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Summary:

Demand Media is feeling the glare of the spotlight as it prepares for an IPO expected to be in the $1.5-billion range. Its financial statements have drawn some red flags, there are concerns about its web traffic, and the quality of its content is being criticized.

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Demand Media CEO Richard Rosenblatt

Updated: Whenever a company files for an initial public offering (IPO) — particularly in the IPO-starved technology sector — it gets put under a microscope, since it’s the first chance observers have to see the actual numbers behind the business. Demand Media is the latest to see its weaknesses exposed under the glare of this public spotlight, as it prepares for an initial stock offering that is expected to be in the $1.5 billion range. The content-generating company filed an S-1 document detailing its finances late last week, and that’s drawn some red flags; in addition, there are concerns about the company’s web traffic, and a consortium of traditional content companies wants producers like Demand to submit to industry guidelines governing the quality of its content.

The Case of the Missing Profits

In Demand’s securities filing, the company breaks down the finances of its main business: the content-production unit Demand Studios, which produces web copy, photos and videos based on algorithms that look at which advertising keywords are getting the most traction. According to the document, this business had revenue of $198 million in 2009, and booked a net loss of $18 million, while in the first six months of this year, it had revenue of $114 million and a net loss of $4.2 million. Yet (as the Wall Street Journal notes) Demand CEO Richard Rosenblatt has repeatedly insisted that the company is profitable, including in an interview with Om, which is embedded below.

Profit, of course, is a fluid concept — as any Wall Street investment banker knows. Rosenblatt could well have been referring to the fact that the company has consistently generated a profit from its actual operations, since the net loss has been driven by amortization of acquisitions, something accountants require companies to book but doesn’t really affect the actual profitability of the business itself. Still, saying “we are profitable” traditionally means bottom-line profitable, not on a cash-flow or EBITDA (earnings before interest, taxes, depreciation and amortization) basis. If the Demand CEO meant operating profit, he should probably have said operating profit.

A Traffic Cop Named Google

Meanwhile, questions have been raised about Demand’s traffic, which appears (based on some rankings) to have dropped sharply. According to an analysis by peHUB, which looked at Quantcast data, traffic to the company’s various web properties (which include the Cracked.com humor site and bike-racing star Lance Armstrong’s Livestrong site) dropped precipitously from more than 7 million daily visitors to less than 2 million. A glitch? Perhaps — since other measurements show no drop. Demand is in a “quiet period” mandated by securities regulators in advance of the IPO, and so can’t comment. But one of the concerns about the kind of content that Demand offers is that it is susceptible — as the company notes in its filing — to the whims of Google’s algorithm, which generates about 40 percent of the company’s traffic. If Google decides to devalue it, it’s worth less, period. And there’s also the chance that Google will compete with it.

Attack of the Traditional Content Providers

Speaking of devalued content, a group of content producers have recently taken aim at Demand (although they don’t mention it by name) and similar auto-generated content companies that they believe are devaluing content online. Known as the Internet Content Syndication Council, the group yesterday sent out proposed content-publishing guidelines to its members, who include Reuters, Sony BMG and Google, as well as New York Times subsidiary About.com, which some would argue takes a very similar approach to content as Demand Media. The guidelines (which are voluntary) include requiring publishers to “clearly display the credentials of the sources used to create the material” and “ensure that all content submitted is vetted by established and qualified editorial reviewers.”

The spotlight on Demand’s business will get turned up another notch when the IPO is finally priced — which should happen within the next month or two — and analysts can debate the valuation of the company, a job that some have already started on. According to some estimates based on market multiples for its content business and domain-registration unit, the company could be worth as much as $1.8 billion. But that assumes the spotlight doesn’t turn up any other uncomfortable blemishes on the company’s business.

Update: As a reader has pointed out in the comments, Demand’s domain-registration business has also come in for criticism, based on the reportedly large numbers of websites hosting malware, viruses and other abusive or illicit content that have registered their domains through the company’s eNom business. An earlier report accused the company of knowingly registering domains to illegal pharmaceutical distributors.

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  1. the Quantcast analysis is misleading. Demand simply took out the Quantcast tags on their eHow site as a network trace shows. Traffic to the site is unchanged as indicated by alexa.

    that said, Demand’s dependence on Google for revenue and traffic does not bode well for an independent company.

    1. Thanks, Les — you are right that the Quantcast data seems to be the result of a dropped tag, which PEHub mentioned. But the larger point about Demand relying on Google for traffic is still a good one.

  2. Honestly, any vetting of sources is going to kill them. Seeing as the pay rate for the main property is usually in the $5 range for most articles they request on the site, who exactly would write them? Certainly not anyone with decent credentials, who’d be making far more than writing mill pay for an article.

    1. Yes, I think that’s something the company will continue to struggle with — trying to improve quality will likely result in higher prices.

    2. It’s actually $15 dollars an article & people who write for them are people who don’t yet have the credentials they want because editors won’t give them a chance or who are simply embarking on a new career. Of course you wouldn’t write for them if you’re already a professional. However many who write for the site are professionals in other areas. A site like eHow, for example, is an excellent place for beginners who have been teachers or doctors or scientists to learn whilst being guided by editors. Also, in this economy, Demand Studios has been a reliable source of income for many people. It’s all about perspective, I guess.

