SAN FRANCISCO -- In late August, a Silicon Valley start-up called Namezero.com, which supplies free Internet domain names, announced that it had raised $25 million in venture financing.

In its news release, Namezero was vague on exactly who had invested in its "strategic third round." However, the newsletter VentureWire reported that an unidentified corporate investor had joined the firm's existing venture firms in the round.

At the time, I speculated in RealMoney.com's Columnist Conversation that the investor was VeriSign (VRSN:Nasdaq - news), owner of Network Solutions, the leading provider of domain-name registrations. Later that day, Aug. 30, Verisign confirmed that it had made a "small" investment in Namezero, though it wouldn't say how much because it doesn't make a practice of disclosing the size of its investments.

Investors who are puzzled about the 21% drop to $147.50 in Verisign's stock over the last three days (erasing $7.6 billion in value) can look to tiny Namezero for an explanation. Namezero buys domain names (such as you@you.org or .net or .com) from VeriSign and lets its users "borrow" them, assuming the user is willing to view Namezero's advertising. Namezero pays VeriSign between $8 and $10 for the use of the name, a service for which VeriSign typically charges retail customers $35 per year.

There are two reasons this business arrangement has turned into a brouhaha for VeriSign. First, investors are concerned about any indication of slower growth at high-multiple Internet companies.

While Wall Street widely considers VeriSign's authentication-software business to be red-hot, a slowdown in its domain-name registration business would be a sign of weakness when Verisign reports earnings on Oct. 25 after the market closes. As Internet silliness is slowing down, so is willy-nilly domain-name registration. As such, analysts already expect VeriSign's net domain-name additions to be flat with last quarter's, or about 2.1 million names.

That's where the Namezero controversy enters into the equation. Analysts expect Namezero to account for as many as 600,000 of Verisign's 2.1 million new names. A goodly portion of these -- 200,000, according to VeriSign CEO Stratton Sclavos -- are freebie dot-net or dot-org names, which Verisign signed up through promotions meant to generate business from an underutilized asset. (The preponderance of existing domain names VeriSign signs up traditionally have been dot-coms.) With so large a proportion of VeriSign's new names coming from cheapo Namezero, new registrations would seem overinflated.

The other element to the stock drop is VeriSign's previous reticence on the Namezero investment. This is one of those follow-the-money statements, so here goes: Because Namezero effectively is paying VeriSign for its domain names with its venture money, and because VeriSign is one of Namezero's venture investors, investors understandably are concerned that VeriSign is dishing it out with one hand and taking it in with the other.

"If investors were to find out that on a sequential basis registrations are down, factoring out the Namezero additions, that would hurt the valuation," says one VeriSign observer who spoke on condition of anonymity. "They'll have a very strong quarter, but people will get concerned about them stretching."

CEO Sclavos has answers for nearly every element of the Namezero saga. He won't disclose the size of the investment, but says Verisign has made about two dozen such investments, totaling more than $100 million over the last 12 months. He says that Namezero accounted for about 15% of VeriSign's new registrations in the second quarter -- before VeriSign invested in the start-up -- and that Namezero accounted for a similar percentage in the third quarter. In other words, "it's no different than it was last quarter" and therefore not relevant.

Sclavos provided a detailed breakdown of where VeriSign gets its sign-ups. About 30% to 35% are retail customers -- individuals and entities -- that pay $30 to $35 per year. A similar percentage come through resellers like Internet service providers, accounting for annual revenue to VeriSign of about $18 to $22 per name. Five percent of VeriSign's registrar customers are corporate accounts that pay between $50 and $300 per name for a slew of services that come with the name. Finally, between 15% and 20% are from the so-called "bulk" market, a low-margined business that brings in $6.50 to $8 per name.

Namezero falls into the last category. Sclavos argues that Namezero is a relatively high-quality bulk customer because it assumes the costs of marketing to new customers and because it has a lower percentage of speculators, users who buy names simply to sell them. (Namezero typically retains ownership of its names).

The company's fans buy the argument. Dain Rauscher Wessels analyst Stephen Sigmond called the controversy "much ado about nothing" in a report to clients on Thursday, saying that "we believe these concerns are grossly exaggerated, creating a compelling buying opportunity ahead of September-quarter earnings, which we expect will show across-the-board strength."

Sigmond -- whose firm, in an earlier iteration, was one of VeriSign's three lead underwriters in its 1998 initial public offering -- maintains a $300 price target on VeriSign's shares.

Similarly, Geoffrey Beard, an analyst at Thomas Weisel Partners, says he's scrubbed VeriSign's numbers thoroughly, assumed a conservative $24 per registered name and arrived at a $250 price target on VeriSign's shares based on a discounted cash-flow analysis.

It's too early to dismiss Namezero as just another free-this or free-that dot-com. The company has begun upselling services to its users, and VeriSign intends to piggyback on some of that upselling activity. Still, the practice of Big Company A investing in Big Company B, which then supplies meaningful revenue to Big Company A has played out with ugly consequences too many times in the last few months. If Namezero were to go away, VeriSign's lost investment would be the least of its worries. It'd be left with a gaping hole in its revenue-generation machine for a profitable but maturing business.

The company could help its own cause on Oct. 25 by providing specific figures regarding the size of its investment in Namezero and the economics of its relationship with the start-up. Until then, a cloud will hang over the stock.

One of the Best Names of All

Namezero has a public-relations firm named Hypelab. That's goooooooooood!