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T I C K E R : D M D
A N D R E W D . J O N E S , C F A
Short: Demand Media Inc.
1 . F L A W E D B U S I N E S S M O D E L
2 . I N V E N T I V E A C C O U N T I N G
3 . B A D G O V E R N A N C E
P R I C E T A R G E T : $ 5 . 0 0
P O T E N T I A L R E T U R N : 3 0 0 %
Anatomy of a Short Candidate
“ S H * T D O E S N ' T J U S T D I S A P P E A R ! ”
- B E N S T I L L E R I N E N V Y
Flawed Business Model
Company Overview
Demand Media
Content Creation
(55% of revenue)
Registrar
(45% of revenue)
Content creation comprises a number of sites that offer content based on what people are searching for on the internet
o eHow.com; Livestrong.como Content is produced by a stable of 13,000 “freelance” writers
Registrar business is second-largest to GoDaddy.com Demand is the 16th biggest web property by unique visitors as of December
2010
The Content Creation Process
Demand mines data from search engine providers using a
proprietary algorithm to determine key phrases
that people are searching for
These results are sent through another
algorithm that generates story ideas based on key
phrases
Story ideas are sent to editors who make sure that titles make sense
The Content Creation Process
Titles are downloaded into database where
writers can reserve up to 10 stories and
40 videos
Stories are sent to series of editors to
ensure accuracy and authenticity
Stories published on a variety of websites
Types of Articles on eHow.com
The Arbitrarily Location-Specific Article
“How to pick blueberries in Iowa”
The Suspiciously Product-Specific Article
“How to unscrew the iTouchless pepper mill”
The Article That Blows a Problem Out of Proportion
“Ideas for organizing scrunchies”
The Benignly Racist Article
“Best colors for mediterranian men to wear”
Types of Articles on eHow.com
The Article Meant for Aliens Who Just Landed Here
“Types of push buttons”
The Article Offering Advice That Shouldn’t Be Followed
“How to dress like a hipster”
The Article for People in the Narrow Band of Humanity Who
Are Smart Enough to Know About Google But Not Smart
Enough to Figure Out How to Do the Thing They’re Googling
“How to name a kids’ soccer team”
Are these examples of quality content?
How to calculate age from birth date
Types of hats for kids
How to put on a Speedo
How to buy Canadian Molson
How to buy condoms that fit
Are these examples of quality content?
How to understand Ukranian women
How do I manually fill an ointment tube?
How to belch
What are the benefits of cleanliness on job sites?
Are Demand’s 13,000 freelancers really experts?
Demand’s CEO claims that many of the content creators are “professionals”
75% have been published in magazines and newspapers
25% have written a book
25% have held professional marketing roles
Collectively, Demand produces over 4,000 pieces of content per day
There are signs that author matters to search engines like Google
From patent #7,765,209, filed by Google: Claim 1: …second information, associated with the blog, from a source
different than the posts included in the blog; creating, by one or more processors associated with the one or more server devices, a hybrid document by combining the first information and the second information; and using, by one or more processors associated with the one or more server devices, the hybrid document to determine a relevance of the post to a search query.
The method of claim 1 where the extracting the second information includes: extracting, from a feed, at least one of a title of the blog, an author of the blog, or a profile of the author of the blog.
The method of claim 3 where the extracting the second information further includes: extracting, from the blog, at least one of a profile of the author of the blog or a blogroll.
The method of claim 5 where the document includes a profile of an author of the blog.
What does that mean?
Basically, as a person posts articles on the internet, and people visit or link to these posts, they become associated with that topic in the eyes of Google’s search engine
They become an “expert” in that topic and anytime they show up on a webpage with content related to that topic, that page ranks highly in Google search
How can Demand’s freelancers ever become “experts” in the eyes of Google if they are just pumping out content?
What are the incentives for contributors?