  3. This IPO would open the door of opportunity for Demand and the tech sector as a whole.

  4. Earth to Silicon Valley:

    Is it really surprising that Richard Rosenblatt had that god awful piece written about him? He’s a hollywood “club” guy acting as CEO of an Internet company.

    If you read the piece in the WSJ then analyze their filings you can see that there is a SERIOUS disconnect between his public statements and disclosures in the filings. It’s just a fact.

  5. Matt: did you see this report ranking Demand Media as the most abusive registrar on the Internet?

    http://www.managingip.com/Article/2650584/Managing-Internet-IP/Demand-Media-is-most-abusive-registrar.html

    1. Thanks, Marcus — I did see an alternate version of that report, which I have linked to in the post. I also wrote about some earlier criticisms of Demand’s eNom business, so I linked to that as well. Thanks for the comment.

  6. Google dependence is a problem. However, they get the traffic from Google and monetize it on Google. So why would Google penalize them by altering their search algorithm? Google should buy them.

    Mat, as I understand they are in a quite period. Can they still be talking to potential buyers?

    1. Mathew Ingram CH Friday, August 13, 2010

      I don’t think being in a quiet period prevents them from talking to potential acquirers — it simply prevents them from saying things publicly that might affect the market for their stock.

    2. Google routinely gives traffic haircuts to sites that get their traffic from Google and monetize on Google. Why? Because search engines are only valuable when content is fragmented. If any one site gets too big, then users would search directly on that site rather on Google. As users do on YouTube for video.

  7. Wow are you saying Richard mislead you correct me if I am wrong is not what and S1 is for to get clarity around the company and its numbers prior to investing ? the talking points given by CEO’s to a low flying Blog is not designed to be used as an S1 filing I would guess splitting hairs on operating profit vs EBITDA as talking points in an interview to a blog is a far cry from and S1 filing , you are simply looking to find a negative spin on demand media which is clear , investors will read the S1 and come to there own conclusions the beat up by weekend web warriors is for you to get a reaction to your story using the bottom feeder mentality of your blog where unless you write something Negative no one will read it which is more than likely true I respect that , during the S1 filing the company would disclose not hide information , now all the people who either failed at starting a company or don’t have the skills to do so can jump on your soap box and become something they never could on there own. a person who is respected for what they did not what they say .

  8. renaissance chambara | Ged Carroll – Links of the day Sunday, August 15, 2010

    [...] Demand Media Faces Harsh Spotlight En Route to IPO – cost of content creation, even with a ‘content farm’ methodology [...]

  9. Penny-a-word freelancers may earn “content farm” $1.5 billion « Wooden Horse Magazine News Tuesday, August 17, 2010

    [...] questions about the company.  Writers may want to check out the resulting articles, such as “Demand Media Faces Harsh Spotlight En Route to IPO” in GigaOm’s blog.  Also, Carol Tice’s informative blog post “Demand [...]

  10. Google dependence for traffic from an online publishing standpoint is not really that huge of a problem – it is the new reality. What bothers me about Demand is the way in which they are tricking Google’s algorithms into thinking that their low quality content is actually better than they are. Their use of a combination of cypersquatting and redirects, and their use of their thousands of parked domains to create artificial link popularity for their low quality (to trick Google’s Pagerank algorithm into thinking their content is highly linked to and hence of higher quality) content are just some of the ways they are currently gaming the system. Their tactics are well known in the ‘black hat’ SEO community, tactics that are the FOCUS of Google’s anti web spam team. While every online publisher is at the mercy of Google, I’d be wary of any publisher whose traffic is PRIMARILY driven by the black hat techniques. It’s a house of cards waiting to fall over – totally unsustainable. It appears that they are counting on the investment community’s lack of understanding of the SEO dynamics to pull this IPO off… this is really not all…they have also been reported for having done shady things with their writers’ content to avoid paying residuals. Richard R’s history, the lying about the profits, the Google-gaming, the constant alleged cheating of their writers…if not anything, should be enough of an indication of the integrity (or lack thereof) of the company – there is no smoke without fire. And wait till Yahoo advertisers start protesting about their ads showing up on parked pages with no contextual content. Also, why would a company drop their tracking tag with quantcast if they have growth to demonstrate? Especially during a time when they are trying to secure a high valuation?

    Here’s a sample of controversies associated with this company:

    http://www.computerworlduk.com/news/security/3235104/demand-media-accused-of-hosting-malicious-sites-and-spam/
    http://www.buzzmachine.com/2010/02/24/demand-medias-advisors/
    http://gigaom.com/2010/06/21/demand-media-subsidiary-accused-of-enabling-illegal-drug-sales/
    http://www.seodigerati.com/demand-medias-ehowcom-using-interesting-expired-domain-redirect-seo-strategy/
    http://www.xomba.com/ehow_uk_scam_grows_out_control
    http://blogs.wsj.com/digits/2010/08/12/where-did-demand-medias-profits-go/

    The list goes on and on… You just gotta do your own research…

    1. Frank J is right on target. Demand’s business plan is gaming the system and relying on imperfections in Google’s algorithms that turn up third-rate “content” instead of the real stuff. It may work for a while, but not in the long term.

      Moreover, Demand’s “content creators” are getting paid a penny (or perhaps a few pennies) a word, and many of them gaming Demand by churning out formulaic junk.

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