CentralNic Group — Clarifying the narrative

CentralNic is a UK-based software company, providing the tools for businesses to purchase internet domain names (Online Presence) and monetise online traffic (Online Marketing). The company has a strong track record of M&A, having made 21 acquisitions since its 2013 initial public offering (IPO) on London’s AIM market with the aim of consolidating fragmented markets globally. 2022 was CentralNic’s most acquisitive year to date, with a focus on developing its fastest growing and largest business segment, Online Marketing, either through product expansion or vertical integration. In its FY22 presentation, management clarified the narrative of its Online Marketing business, illustrating how it converts general interest media users to high-conviction online consumers.

Recently, the company announced a change in strategic direction, including a review of cash flow deployment and capital allocation within the business. Returns from potential acquisitions will now be benchmarked against possible returns from share buybacks and will be used to bolster the company’s strong levels of organic growth. Management is placing a higher focus on shareholder returns, shown by the completion of its £4m share repurchase programme (announced on 30 December 2022) and proposed 1p dividend for FY22.

CentralNic reported a 77% y-o-y increase in revenue (up 60% organic) to US$728m, driven by continued strong growth in its Online Marketing business. Adjusted EBITDA grew by 86% y-o-y to US$86m, leading to an expansion in adjusted EBITDA to net revenue (its main metric for operating efficiency) of 9.4pp to 48.4%, benefiting from higher operating leverage due to increased scale and vertical integration. Higher profit margins and attractive cash dynamics supported a US$24m reduction in net debt to US$56.6m. For FY23, our normalised income statement forecasts remain relatively unchanged, with net debt increasing by US$15m due to contingent consideration for MA Aporia, a proposed FY22 dividend and its completed share buyback programme. For FY24, we indicate further growth in revenue and profit, as well as a move to a net cash position.

We consider peer valuations cross-referenced against a more fundamental discounted cash flow basis. Both approaches show a significant upside at 301p and 256p respectively. The current discount could be due to the company’s focus on M&A-driven growth and a lack of understanding from investors regarding its Online Marketing business, despite strong top-line growth and margin expansion. However, we believe that CentralNic's valuation has the potential to rise and the discount to peers could reduce if management delivers on its updated strategy, particularly by improving shareholder returns.

We believe further market consolidation poses the greatest threat to CentralNic, particularly from larger incumbents who may use M&A to expand into CentralNic’s specialised domains, heightening competition. Secondly, as online marketing and contextual targeting market growth has benefited from introducing new technologies, growth may slow down as the market matures. Finally, the company operates internationally, generating revenue in multiple currencies, posing foreign exchange risk, although we note there is a high degree of natural hedging in the business.

CentralNic was established in 2000, as a successor organisation to NomiNation, an internet registry founded in 1995. The company listed on AIM on 2 September 2013 and since then has continued to grow through a combination of organic growth and M&A. Prior to the acquisition of Team Internet in December 2019, CentralNic’s main business was the development and management of software platforms to allow businesses to buy internet domain names (Online Presence), essential for websites and email addresses. The acquisition of Team Internet brought domain monetisation (Online Marketing) into its armoury. Supported by several acquisitions since, the Online Marketing segment now represents the majority of group revenues (FY22: 79%).

The company has a strong buy and build track record, having made 21 acquisitions since its IPO for an aggregate consideration of c US$370m. In 2022, CentralNic had its most acquisitive year to date in terms of volume and size, including its largest ever acquisition, VGL, for an initial consideration of €67m. M&A has been key to accelerating revenue growth, building out its Online Marketing business, and for capturing market share by consolidating fragmented markets globally.

During the year, M&A financing was supported by a £42m equity raise on 28 February and a €21m bond placing on 7 March 2022. In addition to M&A successfully driving growth, management also delivered robust organic revenue increases during the year at 60% y-o-y.

To date, CentralNic’s financial strength has allowed it to take advantage of significant market fragmentation and capitalise on the opportunity for contextual marketing, underpinned by upcoming cookie and online privacy regulation. Exhibit 1 illustrates the strategic progress the company made throughout the year, primarily showing how management has used M&A to accelerate growth.