Authors load their queues with titles they can produce quickly and with the least amount of effort
Writers earn about $15 per story while videographers earn about $20 per clip
Paid weekly via paypal
Demand is highly dependent on Google for pageviews and advertising revenue
Nine Months thru
September, 2010
% advertising revenue atrributable to GOOG 28.0%
% of traffic from other search engines 8.2%
% of traffic from GOOG 32.8%
% of revenue from eHow 23.0%
% of eHow traffic generated by GOOG 66.0%
Owned and Operated page
Thousands of page views 6,000,000.0
page views attr. To GOOG 1,968,000.0
other page views 4,032,000.0
Revenue per thousand page views $12.60
Total Revenue $75,600,000.00
Network of customer pages
Thousands of page views 9,300,000.0
page views attr. To GOOG 3,050,400.0
other page views 6,249,600.0
Revenue per thousand page views $3.24
Total Revenue $30,132,000.00
Google is moving to eliminate low-quality content from search results
From Google’s official blog, 1/21/2011:
This would greatly affect the future prospects for Demand
From Google Chrome’s official blog, 2/14/2011:
While some have argued that Demand is not a content farm, Google has offered specific examples related to Demand’s sites
The article Google references as low-quality content is on eHow.com
Source: eHow.com
The article Google references about content farms is from PBS.org and references Demand heavily
From PBS.org:
This is a first-hand account of a former Demand freelancer
Source: PBS.org
What would be the impact on revenue if Demand is tagged as a content farm?
Nine Months thru
September, 2010 Adjusted
% advertising revenue atrributable to GOOG 28.0%
% of traffic from other search engines 8.2%
% of traffic from GOOG 32.8% 20.0%
% of revenue from eHow 23.0%
% of eHow traffic generated by GOOG 66.0%
Owned and Operated page
Thousands of page views 6,000,000.0 5,232,000.0
page views attr. To GOOG 1,968,000.0 1,200,000.0
other page views 4,032,000.0 4,032,000.0
Revenue per thousand page views $12.60 $12.60
Total Revenue $75,600,000.00 $65,923,200.00 ($9,676,800.00)
Network of customer pages
Thousands of page views 9,300,000.0 8,109,600.0
page views attr. To GOOG 3,050,400.0 1,860,000.0
other page views 6,249,600.0 6,249,600.0
Revenue per thousand page views $3.24 $3.24
Total Revenue $30,132,000.00 $26,275,104.00 ($3,856,896.00)
($13,533,696.00)
Demand’s Competitors
About.com
Mahalo
Answers.com
wikiHow
AOL
Yahoo!
" I ' M B E G I N N I N G T O T H I N K N O T O N L Y D I D H E I N V E N T T H E I N T E R N E T , B U T H E
I N V E N T E D T H E C A L C U L A T O R A S W E L L . I T ' S F U Z Z Y M A T H . "
- P R E S I D E N T G E O R G E W . B U S H
Inventive Accounting
You Capitalize WHAT?
“We publish long-lived media content generated by our content studio which we commission and acquire from third party freelance content creators. Direct costs incurred for each individual content unit that we determine embodies a probable future economic benefit are capitalized. The vast majority of direct content costs represent amounts paid to freelance content creators to acquire content units…”
“In determining whether content embodies probable future economic benefit required for asset capitalization, we make judgments and estimates including the forecasted number of page views and the advertising rates that the content will generate. These estimates and judgments take into consideration various inherent uncertainties including, but not limited to, our expected ability to renew at favorable terms or replace certain material agreements with Google that currently provide a significant portion of our revenues…”
You Capitalize WHAT?
“Capitalized content is amortized on a straight-line basis over five years, representing our estimate of the pattern that the underlying economic benefits are expected to be realized and based on our estimates of the projected cash flows from advertising revenues expected to be generated by the deployment of our content.”
Capitalizing content acquisition costs sounds a little strange
Prior to Demand’s IPO, the Securities and Exchange Commission approved a controversial accounting technique allowing the firm to amortize its content costs over five years.
Demand says the “evergreen” content it creates will garner internet traffic for a longer period of time than traditional news articles, which tend to expire on the next day.
Demand has not even been around for 5 years, so how can they know this?
Leaves the door open for large writedowns going forward
M A Y I H E L P Y O U D R . . . ?
