Demand Media's accounting practices: bogus or genius?
Advertisement
Demand Media's IPO raises a big question: Can media companies benefit upfront financially by counting on content to perform well over time?
The company is banking on its army of cheap freelancers churning out evergreen content to be an appetizing recipe for investors. Moving ahead with plans to go public, Demand hopes to raise almost $140 million selling shares priced at $14 to $16 each. That could potentially put Demand's valuation at $1.3 billion.
But one aspect of the IPO has garnered some skeptics, which tend to follow Demand Media around: The company uses an unusual accounting practice by stretching editorial costs over a five-year period rather than when the costs occur. Demand justifies the move by saying content is “long-lived” and therefore has a “probable future economic benefit,” according to its amended prospectus filed with the Securities and Exchange Commission. 
More specifically, Demand assigns articles based on an algorithm determining highly searched terms. The company then pays writers to produce thousands of articles a day, often based on how-to content, for a network of sites including eHow. Or, in SEC-filing language, “we leverage proprietary technology and algorithms and our automated online workflow processes to create content with a predicted economic return above a minimum threshold.”
The practice of realizing editorial costs over time is unusual among most publishers, said Reed Phillips, managing partner at Desilva + Phillips, LLC, a media investment bank. He's heard of publishers amortizing editorial expenses over two or three years, but the bulk of the expense will usually be taken in the first year. “What they're clearly saying is they think the content will be valid over a five-year period," Phillips said in a phone interview.
Phillips doesn't envision other media companies following the same model. "It could become more of a practice if more and more content moves to the Internet and it has a longer history there in terms of staying on sites, but I don't think that's the case right now,” he said. “I think most organizations that put up content find that it's less relevant after a year."
Relying on Google
Demand might have found a financial model that could help content producers who focus on more evergreen content. On the other hand, the accounting practices could prove to be an overambitious valuation.
One bump in the road for Demand ― and for all publishers of evergreen content, for that matter ― is the reliance on search. It's unclear whether Demand and other publishers can keep up as search engines evolve, leveraging better semantic technology that understands context and not just keywords.
Forbes' Jeff Bercovici calls Demand's accounting “even more bogus than it seems,” not taking into account the fact that Google is striving to reengineer search in a way that favors higher quality content. “If anything, the sort of stuff that Demand and other content farms (like Associated Content and Seed, as well as a new one Barry Diller’s IAC recently launched) produce will lose much of its revenue-generating potential over the next few years,” Bercovici wrote.
Demand's prospectus doesn't ignore the possibility that Google (which is mentioned dozens of times) could ruin its plan. The company lists one potential risk to investors as “the possibility that our relationship with Google from which a significant portion of our revenue is generated may be terminated or renewed on less favorable terms.”
Another trend that could threaten Demand's business model: social media. Guillaume Decugis noted on Business Insider: “Whatever definition you want to give to the word, there's the idea that content will be either created, distributed, curated or recommended by humans. Not by a factory.”
But will Demand come up with an algorithm to determine human sharing? Time will tell.
Join the discussion
So, here's where this gets interesting for me. Enthusiast publications that feature cross-stitch patterns or other kinds of how-to content could do the same thing and make their profits look much better than say a newspaper or newsy magazine. B2B publications like Trusts and Estates or even a company like ALM could say that their content lasts a few years unless new legislation comes out. EBITDA would then improve dramatically and multiples might get a bit confusing.
Do they have some kind of paid inclusion deal with Google:
The company lists one potential risk to investors as “the possibility that our relationship with Google from which a significant portion of our revenue is generated may be terminated or renewed on less favorable terms.”
Keith,
They are referring to AdSense and Google Display. Because they have such high traffic volumes, they can negotiate a much higher rev share. Bloggers that sign up for AdSense get around 50% of net revenues. Premium publishers with tons of traffic can negotiate much higher than that. I've heard that the normal starting point for a deal for premium publishers is 70% with some people telling me they've gotten as high as 88%.