Why You Should Stay Away From This Tech IPO

Known best for its questionable Super Bowl ads, domain registrar and Web hosting company GoDaddy is preparing to go public. After filing for an IPO last June, the company recently updated its SEC filing, choosing the New York Stock Exchange as its home and reserving the symbol GDDY.

GoDaddy's position as the leading domain registrar hasn't led to profits. The company last year posted a $143 million net loss on $1.39 billion of revenue, a staggering loss for a mature, 18-year-old company. Domain registration is an extremely low-margin business, and Web hosting is intensely competitive, with big cloud players such asAmazon and Microsoft . along with a slew of smaller players including DigitalOcean, driving prices down.

GoDaddy expects to be valued at about $4.5 billion when it hits the market, or a little more than three times sales. Given its business line, and its inability to turn a profit, this valuation seems outrageous. GoDaddy is one tech IPO to avoid.

Not as bad as it seems, but still not greatThat $143 million loss GoDaddy reported in 2014 is actually not the most useful number in judging the business. GoDaddy is using what's called an Up-C structure for its public offering, in which a new company, the one investors will own after the IPO, buys the assets of the old company above cost. This creates intangible assets on the balance sheet, and some of these can be amortized over time, creating a noncash charge against earnings.

The purpose of this arrangement is to reduce the company's tax burden, lowering taxable earnings going forward. GoDaddy had $1.66 billion in goodwill and $750 million in other intangible assets on its books as of the end of 2014, and it expects to amortize the fixed-lifetime intangible assets as follows:

Source: GoDaddy S-1.

In 2014, the amortization expense was $97.2 million, and adding this back leads to a much smaller loss than reported. GoDaddy is still unprofitable, but the situation isn't quite as bad as it first seems, since this amortization isn't a real expense, instead a byproduct of the complicated Up-C structure.

A tough businessGoDaddy's main business, registering domains, isn't a very good business to be in. It's a high-volume, low-margin commodity business dictated by fees paid to both the registry operator, VeriSign for the .com extension, and to theInternet Corporation for Assigned Names and Numbers, or ICANN. For each .com domain name GoDaddy registers, it must pay $7.85 to VeriSign and $0.18 to ICANN annually, in addition to other annual fees paid to ICANN. It also doesn't help that Google now sells domain names directly.

GoDaddy's position in the industry can help it sell other services to customers, like Web hosting, but the completion there is fierce. Cloud computing providers such as Amazon and Microsoft have been driving down the price of their offerings for years, and Web hosting services are cheaper than they've ever been. Both companies also provide a slew of other services, as well as free tiers of service.

Beyond the big cloud companies, plenty of smaller hosting companies offer extremely low prices. DigitalOcean is one example, charging $5 per month for its least powerful virtual private server option. This is in line with what GoDaddy charges for its low-end shared Web hosting, although an equivalent virtual private server at GoDaddy costs quite a bit more.

There are a tremendous number of options available for Web hosting, and there isn't much of a difference between them besides customer service. I can't imagine margins in this segment will be particularly good, and that leaves GoDaddy with only low-margin businesses.

Stay away from the GoDaddy IPOIn addition, the company is saddled with $1.4 billion in debt, on which it paid $85 million in interest in 2014. The IPO will raise some money, but the company will still have a lot of debt on the books going forward, making it much harder for GoDaddy to turn a profit.

There's not much to like about GoDaddy. The expected valuation doesn't make much sense given the low-margin nature of the company's businesses, and while revenue is growing, profitability doesn't appear to be feasible in the foreseeable future.

If there's any time for GoDaddy to IPO, though, it's now, as plenty of unprofitable tech companies with questionable business models, such asBox, have had successful IPOs recently. It's a much better deal for the company, however, than for prospective investors.

The article Why You Should Stay Away From This Tech IPO originally appeared on Fool.com.

Timothy Green has no position in any stocks mentioned. The Motley Fool recommends Amazon.com and Google (A shares). The Motley Fool owns shares of Amazon.com and Google (A shares). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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