A letter to the Department of Commerce on the Verisign .com monopoly

Michael A. O’Byrne,

245 5^th Avenue,

Suite 1103,

New York,

NY, 10001

U.S. Department of Commerce,

1401 Constitution Avenue,

NW Washington,

DC 20230

January 6^th, 2016.

RE: The anti-competitive nature of the Verisign contract

To whom it may concern,

I would like to like to bring to the attention of the Department of Commerce, the anti-competitive nature of the contract signed between Verisign, a publicly listed U.S. company, and the U.S. government for the right to provide .COM domain extensions.

Before elaborating on why I believe this arrangement goes against the principals of competitiveness and democracy that we should be engendering in our country, I would like to put on the record the following facts:

·         ICANN has been performing the Internet Assigned Numbers Authority (IANA) services since 2000;

·         ICANN is a non-profit organization which lobbied US politicians to the tune of $2.5 million in 2015;

·         Verisign issues generic top-level domains (“gTLDs”) on behalf of ICANN. The price of each of the .com domains has been arbitrarily set to $7.85;

·         Verisign is a publicly listed company; it has a fiduciary duty to act in the interests of its shareholders – and not the general public of the United States;

·         The contract between Verisign and ICANN has ‘presumptive right of renewal’ meaning that it rolls over every six year into a new six-year period;

·         In March 2004, Verisign (acting in the interests of its shareholders) launched a lawsuit against ICANN (an organization supposed to be acting in the public interest);

·         Verisign signs a contract every six years with ICANN. In 2006, Verisign’s lobbying expenses reached $6.98 million. The average lobbying expenses for Verisign in the three years previous to 2006 were $393,000;

·         By virtue of the nature of the ICANN and Verisign contracts outlined above, Verisign controls a 100% monopoly on the issuance of gTLDs using .com and .net;

·         The 2014 Annual Report for Verisign shows the following results for the firm:

o   2014 revenue of $1.01 billion; 130.6 million  gTLDs at 12/31/2014

o   2013 revenue of $965 million; 127.2 million gTLDs at 12/31/2013.

·         In 2014, Verisign’s gross profit was $821 million (Verisign 2014 Annual Report, p. 51) and in 2013, its gross profit was $778 million (Verisign 2014 Annual Report, p. 51). Its operating income for the same periods was $564.2 million and $528.2 million, respectively.

·         The performance of Verisign stock (NASDAQ:VRSN) outperformed the S&P 500 Index and the S&P 500 Inforation Technology Index in each of the years between 2009 and 2014 (Verisign 2014 Annual Report, p. 36).

The monopolistic nature of the Verisign deal

On the issue of Verisign’s monopoly, The Federal Trade Commission[1] states: “The antitrust laws prohibit conduct by a single firm that unreasonably restrains competition by creating or maintaining monopoly power. Most Section 2 claims involve the conduct of a firm with a leading market position, although Section 2 of the Sherman Act also bans attempts to monopolize and conspiracies to monopolize.” In light of this, I would suggest that Verisign is also in breach of antitrust laws, or at least operating in a grey area that allows it to maintain a price of $7.85 for each .com registration.

The “right of presumptive renewal’ that Verisign holds for the .com registry is a monopoly in all but name. As Tom Ruiz, VP of GoDaddy stated in an e-mail to ICANN on November 28^th 2005: “under the current.COM agreement, Versign is granted a one-time presumptive renewal of four years. The conditions for renewal are carried forward from one renewal to the next. In the proposed new agreement, Verisign is granted this presumptive renewal on a perpetual basis. The difference is subtle, but as a result, there will be no future opportunity to re-bid (for ).COM unless Verisign breaches the agreement AND fails to cure the breach within the allotted timeframe, regardless of how many breaches should occur. The result is that this would effectively establish Verisign as the owner of the .COM namespace.”

It’s also worth noting on the issue of monopolies that none other than Warren Buffett found the Verisign monopoly sufficiently attractive to break his no-technology stocks rule. On technology stocks, Buffett told Berkshire Hathaway shareholders in 2000: “technology is just something we don’t understand, so we don’t invest in it.” However, one thing Mr. Buffett certainly does understand is a monopoly: In 2007, he told students at the University of Florida: “I don’t want a business that’s easy for competitors. I want a business with a moat around it. I want a very valuable castle in the middle. And then I want…the Duke who’s in charge of that castle to be honest and hard working and able. And then I want a big moat around the castle, and that moat can be various things.”

