) that purchases network access from other networks such as Sprint and T-Mobile to create and sell mobile phone plans. In the context of Singapore, this is similar to local providers such as Circles. Life. At the moment, Ting is aiming to make a name for itself in this space. It is focused on providing high-quality services and plans that will drive value for its account holders.
On top of mobile phone networks, the company is also making a foray into the internet fiber networks space with Ting Internet.
The Internet business is relatively new to Tucows as compared to the previous two that were mentioned. However, the validation of the attractiveness of this opportunity can already be seen in Google Fiber’s continuous expansion into additional cities after successful deployments in smaller ones. Tucows is steadfast in its attempt to provide small communities with fiber networks which comes with high Internet speeds. It currently has services in five towns which includes Charlottesville, Westminster, Holly Springs, Sandpoint and Centennial.
Management has charted the project cautiously in order for it to be sustainable. It will continue to build out its broadband service network in smaller cities with an eye toward scaling it up in larger cities in the near future. Using smaller markets as a testing ground seems to be an efficient way to gain an understanding of what consumers want and how to better meet their needs. With a customer-centric approach, the business stands a good chance of increasing its minuscule market share while increasing shareholders’ value.
- Risks
Competition in the mobile and Internet industries is extremely stiff and Tucows is facing strong, entrenched competition from the likes of other big players.
The mobile network industry is dominated by a few large players with some smaller players fighting for a share of the market. In an event when prices are lowered, the larger firms tend to collude with one another. This could possibly mean that the industry does not have pricing power as no player would have any incentive to raise prices on the monthly mobile phone bills. Raising prices would result in consumers flocking over to a rival firm and thus, lower revenue and profits.
If the mobile and broadband network providers collude to raise prices, Tucows will likely suffer from it as well. This is because it replies on Sprint’s and T-Mobile’s networks to serve its wireless customers. By raising prices, Tucow’s margins and profitability would be hampered and so will future returns. While having a good working relationship with your competitors might be a good thing, it can always turn around and bite you and investors should be aware of the dynamics.
Lastly, key-man risk is one that will stick with this company for quite a while. Ever since Noss had become the CEO in 2001, the company has been profitable and cash flow positive while consistently growing sales each year. After all, investments like Tucows that rely on superb capital allocation chops are only as good as the people running the business. Noss owns roughly 6% of the business along with his team of owner-operators to form a combined 16% insider ownership. Warren Buffett has said that he loves to find CEOs managing the business as if it is the only asset that they will ever have and we can see that in Elliot Noss and his team. If he were to lose his focus and expand too widely or leave the business altogether, it will put a big dent into the investment thesis.
- Conclusion
There are some benefits of investing in a small cap like Tucows. Investing in a younger company also brings about different risks for investors. One way to lower your risk is to take up a small position in your portfolio and dollar-cost average from there. With a dedicated management team who knows how to wisely allocate capital, investors will be handsomely rewarded by this cash cow.
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Marcus Ho
Research Analyst, Mind Kinesis Value Investing Academy
Disclaimer: Please note that all information stated in this article is just for education purpose only and should not be used as any form of recommendation or advice.