F L E T C H : O H , I T ' S M E , D R . R O S E N P E N I S . I ' M J U S T H E R E T O C H E C K O U T A L A N S T A N W Y K ' S F I L E .
D R . W H O ?
F L E T C H : D R . R O S E N R O S E N , I ' M H E R E T O G E T T O T H E R E C O R D S R O O M .
W H A T W A S T H A T N A M E A G A I N ?
F L E T C H : I T ' S D R . R O S E N , I W A N T T O C H E C K T H E R E C O R D S R O O M .
D R . W H O ?
F L E T C H : D R . R O S E N . W H E R E ' S T H E R E C O R D S R O O M ?
Bad Governance
Eric Estrada Richard Rosenblatt
CEO Richard Rosenblatt has a less than savory track record
1993: Richard Rosenblatt set up a company that offered a $3,000 web-design seminar that came with a custom-built website The company, iMall, went public at $18 en route to $112 FTC investigated the company’s claim that its clients’ sites were
earning $11,000 per month (they weren’t, surprisingly) The company killed the seminar division, losing 95% of its $16
million in annual revenue Rosenblatt sold iMall to Excite@Home for $500 million
2000: Rosenblatt took over drkoop.com, an online site tied to C. Everett Koop Wanted to turn the Koop into a brand like Martha Stewart or Walt
Disney Created a line of Dr. Koop Men’s Prostate Formula pills The company folded
C. Everett Koop
Rosenblatt’s history even includes outright devious behavior
2004: Rosenblatt was tapped to run eUniverse (later renamed Intermix Media), an internet conglomerate that happened to own MySpace
NYAG Elliot Spitzer charged Intermix with bundling adware and spyware with its free games and screensavers
The company settled immediately for $7.5 million (the entire cash holdings of Intermix)
Elliot Spitzer
The Board is not as independent as you would think at first glance
Demand Media Board of Directors
Name Notes
John Hawkins
Victor Parker
Joshua James
Gaurav Bhandari Goldman Sachs MD (lead underwriter)
Peter Guber
Robert Bennett
Richard Rosenblatt
Fredric Harman
James Quandt Served on Intermix board with Rosenblatt
Valuation
Key Statistics
Market Cap: 1.64 billion
Enterprise Value: 1.54 billion
EV/Revenue: 6.55x
EV/EBITDA: 35.93x
Current Price: $20.00
Target Price: $5.00
Potential Return: 300%
Expected future content revenues
2008 2009
Nine Months thru
September, 2010 2010E 2011E 2012E 2013E 2014E 2015E
Owned and Operated page
Thousands of page views 5,900,000.0 6,800,000.0 6,000,000.0 8,000,000.0 9,600,000.0 12,000,000.0 15,000,000.0 18,750,000.0 23,437,500.0
15.3% 17.6% 20.0% 25.0% 25.0% 25.0% 25.0%
Revenue per thousand page views $10.56 $10.69 $12.60 $12.60 $11.50 $11.75 $12.00 $12.25 $12.50
Total Revenue $62,304,000.00 $72,692,000.00 $75,600,000.00 $100,800,000.00 $110,400,000.00 $141,000,000.00 $180,000,000.00 $229,687,500.00 $292,968,750.00
Network of customer pages
Thousands of page views 5,400,000.0 10,000,000.0 9,300,000.0 12,400,000.0 15,500,000.0 19,375,000.0 24,218,750.0 30,273,437.5 37,841,796.9