In Q422, management announced a change in strategic direction, including a review of cash flow deployment and capital allocation within the business. We anticipate that the company will continue executing some M&A in 2023, albeit smaller in size and volume, targeting bolt-on acquisitions that can support margin progression rather than top-line growth. On 30 December, CentralNic commenced a £4m maiden share buyback programme on the back of strong trading and an improved debt position, which it completed on 19 January, adding 2.6m treasury shares (0.9% of total issued share capital). The company also announced a proposed 1p dividend (0.6% yield) for FY22 as part of its strategy to improve shareholder returns.

Alongside its updated strategy, the group has undergone a series of management changes, most notably CEO Ben Crawford’s retirement from the board, with group CFO Michael Riedl appointed as his successor. Importantly, long-time incumbents of CentralNic have been appointed to these management positions, ensuring a high level of business continuity.

Alongside its FY22 results, the group has repositioned the narrative of its Online Marketing segment, providing investors with greater clarity on the mechanics of its fastest growing and largest business.

Online Marketing has quickly become CentralNic’s primary revenue driver, with its share of total revenue growing rapidly y-o-y. Global spending in the online marketing sector has been growing at faster rates than online services, with this trend expected to continue. The company’s unique value proposition has enabled its Online Marketing segment to outperform the overall market I which it operates.

CentralNic has repositioned its narrative following its recent strategy update and management changes, helping clarify its value-add to the online marketing space. Its new narrative focuses on leveraging its technology to convert general interest media users to high-conviction online consumers, primarily through proprietary educational CentralNic sites. Its old narrative, on the other hand, centred around scaling the reach of advertisers beyond typical domains, providing less emphasis on how its software enhances conversion rates.

Since the acquisition of Team Internet in 2019, management has developed a platform that can effectively connect advertisers to a broad range of potentially untapped consumer groups. Its platform benefits a marketing campaign by being able to publish across a large array of social media, websites and search engines, maximising exposure and ensuring an advert is seen by the most relevant audiences. This is done either independently or through leading online aggregators to achieve maximum scale. Consumers also benefit as CentralNic prequalifies merchants to ensure that the consumer is shown high-quality products that match their intent.

By leveraging its portfolio of 25m websites and analysing billions of consumer interactions using machine learning technologies, management has learnt which formats are most effective to drive consumer engagement for a myriad of sites, including native, social media, domains and search ads. Advert placement is also automatically measured against the cost to advertise on the site, ensuring optimum profitability for the merchant. Its technology also analyses reviews to verify authenticity and to present consumers with the most relevant product selection based on their intent.

Its marketing platforms work via contextual targeting, which does not rely on third-party cookies, collect personal data or use Google Search for website discovery, but instead matches the most relevant advert to the content of the webpage using machine learning technologies. Contextual targeting ensures that consumers only see the most relevant adverts without compromising their online privacy.

Management has developed its Online Marketing business, both internally and through M&A, focusing on vertical integration and further broadening its product suite.

CentralNic works with a range of advertisers, primarily through its main partners Amazon and Google, to help effectively expand the reach of their marketing efforts through various online channels. Through these partnerships, CentralNic can offer a large pool of advertisers access to new, relevant audiences in a cost-effective manner, where replicating this process internally would otherwise require significant levels of investment.

Management specialises in specific micro-categories typically beyond the reach of Amazon and Google, enabling it to qualify and reach consumers in these categories more effectively. During this process, consumers are shown educational content, helping with product selection and support higher conversion. By working with CentralNic, advertisers can more efficiently and profitably connect with audiences that may otherwise have been overlooked according to management.

Exhibit 4 summarises the mechanics of this process.

The company highlights its strategic approach to reaching relevant consumers through various formats and channels, which is optimised through machine learning. Management will place a broad range of consumer contact points across the web using a variety of approaches depending on the platform, as highlighted by Exhibits 5 and 6.

Exhibit 5 shows a social media user’s experience, where they are presented with a broad topic, such as ‘fastest internet plans in the US’. After a maximum of four clicks, the consumer is qualified based on data such as their region, age and product preference, before they are presented with the CentralNic site containing the most relevant ad to them.

In contrast, Exhibit 6 illustrates when a user enters a specific query into a search engine, following which they may be directed to one of CentralNic’s product comparison sites directly. Here, with just one click, they will be taken to one of CentralNic’s most appropriate comparison sites. According to management, this targeted approach ensures that the consumer is presented with the most relevant options, which in turn helps drive better conversion rates and return on investment for CentralNic's partners.

