It would be great if this can be written the wiki-style, with folks knowledgeable with the diff aspects of PM contributing to this effort. All meaningful contributions are welcome! All contributors will be acknowledged.

 

 

Domain Names Portfolio Management Theory

Simplified version with emphasis on educational & entertainment aspects of DNPMT and some historical notes

 

Abstract

Domaining is becoming a business in its own right. Literally thousands of investors all over the world are putting time, money and efforts in collecting and trading domain names. This trend is somewhat similar to the stock and bond investing mania of their parents’ and grandparents’ generations. The following Table lists estimates of the total value of the world financial markets in the trillions of dollars:

·        Treasuries:  $27 T

·        Corporate Bonds: $15 T

·        Municipal Bonds: $25 T

·        Stocks: $50 T

There are also commodities, FOREX and the real estate markets. And probably a few more.

 

In comparison, the entire size of the ‘visible’ domain name market is no greater than $3 Billion.  We are in the midst of the new ‘industrial’ revolution – this time info-lution. It’s taking the entire world economy by the storm. The old ways of doing business are going the way of Dodo. The entire infrastructure of the sales and marketing force in most industries is being either discarded or totally revamped. And just like Titanic-the ship saw only the tip of the iceberg, it was the ‘invisible’ part that did the trick. The size of the economy that critically depends on the web presence and web transaction capability is already in the Trillions. Par example, multimillion-dollar businesses are built around diamond.com, rent.com, apartments.com, Mapquest, Amazon, Hotels.com, Travelocity, eBay, etc. The future wannabe: Fund.com. For the new large-scale enterprise the actual dollar price paid for the domain, whether it’s a $10 reg fee or $10 million on the secondary market is becoming irrelevant.

In this paper we will try to bring about and apply the ideas and methods of investing and portfolio management which are already in existence in other markets.

 

Introduction

People were collecting stuff for fun and pleasure since they were monkeys. The Egyptians were collecting the pyramids (Were those pyramids any good for the pharaoh’s contemporaries other than to starve and kill the slaves employed in the pyramid’s construction?) , the Greeks – scientific knowledge, the Romans – slaves & the legal code, the Jews – Talmud wisdom and moral code, the Dutch in XVIc. – Tulip flowers (1), the Germans in the 1940s – gold teeth & hair from the prisoners (2),  Russians and East Germans in the 1970s – Olympic Gold medals with the help of anabolic steroids (3), American and European investors – Treasuries & stocks, including billions of dollars of worthless stocks (1950s – current), baseball players – home runs with the help of the same steroids (2000s), Geeks an Nerds - domain names (1994 - ?), etc. As you can see from this short list many of the items people collect are of dubious value.

 

The sheer volume of DN is mind-boggling. As of 2007 the numbers are:

Biz          1,860,669  

Info         4,981,597  

Org         6,194,878  

Net          10,476,009  

Com        73,433,353

Total        96,946,506  

 

In 2008 it will be well over 100 million.

 

By default Domain Names became an investment class. Many wealthy investors and financial institutions started gobbling up this product. And just like with any investment people found out that some are real pearls, some are ‘working horses’, but most are rotten apples. In the absence of any meaningful guide investors turned to the forums to exchange ideas and products. A number of simple ideas on what constitutes a ‘good’ domain became public knowledge. Investors started to buy not just single domains, but small and large portfolios. Currently there are pools with 50,000 and 300,000 domains in them. But most of the portfolios are still 100 to 5,000 domains.

 

The issues that these new-found managers facing are formidable:

·        Am I collecting names for fun only?

·        Can I stand to lose money every year?

·        How much can I stand to loose?

·        Can I make money every year?

·        Shall I trade?

·        Shall I buy at Land rush, secondary markets, drops, auctions or just reg it myself?

·        How do I optimize my portfolio?

·        Can I swap portfolios?

·        How do I price portfolios?

·        Shall I diversify?

·        Can I make big money?

