Tucows Serves Up a Quarter of Acquisition-Fueled Growth

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Before diving into any discussion about Tucows (NASDAQ: TCX), it helps to understand the company's overarching strategy. Tucows operates three separate business segments -- domains, mobile service, and fiber internet -- and uses the cash flow generated by the first two segments to fund what it believes is its biggest long-term opportunity in the third segment. The company's Q2 results showed strong top-line growth in domains and continued gains in its mobile business, although it didn't yield much in the way of tangible progress for its internet service segment.

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Domain growth got a big boost from the Enom acquisition

Tucows' largest segment is domain services, which posted Q2 revenue of $62.8 million, up roughly 120% from last year. That growth was fueled primarily by the acquisition of domain provider Enom in early 2017. In the first full quarter with consolidated results that include Enom, the domain segment achieved a gross margin of $15 million, up 76% from last year. CEO Elliot Noss noted that the integration of Enom is going well and that the company's legacy domain business exceeded expectations for a second consecutive quarter.

Thanks to the acquisition, growth in this segment will remain robust for the remainder of this year. But it won't be until 2018 that investors will really be able to see apples-to-apples year-ago comparisons that give a better sense how the business is performing. Citing synergies from the combined operations, management continues to believe that it can eventually grow Enom's $15 million in adjusted EBITDA contribution to $20 million by the end of 2018.

Ting Mobile keeps growing by double digits

The company's mobile-services segment, Ting Mobile, reported Q2 revenue of $20.4 million, up around 14% from last year. Gross margin for the segment was $9.7 million, up 15% from last year. The company says it had organic growth of around 4,500 members in the quarter, although Noss mentioned the business is expected to get even more competitive going forward.

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With monthly customer churn during the quarter of just 2.19% -- its lowest rate in two years -- Ting ended Q2 with a total of 170,000 accounts and 278,000 devices. That's up from 151,000 accounts and 245,000 accounts at the end of 2016. The company admitted it overestimated Ting Mobile customer additions in Q1, which makes looking at the first half of the year a more accurate way to see the segment's growth. With Ting reaching this level of active devices, Tucows believes that in the quarters to come, customer retention will begin to have as much impact on results as customer acquisition.

A quiet quarter from Ting Internet

The company's high-speed fiber internet business, Ting Internet, is its smallest segment. With revenue of just $1.1 million, it hardly factors into Tucow's results yet -- though that was up 13% over last year. And its gross margin of $0.1 million, down from $0.5 million last year, amounts to little more than a rounding error. But Ting Internet remains Tucows' big bet on future growth.

Noss noted the company's steady progress in its first three "Ting towns":

Charlottesville is really only limited by how many customers we can install in a week, Westminster by how quickly the town can expand the network and Holly Springs by how quickly we ourselves can expand the network. [...] While Charlottesville continued its steady growth in Q2, the combination of Westminster and Holly Springs, both at earlier stages, more than doubled in customers, recurring revenue and, most importantly, operational capacity. 

While no new Ting towns were announced this quarter, Noss stated that they're in several active conversations. It's clear, however, that as it attempts to expand, working with city governments is going more slowly than the company expected. Ting Internet's next two markets -- Centennial, Colorado; and Sandpoint, Idaho -- were revealed last year. Noss said while he still believes Ting will announce new markets before the end of 2017, nothing's guaranteed.

Interestingly, Noss also mentioned that if things continue to move slowly and the company isn't able to ramp up its capital expenditures this year, it may consider a share buyback (which Tucows has a rich history of doing) as an alternate use for its cash.

The company continues to believe that Ting Internet can become highly profitable over time. Tucows expects that 50% of Ting's serviceable addresses will become customers within five years of launching in a community. And while it will cost an estimated $2,500 to $3,000 to connect each customer to the network, each customer is expected to yield $1,000 a year in gross margin. With numbers like that, it's easy to see why so much of the cash Tucows generates is being earmarked for its fiber business.

Putting it all together

For the second quarter, Tucows reported strong year-over-year growth across the board, driven mainly by the Enom acquisition and to a lesser extent by the growth in Ting Mobile. In total, revenue grew 78%, net income grew 29%, and adjusted EBITDA grew 50%. And crucial to its long-term strategy, the company also generated cash flow from operations of $8.1 million, up 218% from last year. As far as guidance goes, the company simply reiterated its expectation of $42 million in adjusted EBITDA for full-year 2017.

Halfway through 2017, Tucow's three businesses all appear to be performing admirably, although investors are no doubt eager to hear about more concrete progress on the Ting Internet front in the coming quarters.

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Andy Gould owns shares of Tucows. Andy Gould has the following options: short August 2017 $55 puts on Tucows. The Motley Fool owns shares of and recommends Tucows. The Motley Fool has a disclosure policy.