Could Legal Troubles At VeriSign Doom IIH?

by on July 20, 2010 | ETFs Mentioned:

Tech firm VeriSign (VRSN) has had a pretty good deal with the U.S. Commerce Department over the past few years in regards to its control of domain names. The company controls all “.com” and “.net” domain name registers thanks to a contract with the Internet Corporation for Assigned Names and Numbers (ICANN), an agency that acts on behalf of the Commerce Deptartment. VeriSign collects a fixed fee each time individuals or businesses register a new .com or .net domain name or renew the registration of an existing domain name, giving the company a recurring revenue stream and significant power in the Web site market.

But some groups have argued that the deal is too sweet for VeriSign at the expense of others; members of the Coalition for ICANN Transparency (CFIT), a non-profit organization of web site owners, brought a lawsuit against VeriSign hoping to block the company’s registration service for expiring domain names. The CFIT argued that the company was attempting to monopolize the market, and was engaging in anti-competitive practices. The lawsuit was initially thrown out, but in an appeal to a higher court by the CFIT the decision was reversed; the appeals court ruled that the lower court “failed to appreciate the seriousness of the allegations of anti-competitive conduct,” and by rejecting the existence of a separate market for expiring domain names, “improperly relied on already outdated authority” [see Three ETF Ideas For The Third Quarter].

This decision, as well as the court’s rejection of an appeal by VeriSign, leaves the company in a tough spot going forward. According to attorneys for CFIT, one of two things will happen from here: either VeriSign will petition the Supreme Court to hear the case, or it will go back to the district court for a trial. If VeriSign ultimately losses, it could have a disastrous impact on company’s share price. By some estimates, more than half of the company’s value stems from its .com and .net domain holdings, which generate more than $6.30 for every new domain name and for every renewal for the company. A loss of control over these assets could send the prices plunging for individuals seeking domain name registration, but would also heavily eat into VeriSign’s margins as more competitors entered their once exclusive market [also see Ten ETF Ideas For 2010].

VeriSign: Critical Holding of IIH

Investors in the Internet Infrastructure HOLDR (IIH) should be watching the developments in the VeriSign case very carefully; IIH currently holds almost 50% of its assets in VRSN (Akamai Technologies which accounts for another 32% of the fund). IIH only has 8 securities in total, with the remaining six companies making up the last fifth of the fund’s total assets [also read Five Facts About HOLDRs Every ETF Investor Must Know]. The fund is split right down the middle in terms of sector allocation, with half going to telecommunications and half going to software. Despite these ongoing legal troubles for its top component, IIH has produced a robust return for investors; delivering a gain of more than 25% so far in 2010 and nearly 60% over the past 52 weeks [also see Five Equity ETFs That Have Held Their Ground During The Recent Market Slide].

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Disclosure: No positions at time of writing.