As highlighted by Exhibit 7, management has developed its Online Marketing business primarily through a buy and build strategy, focusing on vertical integration and product additions.

Vertical integration is often achieved by acquiring domains that provide direct access to monetizable publishing inventory and traffic, removing aggregators and thereby creating a more efficient ecosystem. Although it may not be accretive to the group’s gross revenue, vertical integration will expand CentralNic’s share of the advertising revenue, elevating net revenue and profit margins.

VGL, CentralNic’s largest acquisition to date, showcases how M&A has been leveraged to expand its service offering, adding product comparisons to its arsenal. Product comparison sites can increase the likelihood of a consumer buying a product by providing a range of options and relevant educational information such as ‘best’, ‘cheapest’, and ‘best price-quality’. After making a selection, consumers are directed to the product page on the merchant’s site (Amazon more than 90% of the time), resulting in a commission for CentralNic for the referral. The company claims that its process for qualifying and educating consumers benefits merchants by increasing conversion rates and reducing returns.

We note that VGL operates solely in German-speaking regions, providing scope for management to expand its operations outside of these regions to drive organic growth.

Online Presence is split into Direct and Indirect segments.

CentralNic remains a world leader in its Indirect segment, supplying domain names and other services to the largest and best-known retailers of domains. At the end of FY22, the company’s 20k reseller clients provided access to c 2.5m small and medium-sized businesses. The segment includes CentralNic Registry Services, the world’s premier distributor of nTLDs (additional top-level domains), and SK-NIC, operator of the official country code domain for Slovakia. It also includes the reseller business, which allows retailers to procure and resell virtually any domain name in the world, through a single API, with a single invoice.

The Direct segment includes the group’s enterprise businesses, which service large corporations that view domain names as a form of intellectual property similar to trademarks. It also includes the group’s SME and domain investor-focused retail businesses, spanning 250k customers across c 200 countries. Revenues in the enterprise division were negatively affected by COVID-19 (as a number of clients postponed spending in 2020) but have grown robustly since. Its enterprise clients include well-known names such as Mercedes Benz, Johnson & Johnson and Rolex.

Management remains committed to growing its Online Presence business, despite its slower revenue growth and smaller size compared to Online Marketing. Given the difficulties of switching suppliers, customers in the domain industry tend to be very sticky. Client wins from other suppliers are relatively rare, with management stating that only 2% of customers change each year, equating to high levels of recurring revenues. CentralNic has continued to win customers from its competitors, despite the typical stickiness of the industry, due to a focus on expert service, close collaboration with clients and feature-rich, flexible and automated technology.

Its commitment to growing the segment is evident from its reseller business’s (Indirect) recent announcement of a partnership with WHMCS, a leading provider of web hosting automation. The new partnership allows WHMCS’s web hosting customers to quickly expand their existing domain offerings, where they can go from set-up to selling more than 1,100 domain names in minutes.

CentralNic’s largest addressable market is online marketing, with global spending reaching US$616bn in 2022 and forecast to grow at a CAGR of 10% to 2027, according to Statista. While CentralNic currently has a small share of this market, its proprietary digital marketing capabilities and blue-chip partnerships offer the potential for rapid growth. However, further market consolidation may result in heightened competition from larger competitors, namely marketing technology companies like The Trade Desk or AppLovin for example.

The Online Presence opportunity remains robust, with management estimating global revenues of US$5bn and an additional US$25bn for domain-related value-added services. Europe offers a more appealing landscape versus North America, as the market is less competitive and more fragmented.

CentralNic’s Online Marketing segment has delivered robust growth, where its small share of its current addressable market and existing digital marketing capabilities indicate potential for future organic growth. As highlighted by Exhibit 8, the company’s primary demand-side partners, Google and Amazon, have grown their investments in online traffic acquisition and marketing at three-year CAGRs of 18% and 31% respectively, spending totals of US$49bn and US$42bn in 2022.

These investments aim to acquire high-quality traffic to foster customer loyalty and satisfaction, while keeping costs low, which they can do either internally or through partners such as CentralNic. CentralNic’s FY22 revenue of US$728m was less than 1% of the two companies’ combined marketing spend in 2022, indicating the potential for growth by continuing to offer monetisable high-quality, low-cost traffic in specialised domains.