 

In the mid-XIX century American economy started to generate humongous wealth. The titans of that period invested their family fortunes with the financial horizon of several generations, probably a 100-year horizon. These days many bankers at the major Wall Street firms play an arbitrage game where the ‘investment horizon’ is 10 seconds or shorter. We will talk about the investment horizons and how they affect the financial picture.

 

As the financial markets started to grow and mature the new financial theories abound. Harry Markowitz from Baruch College in New York did a fabulous job in the 1950s on Portfolio Theory: hm

Michael Milken mm was pioneering the modern high-yield (junk bonds) market at Drexel in the 1980. He pissed off a lot of well-entrenched Ivy-league professors and the Wall Street old-timers by showing that his investing methods are way superior. They were superior to the point that the old guard decided to destroy Drexel & put Milken away. At his predicament the issues discussed in Greenwich, Connecticut were ‘class, ethnicity & entitlement’. Milken is a thorough portfolio manager and a scholar. But he didn’t publish any scholarly papers. He did talk about his management methods at various meetings with potential clients. His methods of maximizing portfolio performance are directly applicable to the DN industry.

 

Black, Scholes, Merton, Cox & Ho applied equilibrium methods from Mathematical Physics to Finance to price financial derivatives: bs.

A great number of finance scientists were awarded Nobel prizes in the last 20 years. These studies are distinct from Economics in a major way: They talk specifically about the mechanics and underlying math of the specific investments. But it is interesting to note that many of the latest crops of the Nobel folks in finance theory didn’t do so well in the financial markets themselves as investors. As a matter of fact, many of them invested in the Long Term Capital Management Fund (ltcm), which almost crippled the entire world economy! They weren’t just passive investors. They came in as advisors and gurus with their Nobel prizes and the Harvard, Berkeley and MIT tenures. They put on a $2 Trillion bet with John Meriwether, the hero of the book Liar’s Poker (lp). And they lost. If the Government didn’t step in and helped to unwind the positions they took the 1928 stock market crash would’ve looked more like another ripple.

 

24 hours before the LTCM meltdown the Federal Reserve Bank of New York folks called on the S&P brass and requested that they look into the situation. S&P hastily organized a late meeting in the basement at 25 Broadway. It was scheduled to go at 8 p.m., after all the analysts gone home. It was important not to give anybody any clue and not to freak out the Wall Street community. The cleaning crew was told that no cleaning needs to be done there. Professors from MIT, Stanford, Princeton, Yale, & Cornell were flown first class or on charter flights. The NYU folks just walked across the street from the Stern School. A year earlier S&P has developed a sophisticated computer model which puts the entire economy under dynamic stress. It was written by two Russian mathematicians who were bored to death at their day job. The game these folks played that night resembled the simulated war games that our brave generals play at the Pentagon all the time.  After just a few simulation runs it became apparent to everybody that all the financial markets will collapse, there will be no liquidity and the US economy will take a nosedive.

 

In the 1980s the discount brokerage was introduced in the USA. Instead of paying 5% on the total transaction price many investors could trade for just $9.99 or even less. After the market turmoil in 1987 many stock and bond brokers found themselves unemployed. The smartest of them have figured that instead of pitching themselves as discount brokers they would rather become money managers or portfolio managers to their clients. And so there is a new breed of money managers who instead of running a mutual fund end up running hundreds of tiny portfolios for their clients. Many portfolio managers wouldn’t take a portfolio that’s smaller than, say, $100,000.  They charge their clients a percentage of the portfolio’s total value. The old-fashioned stock broker is gone for good.

 

We can foresee some of the trends in domaining which will follow in the footsteps of other financial markets:

Portfolio leasing

SWAPS

Portfolio repurchase agreement – repos

Introduction of the DN Portfolio Duration

 

In simple terms, some of the deals will involve:

One party giving up portfolio revenues for a fixed period of time in exchange for fixed payments from another party

One party exchanging DN portfolio for another portfolio with or without remuneration

 

To correctly describe DNPT one needs the tools of stochastic analysis, partial diff equation and sigma-algebra. These tools became the everyday staple of many players on Wall Street, the analysts at the US Treasury Department and probably the classroom toys in places like Wharton & MIT. For our purposes we will use here only the simple methods or none at all.