In the case of Verisign, the moat that Mr. Buffett refers to is the lack of open competition. Berkshire Hathaway currently owns approximately 11.5% of Verisign’s shares. The reason, clearly, is Verisign’s ability as a monopoly – like most good monopolies – to generate free cash flow. From the NASDAQ website: “Verisign has a very profitable business which generates a tremendous amount of cash,” and “over the trailing twelve months, Verisign generated $437 million in free cash flow. That puts its free cash flow yield just above 6%, which is right in-line with the cash flow generating giant Apple.”

Let us put this in context for a moment: Apple is the world’s most valuable brand, one of America’s greatest innovators of the last decade (and before) and sitting on the largest cash pile of any publicly-listed corporation in the world. Its free cash flow yield “is in-line” with that of Verisign. In case there is any doubt, the annual reports of Verisign will confirm that this is not because it is a valuable globally-recognized brand, nor because it is one of America’s greatest innovators. The reason behind the extraordinary wealth of Verisign (and thus its attraction to individuals like Warren Buffett) is its ability to charge $7.85 for each .COM domain, which essentially costs nothing to ‘produce.’

The economics of the Verisign deal

A number of experts on the topic – from technology, policy and economic fields -  have argued convincingly that the $7.85 price charged by Verisign should be reduced (see Appendix). In many cases, the reduction called for by these experts was by just $2. As the figures on the previous page clearly show, reducing the cost by $4 is not unreasonable and still provides for a return for Verisign’s stock holders. Bear in mind also, that these figures – by the very nature of the online industry – will continue to grow, providing an ongoing dividend to these same stock holders.

The Verisign website (see:VerisignInc.com/zone) maintains a running total of the .com and .net registrations. As of 01/04/2016, the division between .com and .net domains is 88.7% to 11.3% respectively. Conservatively assuming that all of Verisign’s 2014 revenues derived from .com and .net account for 100% of its revenue and that 88.7% of these registrations were .com domains, this assumption leaves us with $878[2] million in revenue derived from .com domains, and the remaining $132 million coming from .net registrations.

In such a scenario:

·         If Verisign were to lower the cost of .com registrations from the current $7.85 to $3.85, its revenue from .com registrations alone would still be $430 milion[3];

·         The combined revenues of .com and .net would be $562 million;

·         These revenues would sufficiently cover Verisign’s 2014 total costs and expenses (p.65 of 2014 annual report) of $445 million, to give an operating margin in excess of 26%

·         A 26% operating margin would still comfortably be in excess of the average operating margin on firms on the S&P 500, which are currently running at less than 15%[4].

On this basis, a reduction in the price of a .COM domain from $7.85 to $4.85 would seem justifiable. Instead, a situation exists where the most successful investor in the history of the United States, deems Verisign – a company which should be operating in the public interest – enough of a cash cow to hold over 11% of its stock. And that stock has performed remarkably well by all standards. As the 10-year stock chart below shows, Verisign (in blue) has achieved a return of approximately 229% since the beginning of 2006, considerably outperforming both the NASDAQ (in green) and the S&P 500 (in pink), who grew by 102% and 49% respectively.

Figure 1. Verisign (VRSN) stock performance v. NASDAQ, S&P 500

Again, it bears repeating here that NASDAQ and the S&P 500 are composed of profit-making companies, and yet they didn’t perform as well as Verisign, which was awarded the .COM domain registry in the public interest.

The context for Verisign’s stock market performance is clear: ramping up prices on .COM (and to a lesser extent, .NET) domains over a period in which technology costs (storage, speed, etc.) have fallen considerably. The graph below, adapated from Deloitte findings on the falling price of technology over  a seven year period, shows this discrepancy; while the relevant technology costs have fallen by over 90% in this period. It is also worth bearing in mind that US inflation, as measured by the CPI Index, only surpassed 3% twice in this period and reached an accumulated total of just under 14% - still significantly below the price inflation in .COM domains.