Another way CentralNic can develop its partnerships is by expanding the number of domains it covers, with management stating that it currently serves 350 verticals with the aim of adding approximately one vertical per week in FY23.

CentralNic’s partnerships with Google and Amazon are not exclusive and management has started working with merchants from eBay, Yahoo! and other leading names. Microsoft (Bing) is another partnership which management has named as a potential target given its large and growing marketing spend (Exhibit 8).

Privacy regulations, such as the General Data Protection Regulation in Europe and changes to company privacy policies have made it challenging for advertisers to effectively target the most relevant consumers. With Google’s planned depreciation of third-party cookies in late 2024, the need for advertisers to explore ways of privacy-safe ad targeting is becoming more pressing. CentralNic’s ad platform offers an opportunity for advertisers to address this need while expanding their domain reach.

The online marketing space has limited demarcation between companies; many use a vertical integration strategy to capitalise on market fragmentation and improve efficiencies by removing intermediaries, similar to CentralNic. The table below provides examples of deals that have completed so far in 2023.

M&A in European and North American advertising has been driven by incumbents in the advertising sector, closely followed by private equity according to Refinitiv data. Volumes have declined since their peak in January 2022, but could increase in 2023 as online marketers seek to consolidate to improve efficiencies, achieve the scale to work with larger clients and enhance cross-selling opportunities. Further consolidation could potentially intensify competition for CentralNic, particularly as M&A activity in this market has historically concentrated in the company’s primary geographies.

For Online Presence, the US market is dominated by Verisign and GoDaddy, capitalised at US$23.2bn and US$12.8bn respectively, creating high barriers to entry. Therefore, we believe management could invest more in the European opportunity, where CentralNic remains a market leader and could grow further by consolidating a less competitive and more fragmented market than the United States, where acquisition multiples are lower.

Domain names are a low-priced, essential service for a company’s online presence and therefore largely immune to economic downturns. Management estimates the global domain name registry market to be worth c US$5bn with 3% growth, while it estimates that domain-related value-added services (website builders, website hosting, email software, etc) offer an additional US$25bn market, growing at c 6% annually.

CentralNic has built a steady market position in the domain registry market, building a comprehensive inventory of web addresses over 20 years. Management estimates that more than 45m domains use at least one of CentralNic’s platforms (12% of domains globally). Not only does this highlight CentralNic’s reach, but it also underlines the opportunity for upselling services to customers with only a single touchpoint today. The company’s extensive reach, including exclusive rights to revenue-generation from traffic from 25m domains, helps drive the performance of its Online Marketing business.

CentralNic’s cash-generative business model, characterised by high recurring revenue, predictable renewal rates and attractive cash dynamics, supports management’s updated strategy. Recent margin expansion has been driven by economies of scale and acquisitions. Enhanced profitability has supported a reduction in net debt and generated high levels of free cash flow, which will be key to achieving the company’s goal of elevating shareholder returns. We expect that the company’s balance sheet will further strengthen, and we forecast a net debt position of US$18.2m by end-FY23, equating to a US$38.3m reduction in the year.

CentralNic’s Online Presence and Online Marketing businesses have strong underlying fundamentals, which should support management’s focus on strong cash flow generation and improving profitability. These include:

We believe that when evaluating the top-line performance and efficiency of the business, it is prudent to focus on net revenue rather than gross revenue. Net revenue deducts the direct and indirect costs incurred in generating the revenue, including pass-through costs such as revenue shares with media buyers/publishers/advertisers or registry fees. Focusing on net revenue provides a more accurate representation of the company's actual financial performance and enables more meaningful ratio comparisons for assessing operating efficiency.

CentralNic has been able to successfully strengthen its operating leverage as its Online Marketing business has scaled, supported by its automated platform and recent acquisitions. EBITDA to net revenue, its primary key performance indicator for measuring operational efficiency, expanded from 39% in FY20 to over 48% in FY22, which we forecast to grow by a further c 1pp in FY23. Most of the investments in the platform are now complete, but potential wage inflation and hiring needs may offset significant progress in margin expansion this year. Our FY23 forecast is significantly ahead of the 42% margin for our basket of Online Marketing peers, but still far below Stroeer & Co and AppLovin forecast to have the highest margins, at 73% and 55% respectively (Refinitiv).