 

 

Profit & Loss Scenarios

 

The following Table represents diff revenue scenarios. We look at portfolios which generate NO revenue at all, and portfolios with 1 penny a day per domain, up to portfolios with $1 revenue daily

 

Annual Portfolios Revenues with Diff P/L values per domain

 

 

 

 

 

 

Domains

P/L=1c

P/L=5c

P/L=10c

P/L=50c

P/L=$1

100

-$640

$800

$2,600

$17,000

$35,000

200

-$1,280

$1,600

$5,200

$34,000

$70,000

500

-$3,200

$4,000

$13,000

$85,000

$175,000

750

-$4,800

$6,000

$19,500

$127,500

$262,500

1000

-$6,400

$8,000

$26,000

$170,000

$350,000

1500

-$9,600

$12,000

$39,000

$255,000

$525,000

2000

-$12,800

$16,000

$52,000

$340,000

$700,000

2500

-$16,000

$20,000

$65,000

$425,000

$875,000

3000

-$19,200

$24,000

$78,000

$510,000

$1,050,000

4000

-$25,600

$32,000

$104,000

$680,000

$1,400,000

5000

-$32,000

$40,000

$130,000

$850,000

$1,750,000

 

A small portfolio with 100 domains generating 1 penny a day per domain will rack up $640 losses a year. Not that bad. But if your portfolio has 5,000 domains making a penny a day you should be prepared to shell out $32,000 just to stay even.

 

Now, if you’re lucky to get 10c a day per domain and there 1,000 domain in your portfolio you can expect to get $12,000 profit! And if you have 5,000 domains making $1 a day each you’re a fat cat with $1.75 million revenue a year. Congratulations!

We made a number of plausible assumptions in constructing this Table: your average expenses per domain are $10 a year and you pay no other expenses to maintain your portfolio.

A trivial, but important result:
The break-even point: 3c a day per domain. In lay terms it means that inn order to stay put and not to loose a shirt your portfolio should generate AT LEAST 3c a day per domain.

 

When you're looking at a pair of ripped underpants with the brown stains - it's WORTHLESS. If you own MyFavouriteGreekPizza.xxx in any tld it's not just
WORTHLESS, it's got a NEGATIVE VALUE.
Let me explain. You reg it for $10 a year. You keep it for 10 years. You charge it to your credit card at 18% annual. Your estimated cost is $ 200, and PV is little
diff. Say, you have a portfolio of 1,000 domains which you intend to keep for 10 years. There are great names like, say, FreeCreditCardIsHere.XXX in your portfolio.
Then the portfolio's NEGATIVE VALUE is around $200,000.

 

 

Star Performers

It turns out that one doesn’t need star-quality domains to make a decent living. As a matter of fact, some of the stars can literally kill your business.

Let’s take a look at the financial workings of sex.com. This domain was purchased for $12,000,000 with a commercial rate loan at 11.75%/10 year.

At this rate the sex.com owner has to pay $170,435 in monthly payments. It was reported that sex.com attracts close to 3,000 visitors a day, with half of those converging. Several years ago the adult industry was paying publishers anywhere from $2 to $5 per visitor. These days the numbers are $0.25 to $2.00. Assuming sex.com is getting the top dollar we get

3000 x $2 x 30 days x 50% = $90,000 estimate.

$170,435-$90,000= $80,435 shortage!

Yes, there is a good chance that another shmuck will come along and shell out $25 million for this domain and rescue the current owner. Meanwhile, the sex.com owner is bleeding.