85.2% 24.0% 25.0% 25.0% 25.0% 25.0% 25.0%
Revenue per thousand page views $4.04 $3.45 $3.24 $3.24 $3.25 $3.25 $3.25 $3.25 $3.25
Total Revenue $21,816,000.00 $34,500,000.00 $30,132,000.00 $40,176,000.00 $50,375,000.00 $62,968,750.00 $78,710,937.50 $98,388,671.88 $122,985,839.84
Total Content Revenue $84,120,000.00 $107,192,000.00 $105,732,000.00 $140,976,000.00 $160,775,000.00 $203,968,750.00 $258,710,937.50 $328,076,171.88 $415,954,589.84
27.4% 31.5% 14.0% 26.9% 26.8% 26.8% 26.8%
Pieces of content created per day 4,000.0 5,479.5 6,500.0 7,500.0 9,000.0 11,000.0 13,000.0
37.0% 18.6% 15.4% 20.0% 22.2% 18.2%
Total pieces of content created 1,460,000.0 2,000,000.0 2,372,500.0 2,737,500.0 3,285,000.0 4,015,000.0 4,745,000.0
Total page views per piece of new content 11.5 10.2 10.6 11.5 11.9 12.2 12.9
Projected Income StatementProjected Income Statement for Demand Media Inc.Dollars in millions, except per share
2010-2015
2008 2009 2010 2011 2012 2013 2014 2015 CAGR
Revenues 170.3 198.5 239.1 $265.3 $316.0 $378.7 $456.6 $553.5 18.27%
16.6% 20.5% 10.9% 19.1% 19.9% 20.6% 21.2%
Content 84.8 107.7 141.5 $160.8 $204.0 $258.7 $328.1 $416.0
27.0% 31.4% 13.6% 26.9% 26.8% 26.8% 26.8%
Registrar 85.4 90.7 97.7 104.5 112.0 120.0 128.5 137.5
6.2% 7.6% 7.0% 7.2% 7.1% 7.1% 7.0%
Cost of Sales 98.2 114.5 126.9 145.9 172.2 204.5 244.3 293.3
Gross Profit 72.1 83.9 112.2 119.4 143.8 174.2 212.3 260.1 18.31%
SG&A 43.4 48.5 58.5 66.3 77.4 90.9 107.3 127.3
Product Development 14.3 21.7 25.5 26.5 31.6 37.9 45.7 55.3
Amortization of Intangibles 33.2 32.2 32.6 33.0 33.0 33.0 33.0 33.0
Other Operating Expense/(Income) 0 0 0 0.0 0.0 0.0 0.0 0.0
EBIT (18.8) (18.4) (4.4) (6.5) 1.8 12.4 26.4 44.5 #NUM!
Plus: Depreciation & Amort. 43.7 47.1 49.9 48.0 48.0 48.0 48.0 48.0
EBITDA 24.9 28.7 45.5 41.5 49.8 60.4 74.4 92.5
Interest Expense (2.1) (1.8) (0.7) (0.7) (0.7) (0.7) (0.7) (0.7)
Interest Income 1.6 0.5 0.0 0.0 0.0 0.0 0.0 0.0
Other Non-operating Inc./(Exp) (0.3) (0.0) (0.2) (0.2) (0.2) (0.2) (0.2) (0.2)
Unusual Items 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Income Taxes (4.6) 2.8 3.2 (1.6) 0.4 3.1 6.6 11.1
Minority Interest 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Net Income ($14.9) ($22.5) ($8.5) ($5.7) $0.4 $8.5 $18.9 $32.5 #NUM!
Diluted Shares Outstanding 72.8 72.8 92.0 92.0 92.0 92.0 92.0 92.0
EPS ($0.20) ($0.31) ($0.09) ($0.06) $0.00 $0.09 $0.21 $0.35 #NUM!
Discounted Cash Flow Analysis for Demand Media Inc.Dollars in millions, except per share
0 1 2 3 4 5 2010-2015
2008 2009 2010E 2011 2012 2013 2014 2015 CAGR
Sales $170.3 $198.5 $239.1 $265.3 $316.0 $378.7 $456.6 $553.5 18.3%
EBITDA 24.9 28.7 45.5 41.5 49.8 60.4 74.4 92.5
EBITDA Margin 14.6% 14.5% 19.0% 15.7% 15.7% 16.0% 16.3% 16.7%
Depreciation (43.7) (47.1) (49.9) (48.0) (48.0) (48.0) (48.0) (48.0)
EBIT (18.8) (18.4) (4.4) (6.5) 1.8 12.4 26.4 44.5 #NUM!
