Telecom's New Star
For those who were snoozing under the barbecue, NeuStar went public last week at $22 per share (see NeuStar Twinkles on Wall Street). The IPO was well received, and it's already trading about 20 percent higher than its offering price. (For the record: In keeping with LR policy, I do not buy or sell stocks I write about in this space.)
On an investment basis alone, NeuStar is interesting. It has profit margins of 30 percent. It's growing about 40 percent year-over-year. And with a forward P/E ratio of about 30 and an annual revenue run rate that is closing in around $250 million, the stock is not really even that expensive. At $26 a share, the company has a market capitalization of about $1.5 billion. There is plenty of room to grow.
But it's not just that NeuStar's numbers look great. What's really interesting is what NeuStar's business model is saying about the telecom industry. Ignore it at your own peril.
What does NeuStar do, you ask? Well, in a nutshell, Neustar does phone numbers.
Phone numbers? Who thought that could be interesting? Specifically, NeuStar aids with the portability of phone numbers, both between wireless and wireline service providers, including VOIP services. NeuStar administers several mammoth databases that allow service provides to route calls and exchange phone numbers. Specifically, it's got contracts with North American Portability Management LLC; North American Numbering Plan Administrator (NANPA); and the National Pooling Administrator (NPA). The NANPA and NPA contracts reside with the U.S. Government.
In short, NeuStar hosts and maintains these huge numbers databases and collects a small fee each time they are accessed by service providers. It's got a quasi-monopoly – although, like all monopolies, it could always be taken away.
Skeptics will point out that this seems like a commodity business with a low barrier to entry. The contracts can be cancelled, and competitive companies could provide similar services. This is all true. In fact, NeuStar states in the "Risk Factors" section of its S-1 filing: "If we fail to meet the expectations of the FCC, the U.S. Department of Commerce or our customers, as the case may be, for any reason, including for performance-related or other reasons, or if another provider offers to perform the same or similar services for a lower price, we may be unable to extend or renew these contracts."
This has led some folks to compared NeuStar with Telcordia Technologies Inc. and ask: Where's the proprietary system? But that's exactly my point: Proprietary is bad; open is good. Have you checked on Telcordia's business lately? (See Telcordia D-Day Approaches.) Like all open, Internet business models, such a business is really about scale and critical mass. NeuStar is more like eBay or Google (Nasdaq: GOOG) than it is like Telcordia. It's a Google for phone numbers, with some government contracts. The fact is that NeuStar remains in an enviable position as the "number broker" for all of North America, and, at a time when phone numbers have never been more dynamic, that's not bad at all. With wireless devices and VOIP services spreading like weeds, I wouldn't mind being in NeuStar's position, would you?
Moving beyond NeuStar in particular, here's why phone-number portability – and the advent of ENUM – is of even larger importance to the industry: It means the brains have been ripped out of the telephone switch. You could even say that the brains are being ripped out of the service provider's network.
Why is this a big deal? In the old world, telecom companies ran huge, proprietary systems. They had all sorts of OSS, directory, and numbering systems that were locked into their particular networks. Why, they even had their own proprietary printed directory – the phone book.
That era is over. Packetization means that phone numbers have gone virtual, and so will everything else: Any communication application and service will easily outsourced, switched, and virtualized. All of these systems are moving to open models, where they can be torn down and moved around to any network, at any time. Yes, somebody will own your physical connection, one way or another. But the real money will be made in the value-added services and software that's layered on top of that. Like the phone number management that NeuStar does, much of this will be outsourced by the major service providers
As we move to this open system, it should spur growth in the industry. Think about what Web addresses did for the Internet. Hopefully, this transition will happen sooner rather than later.
Will NeuStar see competition? Most certainly. Are there other phone number, ENUM databases, and VOIP companies seeking pieces of this busines? Yep. VeriSign Inc. (Nasdaq: VRSN) is ramping up its own outsourced security and directory services. And service providers such as Stealth Communications Inc. are looking to build large VOIP peering fabrics and ENUM databases of their own. It's a growth market (see VOIP Peering: Incumbent Killer?).
What about NeuStar stock? Buy it, I say. It's not often that a company comes along that reflects fundamental changes in an industry's business model. NeuStar seems like a fairly safe bet to capture some potentially huge upside in the proliferation of VOIP and wireless data services.
— R. Scott Raynovich, US Editor, Light Reading