Figure 2. Relative prices of .COM domains and technology, 2006-2012

It can be no wonder then that Verisign’s management has deemed it appropriate to authorize so many share buybacks in the past five years – a de facto admission by any company that its stock is undervalued based on its future earning potential. As if Warren Buffett’s intent to purchase over 11% of the stock wasn’t sufficient indication of the company’s profit-making potential, the company’s management themselves decided to underline it. Between 2010 and 2014, the firm embarked on what can only be described as a spree of buybacks (see figure 3 below). As of the Q3 earnings report, the company noted that they had a remaining $605 million set aside to purchase outstanding stock. Someone is certainly benefitting from the verisign deal with ICANN – regrettably, it’s just not the average US consumer.

Figure 3. Verisign share buybacks, 2010-2014

As a relevant aside to all of the above, Senator Jay Rockefeller (D), in a letter to the Senate Commerce Committee in March 2014, that the proposed introduction of a .SUCKS internet domain name by ICANN was: “little more than a predatory shakedown scheme.” That is to say, the same organization that has stood behind a monopoly and $7.85 for a .COM domain name is now proposing to introduce a .SUCKS  internet domain name. Sir, I ask you firstly, should anyone really be surprised that they have deemed a .SUCKS domain suitable? And secondly, how can the Department of Commerce stand by such an organization?

The U.S. economy is based on principals of democracy and economic competitiveness. I believe that the contract signed with Verisign by the U.S. Government is in gross negligence of these principals and thus, should be rescinded immediately.

Kindest Regards,

Michael A. O’Byrne

Appendix: Opinion on the Verisign deal

“Registry operation services consist of commodity technical services that are widely available from a large number of well-qualified potential providers. It is widely acknowledged that the price of commodity technical services tends to fall, not rise, over time – particularly in the database management field, given that prices for data storage continue to decrease dramatically in accordance with Moore’s Law – so there is no reason for the DOC to permit unjustified price hikes for such services.”

Philip S. Corwin, Counsel, Internet Commerce Association

“Would you think it a fair exchange if you gave someone $15 and they said, here I’m repaying you with this nice shiny one cent piece?” Well, that’s roughly the same ratio of the benefit that ICANN confers unto Verisign every year and the amount of Verisign’s “sponsorship” amount, i.e. about 1500:1. Basically, the munificence of this event reminds me less of words like “dignified” and more of words like “ostentatious.” Perhaps “corrupt”; certainly “for sale”. We of the internet community are paying for all of this… I do find ICANN’s expenditures to be entirely out of line with its mission and its status as a non-profit, tax exempt, public-benefit organization.”

"The actual cost to VeriSign of providing the service of registering a domain name and publishing it via VeriSign's DNS servers is probably on the order of $0.03 per year per name, or less."

Karl Auerbach, Former ICANN Board member

“But after the dispute with VeriSign, it is clear that an equal threat facing the network is unbridled commercialisation.”

The Economist, October 13, 2013

“The economics lesson starts here. It’s important to first realize that it costs VeriSign, the .COM registry operator, next to nothing to add each new .COM name to the registry, because unlike registrars, VeriSign has everything handled by an automated process. The costs of operating these automated processes (i.e. bandwidth, storage, etc.) have been and are expected to continue to decline.”

The Economist, October 13, 2013

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[1] See: https://www.ftc.gov/tips-advice/competition-guidance/guide-antitrust-laws/single-firm-conduct/monopolization-defined

[2] $1.01 billion x 0.87

[3] $878 million x $3.85/$7.85

[4] See: http://csimarket.com/Industry/industry_Profitability_Ratios.php

The Australian Banking System is an Oligopoly

Oligopoly is a well-defined theory of economics that needs little introduction. All economists from Keynesians to Classicists agree on its parameters. Put simply, it is “a situation in which a particular market is controlled by a small number of firms. An oligopoly is much like a monopoly, in which one company exerts control over most of a market. In an oligopoly, there are at least 2 firms controlling the market.”[1] Even to an outsider of economics, this appears to describe well what has happened inside the Australian banking system with the “four pillars.”

The Four Pillars

The “four pillars” is a name given to the four banks that dominate the Australian Banking sector. These are, in descending order of size, the Commonwealth Bank, Westpac Banking Corporation, the Australia and New Zealand Banking Group and the National Australia Bank. The “four pillars” name conveys importance – and indeed, the banks are of significant importance to the stability of the Australian economy at large – but given their similarity to each other, the banks might well be known as the “four sisters.”

