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The Marchex Story: Why They Spent $164 Million on Domains and What They Have Planned For Their Eye-Popping Portfolio

More than a decade ago, a small group of visionary individuals began dabbling in a hobby business that eventually mushroomed into what we now call the “domain industry”. Those early pioneers realized that domain names constituted the real estate of the Internet and, despite being ridiculed by others, they firmly believed that one day domains would hold great value. 

Their faith was strengthened as they observed that people who were surfing the Internet would often type in specific domain names when searching for something on the web. That behavior produced “traffic”, something the first domainers knew would be prized by advertisers, just as foot traffic is prized by commercial businesses in the real world. 

Equipped with this knowledge and the foresight to act on it, early domain investors built portfolios of good generic domains and many went on to make a very nice living by selling their traffic to Internet advertisers. The fledgling industry flew under the radar for years, dominated by “Lone Rangers” scattered around the world. 

Seattle-based Marchex, Inc. changed all of that and ushered in the “modern era” of the domain industry early last year when they closed on the $164 million purchase of the Name Development portfolio (more commonly known by domainers as the Ultimate Search portfolio), a collection of over 100,000 domains that had been assembled by an exceptionally savvy domain pioneer named Yun Ye. That huge acquisition by a publicly traded company (NASDAQ: MCHX) suddenly put the domain business in the spotlight and attracted other major investors, both public and private, who are now spending tens of millions of dollars in this space. 

“Prior to founding Marchex, my colleagues and I were among the primary senior management team of a publicly traded internet company, Go2Net, which focused on consumer search, as well as merchant transactions,” Christothoulou said. We held similar positions at Go2Net to which we hold now at Marchex - Russell Horowitz is the Chairman and Chief Executive Officer; John Keister is the President and Chief Operating Officer; Ethan Caldwell is the Chief Administrative Officer and General Counsel; and I am the Chief Strategy Officer.  After Go2Net’s merger with InfoSpace in 2000, we incorporated Marchex in 2003 and we are all here today and committed to growing Marchex.   

164 million seeds for future growth were planted with the landmark deal for the Name Development portfolio. At the time those domains were purchased, they were reportedly generating about $19 million a year in revenue. That worked out to a price of about 8.6 times annual revenue, but with real content added to many of their domains and advertising dollars migrating to the Internet from traditional media, Marchex is expected to recoup their initial investment in a much shorter time frame.  

“The Name Development transaction surprised a lot of people because it was the first transaction of its type and by the sheer magnitude of the deal,” Christothoulou said. “By virtue of Marchex’s third party distribution network, which partially consisted of domain portfolio owners, we had been fortunate enough to see the operational characteristics and financial trends of these assets, including the high quality traffic (defined as high advertiser conversion rates) and strong growth rates they generated on a consistent basis.”  

“In addition, because of our large base of search advertisers who were purchasing pay-per-click and contextual advertisement listings, it was important to secure a direct source of proprietary high quality distribution that, as is commonly known, helps to increase overall advertiser conversion rates. In short, the deal was a great fit for our search marketing products and services. The transaction would not have been as effective or compelling absent those assets.” 

Yun Ye’s portfolio was not the only large portfolio Marchex could have gone after. Christothoulou explained why it was the one they set their sites on. “As most people know, domain name quality is a big differentiator. We selected the Name Development portfolio based primarily on the quality and quantity of its holdings: tens of thousands of generic, commercially relevant Web sites in key commercial verticals (for example, travel, finance, health, etc.). Given a choice between 100,000 high quality sites and a million sites that lack the characteristics we think are important, we’ll opt for the 100,000 sites every time. We carefully evaluated a wide range of options in the marketplace based on specific criteria that we had established internally, found that the Name Development portfolio was, by a wide margin, what we believed to be the best portfolio in the space and commenced our process.” 

Today there are several entities that hold portfolios of 100,000 or more domains. With new competitors in the space, we asked Christothoulou if it is more difficult now to acquire domains that are similar in quality to those Marchex already holds? “Our current focus is less on acquisitions and more on product development (building out the Web sites). As such, the current environment doesn’t really affect our business. It does, however, validate the value of our Web sites and our strategy,” he said.

“Each domain is a unique asset – so while others may look to get similar names, there can only be one Remodeling.com, one BayAreaHotels.com, one Beijing.com, one Cuisine.com, etc. – which are names Marchex owns. Additionally, because our strategy involves “verticalizing” our Web sites (for example, hotels.beijing.com, restaurants.beijing.com, etc.) and “localizing” our Web sites (for example, seattle.remodeling.com, newyork.remodeling.com, etc.) with the creation of sub-domains or sub-pages, we have the opportunity to create additional valuable inventory at very little incremental cost. In other words, if we didn’t purchase another domain, we would have the opportunity to continue to grow our business by making our existing Web sites deeper (multi-page Web sites), which is unique to Marchex by virtue of the way in which we power our Web sites by leveraging our Open List technology to populate the pages with relevant information,” Christothoulou said. 