 

Portfolio Valuation

 

Presently there are literally hundreds of models for asset valuation. Asset could be any instrument: security (bond, stock, CD, domain name, derivative, variable rate annuity, lottery payments, etc.) or portfolio of securities. The simplest models use deterministic values for all the variables.  The more sophisticated models use the stochastic approach, where variables like interest rate are represented by the term structure of interest rate, which is beyond the scope of this paper.

Present value is the value on a given date of a future payment or series of future payments, discounted to reflect the time value of money and other factors such as investment risk. Present value calculations are widely used in business and economics to provide a means to compare cash flows at different times on a meaningful "like to like" basis.

Calculation

The most commonly applied model of the time value of money is compound interest. To someone who has the opportunity to invest an amount of money C for t years at a rate of interest of i% (where interest of "7 percent" is expressed fully as 0.07) compounded annually, the present value of the receipt of C, t years in the future is:

C_t = C(1 + i)^{-t}\, = C / {(1+i)^ t} \

 

The expression (1 + i)−t enters almost all calculations of present value. Where the interest rate is expected to be different over the term of the investment, different values for i may be included; an investment over a two year period would then have PV (Present Value) of:

\mathrm{PV} = C(1+i_1)^{-1}\cdot(1+i_2)^{-1} \,

 

Present value is additive. The present value of a bundle of cash flows is the sum of each one's present value. In fact, the present value of a cashflow at a constant interest rate is mathematically the same as the Laplace transform of that cashflow evaluated with the transform variable (usually denoted "s") equal to the interest rate. For discrete time, where payments are separated by large time periods, the transform reduces to a sum, but when payments are ongoing on an almost continual basis, the mathematics of continuous functions can be used as an approximation.

 

Present Value (PV) of Portfolios with 5-yr Horizon and Diff Interest Rates

 

 

Columns Correspond to Portfolios with Diff Profit & Loss chracteristics (P/L)

 

 

 

 

5-yr Horizon

1 domain

100 domains

1000 domains

Portfolio

Portfolio

Portfolio

Portfolio

Portfolio

Portfolio

Portfolio

 

no income

no income

no income

 

 

 

 

 

 

 

Interest Rate

$0 revenue

$0 revenue

$0 revenue

P/L 1c

P/L 10c

P/L $1

P/L $10

P/L $100

P/L $500

P/L $1000

2%

($53)

($5,254)

($52,539)

$0.63

$6.30

63

630

6,305

31,524

63,047

3%

($54)

($5,387)

($53,872)

$0.65

$6.46

65

646

6,465

32,323

64,647

4%

($55)

($5,525)

($55,249)

$0.66

$6.63

66

663

6,630

33,149

66,299

5%

($57)

($5,667)

($56,672)

$0.68

$6.80

68

680

6,801

34,003

68,006

6%

($58)

($5,814)

($58,142)

$0.70

$6.98

70

698

6,977

34,885

69,770

7%

($60)

($5,966)

($59,661)

$0.72

$7.16

72

716

7,159

35,796

71,593

8%

($61)

($6,123)

($61,231)

$0.73

$7.35

73

735

7,348

36,738

73,477

9%

($63)

($6,285)

($62,853)

$0.75

$7.54

75

754

7,542

37,712

75,424

10%

($65)

($6,453)

($64,531)

$0.77

$7.74

77

774

7,744

38,719

77,437

11%

($66)

($6,627)

($66,265)

$0.80

$7.95

80

795

7,952

39,759

79,518

12%

($68)

($6,806)

($68,058)

$0.82

$8.17

82

817

8,167

40,835

81,670

13%

($70)

($6,991)

($69,912)

$0.84

$8.39

84

839

8,389

41,947

83,894

15%

($74)

($7,381)

($73,812)

$0.89

$8.86

89

886

8,857

44,287

88,575

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Present Value (PV) of Portfolios with 10-yr Horizon and Diff Interest Rates

 

 

Columns Correspond to Portfolios with Diff Profit & Loss chracteristics (P/L)

 

 

 

 

10-yr Horizon

1 domain