Speaking of the dearth of IPO’s and the decline in public issues, we had the arrival of two new companies to the NYSE: Nielson (NLSN) and Demand Media (DMD).
I wanted to take a closer look at Demand Media (DMD) because it is the largest tech IPO since 2004 when Google (GOOG) debuted and because it hearkens back to the heyday of the tech bubble some 10 years ago. Specifically, it reminds me of the 1999 IPO of Priceline (PCLN). Of course, they are in totally different businesses but you’ll see what I mean in a minute.
Demand Media is in the business of finding keyword niches through an SEO algorithm and then to pay someone to write an article around that keyword for $10-15 and then to publish it on their high ranking legacy domains such as eHow.com alongside ads to monetize that ‘content’. The formula produces extremely low quality articles that ranks high in Google (GOOG) and therefore, gets traffic. In their S-1 registration DMD professes that they depend on Google for 28% of their their revenue. Demand Media also owns a registrar (eNOM) but it is a staid business with very little growth prospects accounting for 44% of their revenue while the content farm is 56%.
Profits? Who Needs Profits
Demand Media hasn’t been profitable since 2006 and engages in extremely aggressive accounting (to put it politely). Rather than recognize the cost of their content acquisition immediately, they amortize it over 5 years.
Another serious risk is that Google has come under fire recently for falling behind the ‘cat and mouse’ game between search engines and spammers. Most would qualify Demand Media as one of the culprits who have gamed Google’s penchant for ranking trusted and legacy websites higher. Google responded to the criticism with an acknowledgment of the issue and vowed to redouble its efforts to weed out exactly the type of content that Demand Media churns out every day and relies on for its bread and butter.
For more details on why Google has trouble identifying these lower quality websites and pushing them down its search results, see this response from Josh Hannah (previous owner of eHow.com):
Possible reasons why Google doesn’t manually degrade eHow:
- Google is in love with the idea of a pure, algorithmic, scalable solution to problems and will invest great energy in this before manually tweaking
- eHow addresses a lot of long-tail content topics, for many of which they are probably the best answer (even if they are not a great answer). The eHow algorithm for choosing which articles to write clearly takes this into account.
- eHow generates tens of millions in AdSense revenue for Google annually. Wikipedia generates none.
- Google has more pressing quality problems in product-focused areas, where it seems like the first ten search results are dominated by garbage product spam. Whatever you think of eHow, it’s generally better than that.
As Josh points out, Google has a love hate relationship with spammers. After all, Google provides them with Adsense, the very same platform they use to monetize their sites. So Google is caught in a conflict of interest. They can’t allow their Golden Goose algorithm to deteriorate too badly but removing all low content and spam would also put a serious dent in their revenue. The challenge facing Google is huge but if they do come up with a solution, even a mildly adequate one, then Demand Media could see a dramatic and immediate effect on their revenue stream. Reading between the lines of Matt Cutt’s response, it is clear that Google is dead serious about tweaking their algorithms to improve quality, and are specifically targeting content farms like Demand Media.
Not Just a Pretty Face
If all of the above isn’t enough, then consider who is sitting across the table selling you shares. After all, Richard Rosenblatt has shown an impeccable ability to time previous transactions – to his advantage. Just a few years ago he sold MySpace to Rupert Murdoch for $650 million, before it promptly imploded. Facebook helped, of course, but that is the dynamic nature of the online business. And yet another risk factor faced by Demand Media.
So consider that this is a company faced with huge risks, no profitability, no defensible moat around their business being sold by a great timer of online assets and yet, somehow, private investors and subsequently public investors have given it valuation of $1.9 billion. If that isn’t enough to blow your mind, consider that the New York Times, one of the great sources of content and news for generations is valued at $1.58 billion.
And that is why I was reminded of Priceline. Those who were around 10 years ago may remember that Priceline was valued in 1999 as a company higher than the combined total of all major US airlines! Demand Media isn’t being valued at a higher valuation than all US traditional media… but the fact that it has eclipsed the Grey Lady should give you pause.