Less: Taxes @ 25.0% 4.6 (2.8) (3.2) 1.6 (0.4) (3.1) (6.6) (11.1)
Tax-Effected EBIT (14.2) (21.2) (7.6) (4.9) 1.3 9.3 19.8 33.4
Plus: Depreciation 43.7 47.1 49.9 48.0 48.0 48.0 48.0 48.0
Less: Capital Expenditures (20.1) (15.3) (22.1) (20.0) (20.0) (20.0) (20.0) (20.0)
Less: Purchase of Intangibles (19.3) (22.7) (45.9) (30.0) (30.0) (30.0) (30.0) (30.0)
Less: Changes in Working Capital 1.7 3.3 2.6 5.7 6.9 8.2 9.9
Unlevered Free Cash Flow (10.4) (22.3) (4.2) 5.0 14.2 26.0 41.3 #NUM!
Unlevered Free Cash Flow Growth Rate 114.6% (81.1%) (219.7%) 181.9% 83.2% 58.7%
Perpetuity Growth Method EBITDA Multiple Method
Discount rate 15.0% Discount rate 15.0%
Net present value of free cash flow $45.7 Net present value of free cash flow $45.7
Growth rate of FCF after 5th year 3.0% Exit multiple 4.0x
Terminal Value $354.3 Terminal value $369.9
Present value of terminal value $179.2 Present value of terminal value $187.0
Terminal value as a % of enterprise value 79.7% Terminal value as a % of enterprise value 80.4%
Enterprise value $224.8 Enterprise value $232.7
LESS: Debt, pref. stock & minority interest ($11.9) LESS: Debt, pref. stock & minority interest ($11.9)
PLUS: Cash & equivalents $105.0 PLUS: Cash & equivalents $105.0
Equity value $317.9 Equity value $325.8
Diluted shares 92.0 Diluted shares 92.0
Equity value per share $3.46 Equity value per share $3.54
Discounted Cash Flow
What if the income statement was adjusted for a loss in Google traffic and content acquisition costs were expensed?
Projected Income Statement for Demand Media Inc.Dollars in millions, except per share
2010-2015
2008 2009 2010 2011 2012 2013 2014 2015 CAGR
Revenues 170.3 198.5 239.1 $265.3 $316.0 $378.7 $456.6 $553.5 18.27%
Revenue lost from Google $13.3 $15.8 $18.9 $22.8 $27.7
Cost of Sales 98.2 114.5 126.9 145.9 172.2 204.5 244.3 293.3
Gross Profit 72.1 83.9 112.2 106.1 128.0 155.3 189.5 232.5 15.68%
SG&A 43.4 48.5 58.5 66.3 77.4 90.9 107.3 127.3
Content Acquisition 11.0 10.5 26.0 10.9 12.9 15.3 18.3 22.0
Product Development 14.3 21.7 25.5 26.5 31.6 37.9 45.7 55.3
Amortization of Intangibles 31.0 30.1 27.4 30.8 30.4 29.9 29.3 28.6
Other Operating Expense/(Income) 0 0 0 0.0 0.0 0.0 0.0 0.0
EBIT (27.6) (26.8) (25.2) (28.5) (24.4) (18.8) (11.1) (0.8) -49.99%
Plus: Depreciation 43.7 47.1 49.9 48.0 48.0 48.0 48.0 48.0
EBITDA 16.1 20.3 24.7 19.5 23.6 29.2 36.9 47.2
Interest Expense (2.1) (1.8) (0.7) (0.7) (0.7) (0.7) (0.7) (0.7)
Interest Income 1.6 0.5 0.0 0.0 0.0 0.0 0.0 0.0
Other Non-operating Inc./(Exp) (0.3) (0.0) (0.2) (0.2) (0.2) (0.2) (0.2) (0.2)
Unusual Items 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Income Taxes (4.6) 2.8 3.2 (7.1) (6.1) (4.7) (2.8) (0.2)
Minority Interest 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Net Income ($23.7) ($30.9) ($29.3) ($22.2) ($19.2) ($14.9) ($9.2) ($1.5) -45.04%
