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Below is a critical look at a recent online essay about the methodology to estimate the value of the domain name cars.com, which was estimated to be $850 million. Not about estimation of valuation model’s parameters’ nor whether the estimate is too low or too high. Rather its valuation methodology.
Purpose of Valuations
The purpose of a valuation is Important. Absolute valuation of any asset is its value when put to its best use. On the other hand, for a company that is considering the purchase of a domain name must consider how much additional value the domain name is expected to create. For example, a business that is generating $10 million in annual revenue before and after an acquisition, other things held constant, the value of the domain name to the business is zero.
Valuation Tool
WIPO considers the present value (PV) tool, which is based on the asset’s cash flows adjusted for their riskiness (i.e., discounted cash flows), as the fundamental valuation method. However, the tool used in the article is Relief-from-Royalty, which, as the name suggests, is more appropriately used to value brand and patent licensing. There are no royalty payments associated with the purchase of a domain name.
Definition of Cash Flows
1. Both the PV and the Relief-from-Royalty, rely on expected future cash flows, i.e., expected future net income generated by the asset being valued. However, the application of the latter for domain names requires dividing the value of cash flows by the book value of the domain name. However, its book value depends on what price the domain name had been bought, which renders any such valuation absurd.
2, The article incorrectly points out: “For the domain cars.com, [Relief-from-Royalty] considers the value created to the owner by historical earnings from the Cars.com website and how much future cash flow the domain name is expected to generate over its life.” It is not historical earrings, but future expected income, as noted above. Based on this incorrect assertion, the value of a start-up would be zero because it has no earnings. If correct, there would be no start-ups.
3. The essay notes: “Cars.com is short, memorable and garners a high search volume.” First, the length of the domain name is irrelevant to cash flow estimates. Moreover, based on comparables valuation methodology, the length of the domain name is practically irrelevant. Second, the volume of searches and visits are irrelevant, as many customers search for information online, but purchase from a brick-and-mortar store. There is evidence of the resurgence of the brick-and-mortar. With such a resurgence, the value of domain name’s ability to generate additional revenues are diminished irrespective of the volume of visits.
4. One component of cash flows, which was ignored in the essay, is the value of options to use the domain name in new business areas in the future.
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Your critique is incorrect. Briefly:
1. It was $872 million, not $850 million. The figure comes directly from the Cars.com financial statements.
2. For your statement “There are no royalty payments associated with the purchase of a domain name.” shows a misunderstanding of the relief-from-royalty methodology. What relief-from-royalty does is ask “what are the royalties that would have to be paid if the domain name was owned by someone else, who charged for the use of the domain name?” Since the domain name (or patent, or other IP) is actually owned by the user, no actual royalties or licensing fees change hands. It’s an
imputedamount for the royalty, to determine its fair value. In equilibrium, a profit-maximizing holder of the domain name would charge a royalty or licensing fee just below the incremental profit earned by the licensee of the domain name. (i.e. if the licensor charged more, then the licensee would terminate the licensing agreement, since it would be losing money).
3. For your point #1, there is no “dividing the value of cash flows by the book value of the domain name.” Show me the equation where you think that there is division. What one is doing is attempt to add up (and discounting to today) the expected incremental value of the domain name to earnings in the future.
4. We know from SEC documents that the LasVegas.com domain name was acquired in a $90 million deal, albeit with the payments spread over 35 years (over $30 million paid so far). We know Wal-mart paid $9 million for the Shoes.com domain name in a bankruptcy court auction. Why is anyone shocked, given the enormous size of the automotive industry, that the Cars.com domain name would be worth $872 million? Go try and buy it for less, and tell me what they say….
1. Yes, $872 million
2. A simple present value calculation is superior to Relief-from-Royalty.
3. Book value is what’s on the books, which is determined by how much a business has invested in the asset over time. Book values are not adjusted by market values. Thus, the book value of an asset can easily be out of whack with its market value.
4. Accounting numbers (financial statements) are useful in determining the value of a business’ future cash flows, but not the additional cash flows from a domain name.