In FY22, CentralNic reduced its net debt by US$24m to US$57m at year-end, driving a fall in its net debt/EBITDA from 1.8x at end-FY21 to 0.7x at end-FY22. This was achieved despite a total of US$81m in M&A activity in 2022.

In October, the group refinanced its debt with a US$250m facility that comprised a US$150m term loan and a US$100m revolving credit facility. Borrowing costs on the new facilities will vary with net leverage, up to a maximum permitted leverage of 3.0x. Initial costs are 2.75% above the Secured Overnight Financing Rate (SOFR, c 7.3%), a notable reduction below its previous 7% above three-month Euribor senior secured bond, despite recent interest rate increases globally.

Given the trend in profit growth and an expected reduction in M&A in FY23, we believe the company can further strengthen its balance sheet and we forecast a net debt position of US$18.2m by year-end. To maximise returns to shareholders, management decided to allocate a higher proportion of free cash flow to a £4m maiden share buyback, which commenced on 31 December 2022 and then completed on 19 January, adding 2.6m treasury shares (0.9% of total issued share capital). We estimate the cash cost of the share buyback to be c US$4.8m, in line with management’s target based on current exchange rates.

The company also proposed a maiden dividend of 1p per share for FY22, equating to a payout ratio of c 6% based on its adjusted earnings. We estimate this will have a cash impact of US$3.6m in FY23 based on current exchange rates.

In its FY22 presentation, management discussed the potential for further M&A, placing a greater focus on disintermediating its value chain through vertical integration. This strategy aims to reduce the company’s reliance on third-party providers and provide management with greater control of the advertising process. Targets will need to have a similar recurring revenue and cash generation profile to CentralNic, where the returns from share buybacks will be used as a benchmark for the return on investment from an acquisition. The strategy could also help further margin expansion by increasing its share of the advertising revenue, as previously discussed.

On 12 December, the group announced that Ben Crawford had retired from the board and group CFO Michael Riedl had been promoted to the role of group CEO with immediate effect. Ben has been crucial to CentralNic’s buy and build strategy, driving the company’s revenues from £2.9m in FY13, the first year after listing, to £708m in FY22 at a CAGR of 84%. These management changes reflect its updated strategy of prioritising cash flow generation and shareholder returns, over pursuing high revenue growth rates through M&A.

Michael became group CFO in 2019 following CNIC’s acquisition of KeyDrive, where he had been CFO since 2011. Current Group Financial Director William ‘Billy’ Green was promoted to the group CFO role on 12 December 2022 and was then appointed to the board of directors on 30 January 2023. A UK chartered accountant and Oxford University graduate, Billy joined in 2019 and has been key to evolving the company’s financial management and played a leading role in the refinancing of the group’s debt in October 2022.

There are a number of factors that investors should bear in mind when considering investing in CentralNic:

In FY22, CentralNic reported strong organic growth, bolstered by accretive acquisitions made in the year. Economies of scale was the primary driver of margin expansion, which supported a US$24m fall in net debt to US$57m by year-end. Our FY23 P&L forecasts remain materially unchanged, with net debt affected by a higher-than-expected contingent consideration for MA Aporia, the introduction of a maiden dividend and cash used in its share buyback programme. Our FY24 forecasts indicate further growth in revenue and profit, as well as a move to a net cash position.

FY22 revenue of US$728m was up 60% y-o-y organically and up 77% y-o-y including acquisitions, in line with our forecasts and market consensus (see Exhibit 13). Our forecasts and consensus have both been upgraded several times over the year, most recently following its FY22 trading update in January.

Adjusted EBITDA grew 86% y-o-y to US$86m, leading to an adjusted EBITDA to net revenue expansion of 9.4pp y-o-y to 48.4%, benefiting from higher operating leverage underpinned by increased scale and vertical integration. Amortisation was US$15m higher than our forecast at US$36.4m due to the impact of acquired intangibles, which was the primary cause of reported profits falling short of our estimates. Normalised profit before tax was US$5m lower than our forecast due to higher interest payments in the year.

Online Marketing continues to be the primary growth driver, with revenue increasing by 120% y-o-y to US$574.7m. Performance was driven by a 77% increase in the number of visitor sessions from 2.6 billion in FY21 to 4.6 billion in FY22, and from a 37% uplift in revenue per thousand sessions to US$105. Organic revenue grew at a rate of 86%, primarily driven by the TONIC platform. Inorganic growth saw a full year contribution from the Wando and White & Case acquisitions and was supported by the FY22 acquisitions of VGL and Aporia and, to a lesser degree, Fireball.