By any stretch of the term, the “four pillars” operate in a virtually unchallenged oligopoly, controlling between them around 80% of the Australian banking sector at any one time. The issue is a constant topic of discussion (and grievance) in the Australian media (one article referred to them as the “four pillows”), who note that the banks have become omnipotent since deregulation of the finance industry occurred at the beginning of the 1980s, after the by-now infamous Campbell Report (1981).

How the Oligopoly was Created

Deregulation of the Australian financial system began in the early 1980s. Its primary goal was to stabilize the Australian economy (which was doing badly at the time) and put Australian banks on a more even footing with their international peers. The steps taken to achieve this in the initial phase of deregulation were the free-float of the Australian dollar and the abolition of direct interest rates and portfolio controls for banks and other financial institutions at the end of 1983, issuing new foreign exchange licenses in 1984 and granting foreign bank licenses in 1985.

Assessing these reforms is difficult. Likewise, try to establish if deregulation was in fact responsible for the breakaway group of four large banks in Australia is almost impossible to tell. Giving banks the ability to compete on a level playing field with international competitors is no bad thing in itself, of course. And allowing the Australian dollar to free-float is in line with most economies around the world. That is not to say that the process happened without anyone observing.

A series of mergers (mergers are almost always acquisitions) occurred in the 1980s and 1990s, which, at least in part led to the oligopoly that the Australian banking system now plays host to.  National and regional governments allowed their own savings banks (such as the NSW bank or the State Bank of South Australia, for example) to be purchased by larger commercial banks, in a series of bolt-on acquisitions. I believe now – although it is easy to be wise after the fact – that these acquisitions should not have been given the go-ahead by the competition authority, as they were sowing the seeds for the oligopoly now evident in the sector.

Assessing Oligopolies

That banking in Australia is an oligopoly is hardly surprising. In his book, Principles of Economics (2008), Gregory Mankiw gives examples of oligopolies that exist in various industries in the United States based on figures provided by the U.S. Census Bureau and the Federal Trade Commission. The list is extensive. It includes breakfast cereal with a concentration of 92%[2], soft drinks with a concentration of 93%, and beer, with a concentration of 85%. These figures at least show that banking is not alone as an oligopoly.

Given that so many industries take the structure of oligopolies, why is there such an issue when banking takes a similar market structure? In short, the answer is that banks most likely play the role of scapegoats. They become an easy target for everything that is ill with the economy. 

The Herald Sun neatly captures this in one of its opinion pieces from August 2008:[3]

“Kevin Rudd[4]  goes for a crowd favourite – greedy bankers:

Kevin Rudd stands accused of bank-bashing after vowing to penalise financial institutions that lavish executives with multi-million-dollar pay packages without requiring them to follow responsible investment practises.

Mr. Rudd has asked the Australian Prudential Regulation Authority to prepare rules penalising banks that reward risky behaviour by requiring them to have greater capital reserves than those with more responsible investment practises.

…How the crowd hoots!”

The reality is that oligopolies – in the banking industry or otherwise - aren’t as bad as the media and others would like to portray. A cursory glance at interest rates offered by the “four pillars” shows that they offer consumers a reasonably good spread of interest rates on loans over the same period[5]. By the principles of an oligopoly, all would be striving to offer as small a spread as possible. I still contend that the Australian banking system is an oligopoly but that it is in fact quickly heading towards a monopoly.

In 2012, the range between the market capitalizations of each of the four pillars varied between $30bn and $35bn. As of May 2014, the range is over $51bn, with the Commonweath Bank opening up a considerable distance between its valuation and that of the National Australia Bank (see chart on next page) Likewise, in 2012, the range between the leading two banks, Commonwealth Bank and Westpac Banking Corporation was approximately $20bn. It is now $25bn.

Bank	Market Cap (May 2014)
Commonwealth Bank	$130bn
Westpac Banking Corporation	$105bn
Australia and New Zealand Banking Group	$91bn
National Australia Bank	$79bn

Source: Bloomberg

An Increasing Need for Regulation

The “four pillars” which began as “the six pillars” (when it included Australia’s two large insurance firms), seem sacred to successive governments in Australia. Various excuses are given for the sanctity of the four. The latest on record was given by the head of the current government’s financial system inquiry, David Murray, whose reasoning goes: “if you relax the four pillars policy and went to three, inevitably in some unforeseen circumstance you would finish up having to go to two. And at two, there is definitely a too big to fail question.” So much for sound economic analysis.