Diluted Shares Outstanding 72.8 72.8 92.0 92.0 92.0 92.0 92.0 92.0
EPS ($0.33) ($0.42) ($0.32) ($0.24) ($0.21) ($0.16) ($0.10) ($0.02) -45.04%
Adjusted DCFDiscounted Cash Flow Analysis for Demand Media Inc.Dollars in millions, except per share
0 1 2 3 4 5 2010-2015
2008 2009 2010E 2011 2012 2013 2014 2015 CAGR
Sales $170.3 $198.5 $239.1 $265.3 $316.0 $378.7 $456.6 $553.5 18.3%
EBITDA 16.1 20.3 24.7 19.5 23.6 29.2 36.9 47.2
EBITDA Margin 9.5% 10.2% 10.3% 7.4% 7.5% 7.7% 8.1% 8.5%
Depreciation (43.7) (47.1) (49.9) (48.0) (48.0) (48.0) (48.0) (48.0)
EBIT (27.6) (26.8) (25.2) (28.5) (24.4) (18.8) (11.1) (0.8) (50.0%)
Less: Taxes @ 25.0% 4.6 (2.8) (3.2) 7.1 6.1 4.7 2.8 0.2
Tax-Effected EBIT (23.0) (29.6) (28.4) (21.4) (18.3) (14.1) (8.3) (0.6)
Plus: Depreciation 43.7 47.1 49.9 48.0 48.0 48.0 48.0 48.0
Less: Capital Expenditures (20.1) (15.3) (22.1) (20.0) (20.0) (20.0) (20.0) (20.0)
Less: Purchase of Intangibles (19.3) (22.7) (45.9) (30.0) (30.0) (30.0) (30.0) (30.0)
Less: Changes in Working Capital 1.7 3.3 2.6 5.7 6.9 8.2 9.9
Unlevered Free Cash Flow (18.8) (43.1) (20.7) (14.6) (9.2) (2.1) 7.3 #NUM!
Unlevered Free Cash Flow Growth Rate 129.3% (51.9%) (29.7%) (36.8%) (77.2%) (449.1%)
Perpetuity Growth Method EBITDA Multiple Method
Discount rate 15.0% Discount rate 15.0%
Net present value of free cash flow ($33.2) Net present value of free cash flow ($33.2)
Growth rate of FCF after 5th year 3.0% Exit multiple 1.5x
Terminal Value $62.9 Terminal value $70.8
Present value of terminal value $31.8 Present value of terminal value $35.8
Terminal value as a % of enterprise value (2,246.8%) Terminal value as a % of enterprise value 1,376.9%
Enterprise value ($1.4) Enterprise value $2.6
LESS: Debt, pref. stock & minority interest ($11.9) LESS: Debt, pref. stock & minority interest ($11.9)
PLUS: Cash & equivalents $105.0 PLUS: Cash & equivalents $105.0
Equity value $91.7 Equity value $95.7
Diluted shares 92.0 Diluted shares 92.0
Equity value per share $1.00 Equity value per share $1.04
Sum-of-the-parts
Revenue Total Value Per Share
Content
2008 $84.8
2009 107.7 27.0%
2010E 141.5 31.3%
2011E 160.8 13.6% 5.0 803.9 8.74
Registrar
2008 85.4
2009 90.7 6.2%
2010E 97.7 7.6%
2011E 104.5 7.0% 2.0 209.0 2.27
Enterprise Value $1,012.9
Less: Debt, pref. stock & contractual obs. (386.0)
Plus: Cash 105.0
Equity Value $731.9
Diluted Shares Outstanding 92.0
Equity Value per share $7.96
1 . D M D I S I N A B U S I N E S S T H A T I S D E P E N D E N T O N L O W - Q U A L I T Y C O N T E N T T H A T I S U N D E R S C R U T I N Y B Y I T S B I G G E S T S O U R C E O F R E V E N U E
2 . D E M A N D U S E S A C C O U N T I N G P R A C T I C E S T H A T A R E D U B I O U S A T B E S T
3 . D E M A N D ’ S C E O H A S A L E S S T H A N S A V O R Y P A S T A S A B U S I N E S S M A N
•P R I C E T A R G E T : $ 5 . 0 0
•P O T E N T I A L R E T U R N : 3 0 0 %
Conclusion