Open List is a company Marchex acquired for $13 million in May that provided them with a user-generated content platform as well as content aggregation and search technology they have been able to apply to their sites. “Open List has helped to unlock the value of our Web sites by providing us the ability to dynamically build very deep, multi-page Web sites with targeted content,”  Christothoulou said. 

“Since our inception almost four years ago, we have grown very quickly and have made strong operational and product progress. We own a proprietary source of vertical and local traffic which generated approximately 28 million monthly unique visitors for the month of June 2006, we have partnerships with hundreds of distribution partners, including many of the leading search engines (such as Google and Yahoo), shopping engines (such as Shopping.com and PriceGrabber.com) and vertical Web sites (such as BusinessWeek.com and Forbes.com),” Christothoulou said. “We also have an advertiser base that consists of tens of thousands of merchants who leverage our search marketing technology to sell their products online – on our proprietary traffic and on our third party distribution partner traffic.” 

Wall Street has taken notice of the strides Marchex has made. Motley Fool writer Rick Aristotle Munarriz posted a glowing review of the company’s second quarter 2006 results. Christothoulou said “We reported second quarter revenue of $31.7 million, a 50% year-over-year increase and we are projecting 2006 revenue of $130 million to $136 million. We are cash-flow positive and reported Adjusted Operating Income Before Amortization (Adjusted OIBA) and Adjusted Earnings Before Interest, Taxes Depreciation, and Amortization (Adjusted EBITDA) of $8.3 million and $9.7 million, respectively, for the second quarter of 2006.” 

“It is important to know that our reported ‘loss’ in the second quarter is due to non-cash accounting items (accounting regulations that took effect in 2006), such as stock-based compensation and amortization of acquired intangible assets, and that Marchex continues to generate cash in a very meaningful way. For the second quarter of 2006, we reported Adjusted Earnings per Share of $0.12, which compares to $0.08 per share a year ago. We feel good about our progress thus far and are squarely focused on continuing to build the business.” 

“Fortunately, Marchex was, and is, uniquely qualified to perform this analysis. We have tens of thousands of advertisers who use Marchex’s technology for search marketing – so we see the patterns of keyword bidding (which keywords are being bid for and at what frequency or volume); the trends in keyword bid prices and the conversion rate for keywords (which keywords tend to drive high advertiser conversion). As such, we applied data mining techniques to that information and ran the resulting keyword list against the registry.”  

“Of course, we knew that many valuable names, like Cars.com would be taken, but what we found was that locally focused names were not registered. Things like local and vertical combinations, such as ChicagoDoctors.com, BayAreaHotels.com, MiamiTours.com, as well as ZIP Codes. So, fortunately, we were able to directly register these names at wholesale rates and acquire more than 100,000 locally and vertically focused Web sites in the process. Our strategy has paid off nicely, as many of these names have become very powerful Web sites for Marchex,” Christothoulou said. 

Christothoulou doesn’t expect the .US effort to have a material impact on the Marchex ZIP code network. “We have found that the majority of Internet users navigate the Web using .com or .net, and we feel fortunate to have acquired the majority of ZIPs in those areas. Additionally, the challenge of building out relevant Web sites, increasing Web site utility and promoting repeat usage at the ZIP Code level is in finding an efficient way to populate the pages with geo-specific content on a wide range of topics, such as hotels, restaurants and attractions.  Fortunately, Open List allows us to accomplish this type of integration and we are happy with the results we have seen to date on our ZIP Code Web sites. It will be interesting to watch what happens with this other effort and how they answer the challenge of creating deep, rich Web sites that benefit both consumers and advertisers,” Christothoulou said. 

While the ZIP code battle unfolds, Marchex is continuing to build out dozens of other locally oriented sites. “We have initially focused on content integrations in the travel vertical, with sub-categories in hotels, restaurants, and attractions – meaning that we’ve deployed Open List to all of our ZIP Code sites and more than 100 local and vertical Web sites, such as LasVegasVacations.com,  ShanghaiHotel.com, and NewYorkTours.com. In the coming months, we will extend our Open List platform to additional verticals and sub-categories,” Christothoulou said. “Initial feedback has been very encouraging. In August, we announced that the initial integrations of Open List content and technologies into a sample base of our Web sites have led to very impressive growth in page views and revenue."

As a new industry that is still being shaped, the rate of change in the domain business has been phenomenal. We asked Christothoulou how he thought things might change over the next  2-3 years?  “We believe that there will continue to be a combination of new players and some consolidation, as is the case with any emerging industry. Things are moving quickly, with new participants emerging on a seemingly daily basis. As the industry continues to mature, we believe that marketplace expectations for quality will increase, too. The participants who want to have staying power need to keep focused on quality, while understanding that larger, traditional media companies just might get involved in the space, too. It will be interesting to watch and is an exciting time to be involved,” Christothoulou said.

In closing, Christothoulou noted “The industry is still very young. As is often the case with any early market, its participants need to not only focus on successfully running their business, but also on educating third parties, including the press and Wall Street. It is important that we all continue to work diligently and explain this marketplace in a manner that highlights the benefits we provide in the context of the search ecosystem.”

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