Revenue in its Online Presence segment grew by 3% y-o-y to US$153.5m, and constant currency growth was slightly higher at 4% following the strengthening of the dollar from the start of 2022. The average revenue per domain per year increased by 5% to US$9.90, while the number of processed domain registrations decreased by 2%.

For FY23, we have left our revenue and normalised profit estimates relatively unchanged given our recent upgrades since our last note. On a reported basis, we expect non-core operating costs, which includes acquisition-related costs, to reduce significantly from FY22 due to management’s expected reduction in M&A in FY23 and beyond. We expect administrative cost growth to slow from 27% y-o-y in FY22 to 5% y-o-y in FY23, underpinned by the company’s expectations for its overhead costs to plateau following a hiring drive in FY22.

Higher levels of amortisation from acquired intangibles in FY22 and management’s anticipated US$19m deferred consideration payment for MA Aporia in Q223 following stronger than expected trading have been the primary factors for the 53% reduction in FY23 reported PBT. We also note that interest costs should be more stable going forward given the significant reduction in interest margin following its debt refinancing, which could benefit profits from PBT down.

Our FY24 revenue forecasts indicate y-o-y growth of 9% (gross and net) reflecting the company’s larger size and potential slowdowns in global online advertising expenditure. We leave margins unchanged, with an adjusted EBITDA to net revenue of 49.5%, reflecting potential wage inflation and hiring needs. That said, management is confident that this could increase to over 50% now that most planned investments are complete. The potential for further margin expansion increases if the company continues its M&A strategy of vertical integration, which is not factored into our forecasts.

We expect that maintaining similar margins in FY24 alongside further revenue growth and high cash conversion rates could move CentralNic into a net cash position of US$32m by year-end.

We have looked at CentralNic on the basis of peer valuations, cross-referenced against a more fundamental discounted cash flow basis.

CentralNic continues to trade at a significant discount to its peers, whether we compare it to web services (Online Presence) or online marketing companies. This may be due to the market discounting CentralNic's previous aggressive M&A strategy, without fully factoring in its new strategy that prioritises profitability and free cash flow generation. Our EBITDA to net revenue forecast is above both peer group averages at 49.5%, and our projected sales growth for FY23 is also ahead at 14.5%, despite management's renewed strategy which places less focus on using M&A to drive rapid growth.

In Online Marketing, the peers’ average current year sales growth is 10.4%, with an EV/sales multiple of 1.4x in FY1 and 1.2x in FY2. Average EV/EBITDA multiples are 6.9x and 4.8x for FY1 and FY2, respectively.

The web services peer group in Exhibit 15 trades at average EV/sales multiples of 2.1x for FY1 and 2.0x for FY2, with EV/EBITDA multiples of 7.2x for FY1 and 6.5x for FY2.

The implied share price would be 301p if CentralNic were to trade at the same EV multiples as its peer groups for both years, weighting the averages based on the revenue shares of its Online Marketing (79%) and Online Presence businesses (21%).

Using a discounted cash flow analysis provides an implied value of 256p per share, below the implied price from our peer group and represents 84% upside from the current share price of 139.0p. This is based on an explicit forecast period from 2023 to 2032 (revenue growth trending from 14.5% in FY23 to 2.0% in FY32, EBITDA margin maintained at c 11%), with a 2% terminal growth rate and using a WACC of 10.6%. Our WACC factors in a pre-tax cost of debt of 7.5%, slightly above CentralNic’s current borrowing costs of 7.3%. We show the sensitivity to different WACC assumptions in Exhibit 16.

CentralNic's shares have declined by 13% year to date, but have increased by 7% over the last 12 months. As illustrated in Exhibits 14 and 15, its EV/Sales and EV/EBITDA are at lows based on data from 2018 onwards. This could be due to its focus on M&A-driven growth and a lack of understanding from investors regarding its Online Marketing business, which may have affected share price performance despite strong top-line growth and margin expansion. However, we believe that CentralNic's valuation has the potential to rise and the discount to peers could reduce if management delivers on its updated strategy, particularly by improving shareholder returns.