Demand Media: Worst IPO of the year

Content crap farm ready to crap on investors with crappy public offering

Like most long-time professional writers, I detest content farms such as Demand Media. They pay writers and other content producers crap to produce crap. They clog up Google's search results with their crap content. And Demand Media uses a crap accounting system to hide the true cost of its crap content.

But my job here is to objectively assess Demand Media's initial public offering, which on Wednesday submitted an amended prospectus to the Securities and Exchange Commission in which it said it will offer 4.5 million common shares priced between $14 and $16 each. So, let's get on with my professional, unbiased assessment of Demand Media's IPO. It's crap. In fact, Demand should trade on Nasdaq so its ticker symbol could be CRAP. (Instead it's going on the New York Stock Exchange as DMD. What a blunder!) Craptacular Fact No. 1: Demand Media is losing money. Net loss for the nine months ended Sept. 30, 2010, was $6.35 million, down from $18.54 million the year-ago period. A smaller loss is still a loss, and as Demand points out in the prospectus, the online content world is volatile, so there's no guarantee the trend toward profitability will continue. Craptacular Fact No. 2: Demand is increasingly dependent on search giant Google. It derived 28% of its revenue from Google ad deals in the first nine months of 2010, up from 18% in 2009. Demand's ad contract with Google expires in the second quarter of 2012. If it's not renewed, then what? (See Craptacular Fact No. 5.) Craptacular Fact No. 3: Google could change its search algorithm at any time to the detriment of content farms such as Demand Media, which clog up search results with crap. Google itself is under pressure to constantly improve its search results, and there was talk last year that it would change its algorithm to prevent the Demand Medias of the world from polluting its search results. (Update: Google on Jan. 21 renewed it vow to prevent content farms from diluting the quality of user search results.) Craptacular Fact No. 4: Demand traffic is down 21 percent over the past three months, according to web traffic analyzer Alexa. But those recent stats aren't in the prospectus, which only covers results through last Sept. 30. One more thing: In a PC World article last August shortly after Demand filed to go public, John P. Mello Jr. noted that Demand traffic had plummeted 71% in the days after the IPO filing, according to another web metrics tracker, Quantcast. I was curious to see if Demand traffic had rebounded since then, so I visited Quantcast and did a search on Demand Media. Instead of data and a chart, I got this message: "Traffic data has been hidden by the owner." I did a Quantcast search on about 10 other major web sites to see if this was a common practice. Quantcast provided data for all of them. Hmm. (Update: Some readers have been all over me for citing this traffic stat because demandmedia.com is just the site where writers go to sign up. The real traffic driver for Demand is its ehow.com site, which is ranked No. 111 by Alexa and has seen impressive page-view growth over the past two years. I freely acknowledge that dumb mistake on my part because it's important to admit when you've made a dumb mistake. However, before you get too excited, if you check the Alexa stats you'll see that page views per user and time spent on ehow.com have been drifting down over the past year. Draw your own conclusions from that. In addition, about half of ehow.com's traffic comes from search traffic. See Craptacular Fact No. 3 for the implications of that fact.) Craptacular Fact No. 5: As Demand noted in its prospectus, Google itself could decide to enter the content generation business. OK, maybe that's not a craptacular fact, but it's a craptacular distinct possibility. After all, this is a company that has spread its tentacles into a number of areas that have nothing to do with search. It seems to me that content generation would be a natural for Google (certainly much more so than a driverless car). Craptacular Fact No. 6: As Kara Swisher at All Things Digital points out, Demand amortizes the cost of content over a five-year period, unlike most other publishers who recognize costs immediately. Demand does this because it claims it publishes "evergreen" content whose value extends over time. That could be, since crap is a wonderful fertilizer, but the truth is Demand is just asserting the extended value of its content because it makes its financial results appear more favorable. The SEC flagged this and forced Demand to amend its prospectus to explain this maneuver in more detail. Craptacular Fact No. 7: "Investors purchasing common stock in this offering will experience immediate and substantial dilution." That's right from the prospectus, which explains: "The assumed initial public offering price of our common stock is substantially higher than the net tangible book value per outstanding share of our common stock immediately after this offering. As a result, you will pay a price per share that substantially exceeds the book value of our tangible assets after subtracting our liabilities. Purchasers of our common stock in this offering will incur immediate and substantial dilution of $13.92 per share in the net tangible book value of our common stock based upon an assumed initial public offering price of $15.00 per share." Lovely. Other than all that, Demand looks like a great opportunity.

Chris Nerney writes about the business side of technology market strategies and trends, legal issues, leadership changes, mergers, venture capital, IPOs and technology stocks. Follow him on Twitter @ChrisNerney.

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