What Murray and others in government consistently fail to recognize is that countries which suffered massive banking crises in the not-too-distant past all had banking oligopolies which, in fact, were less concentrated than Australia’s (Australia’s being the most concentrated banking sector in the world)[6]. Given this is the case, it would seem like negligence to ignore the fact that Australia’s banking industry is need of a regulatory shake-up. However, despite the glaring need, there is still opposition from the big four and even the financial regulator in Australia.

When the IMF provided an assessment of Australia’s big 4 in November 2012, the response from those in Australia was predictably hostile. After suggesting in the report that the big 4 should possibly hold more capital to further bolster financial system stability, “Australian Prudential Regulation Authority chairman John Laker and ANZ’s John Morschel rejected the finding, and Westpac’s Lindsay Maxsted warned the banking industry risked becoming globally uncompetitive if there was a further increase in capital requirements.”[7] Anyone who has taken a look at the Australian banking sector would know that these individuals aren’t overly concerned with competition. Capital requirements often have leaders of the banking industry come over in a fit of competitive spirit, however. The IMF’s report was also met with the common lambast that Australian banks are “amongst the most highly capitalized in the world.”

Further Down the Road

As I have pointed out elsewhere in this paper, Australia’s banking industry is not only an oligopoly but it appears to be heading towards a monopoly (or at least a duopoly). The financial industry, which is now a few times the size of Australian GDP (admittedly not unusual for most countries´ financial sector) is in desperate need of regulation. There exists a good chance that the gulf between the largest bank in the “four pillars” will open up a bigger and bigger gap between itself and the fourth biggest of the group.

The popular media in Australia often mentions politicians and financial leaders talking about the need to be competitive internationally (as Australia’s banks seek to tie up business abroad), but this ignores the fact that Australia avoids many banking crises by the very fact that it hasn’t been closely linked to the global financial system until now. By becoming more intertwined with outside banking systems, its risks become more systemic.

Australia’s authorities have failed to see that these banks are already “too big to fail.” By allowing them to grow in the same manner in which they have been until now is negligent on their part. The fifth biggest bank by assets is only around a quarter of the size of the fourth[8], meaning the hegemony is unlikely to be broken anytime soon. The Australian government needs to take action in one of any number of ways. Among potential measures which they could take are:

i)             Higher capital controls for the four pillars than other banks. In this manner, at least other banks are given an incentive to play “catch up.”

ii)            Higher capital controls for all banks, thereby making the system safer, although possibly doing little to break up the existing oligopoly.

iii)           Allow a foreign bank to take over one of the four pillars. This is probably too politically unpopular to ever happen now.

iv)           Nationalize and merge some smaller banks to create a fifth pillar.

v)            Re-regulate some sections of the financial system, such as funds, to encourage new business startup and banks to break off sections of their businesses.

Conclusion

I believe that the seeds for Australia’s banking system oligopoly were sown in the 1980s by a series of government bank sell-offs. From my reading of the literature, there was little strategy behind these sell-offs with no thought given to the consequences of what the purchase of these assets by larger commercial banks would mean for the banking system. Those changes occurred and are now impossible to undo. Given this, regulators need to look at some changes to implement before the banks’ oligopoly becomes any more dangerous to the economy at large.

The reality is that none of the measures I have suggested here are likely to be given the go ahead (with the exception of higher capital controls and probably only after it is too late). Australia’s banking system is clearly an oligopoly and becoming more entrenched in that position as time goes on. Its regulators and politicians need to force through some changes in the financial industry before it becomes the latest textbook example of how a country whose regulators failed to react to the signs before it was too late.

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[1] Taken from: http://www.investopedia.com/terms/o/oligopoly.asp

[2] Meaning that the top 4 producers have a concentration of this amount.

[3] http://blogs.news.com.au/heraldsun/andrewbolt/index.php/heraldsun/comments/bash_the_greedy_scapegoat/P80/

[4] Then Prime Minister of Australia

[5] http://australia.deposits.org/

[6] http://www.tai.org.au/node/1926

[7] http://www.clmr.unsw.edu.au/article/risk/imf-reports-australias-high-compliance-international-standards-raises-concerns-over-market

[8]