If you believe the hype, Demand Media represents the beginning of the end for everything that’s noble about journalism.
Coincidentally, Richard Rosenblatt’s company, which runs sites like eHow, Cracked.com and Livestrong.com, is currently one of the hottest tickets in town among digital commercial types. An out-of-work media executive recently told me that the company, which has opened a London office, ranked high on his target list.*
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*'You can put lipstick on a pig as often as you like,' one digital advertising executive tells me, 'but monetizing low-quality inventory remains a very, very tough business.'*Surely, I asked, he couldn’t work for an outfit that pumped out so much drek? Oh yes he could. The big attraction, he reminded me, is Demand Media’s impending IPO. With that will come share-based wealth for executives.
There’s quite a lot riding on Demand Media. Venture capitalists have invested nigh-on $350 million in the company, and voices close to Demand Media are suggesting valuations of between $1 billion and $1.5 billion. The former would make Demand Media the first $1 billion+ IPO since 2004, when Google reached a valuation of $27 billion on its first day of trading. The latter would make Demand Media more valuable than The New York Times Co., which has a market cap these days of about $1.2 billion.
A few weeks ago, Demand Media published its eagerly-awaited prospectus. It wasn’t exactly received rapturously. Several commentators noted the absence of profits, which sat oddly with co-founder Richard Rosenblatt’s public pronouncements over the years.
Rosenblatt has been describing Demand Media as profitable for a long time. The earliest reference I’ve come across dates back to March 2007, when he told one interviewer: "We're very profitable, and we could go public now if we wanted to." The following year, Rosenblatt described Demand as "highly profitable." In late 2009, Wired was induced to describe Demand Media as “profitable as hell”.
This simply wasn’t true, at least not under GAAP, the collection of accounting rules that the Securities & Exchange Commission forces publicly-traded companies to use. In fact, Demand’s IPO prospectus reveals that the company has delivered losses every year since its launch in 2006, running up an accumulated deficit of $52 million.
After publication of the prospectus, The Wall Street Journal was among those who berated Rosenblatt for his claims of profitability. CNNMoney and Mediapost, the U.S.-based media site, went further, suggesting that Rosenblatt had lied about his company’s performance. Should this worry anyone? Not if you’ve got your head screwed on. Rosenblatt is an old hand, skilled at the art of flipping. And maybe -- just maybe -- the enforced use of GAAP numbers handicaps Demand Media unfavorably.* *
*In the end, investors will need to ask themselves what makes Demand Media different. Is it clever algorithms or just agreements with 10,000 contributors who will write an article for $15?*John Battelle, the author of Searchblog and founder of Federated Media, thinks so. Battelle shares a venture capitalist backer with Rosenblatt, and so might be considered biased. But unlike the Wall Street Journal, Battelle is willing to listen to the argument that after spending $21 million on acquisitions, Demand Media could never look good under GAAP. “The company could have been GAAP profitable,” writes Battelle, “but -- and this is important -- it chose not to be.” Battelle argues that if you strip out non-cash costs like stock options and amortization, Demand Media is actually “minting money”. Perhaps this is true at a corporate level. But there’s a problem: we still don’t have any idea of how much profit Demand Media is making from its content.
Rosenblatt’s company does two things: it sells domain names and it sells advertising against content. Unfortunately, Demand Media’s form S-1 doesn’t split out the bottom line for these different parts of the company. So it’s impossible to tell whether Demand Media’s allegedly revolutionary business model -- the publishing bit, in other words -- is actually profitable.
Instead, the prospectus treats us to a classic of non-standard accounting: a calculation of the internal rate of return generated by text-based content published by the company during Q3 08. At 58 percent over seven quarters, the rate of return looks good. Yet here again, obscurantism prevails. The IIR calculations, we’re told, include only “certain in-house costs” and excludes “indirect” costs such as “bandwidth and general corporate overhead”.
Abruptly, and without further explanation, we’re also told that the revenue generated by this slice of content jumped by 62 percent year-on-year in 2009. Why the sudden hike in revenues? Is this to do with increasing traffic numbers or better monetization? Or something else? Here, too, Demand Media refuses to illuminate would-be investors. For a company that touts efficient production and publication of content as its core skill, the reticence seems odd.
Are you buying it? There is, I suppose, a chance that investors will be attracted by the hype and turn a blind eye to the opaque numbers. There’s also an appealing logic to the company’s suggestion that on the web, editorial costs need to be reduced to match digital revenues. Rosenblatt has certainly done a good job in PR terms.
He also seems to be particularly good at finding the right kind of buyer. A decade ago, the man behind Demand Media sold an an e-commerce outfit called iMall to a company that had just turned down the chance to buy Google for $750,000. Five years later, Rosenblatt sold MySpace to Rupert Murdoch’s News Corp for $650 million. It seems highly unlikely that MySpace ever has, or ever will, make a profit.
In the end, investors will need to ask themselves what makes Demand Media different. Does the company add value to the web thanks to its clever algorithms, which define story ideas that people really want to read? Or does its secret sauce consist of agreements with 10,000 contributors who will write an article in return for $15? Writing clever algorithms fosters all sorts of value-laden associations. Paying low wages to home-based workers brings some very different precedents to mind.
Full of contributors’ smiling faces and suggestions that freelancers can "take control of their careers," Demand Media’s corporate site resembles that of a pyramid selling scheme. Out on the web, you don’t need to search hard to find evidence of disenchantment among former contributors.
Yet even when you accentuate the positive, the nagging doubts won’t go away. Is being really good at search engine optimization and selling large amounts of low-value inventory really so revolutionary?
“You can put lipstick on a pig as often as you like,” one digital advertising executive tells me, “but monetizing low-quality inventory remains a very, very tough business.”
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