Demand Media IPO Bullish, Stirs The Google Grizzly Bear

We’ve written a lot about content farms and in particular the largest of them all, Demand Media. Shares of Demand Media rose 35% today on the back of its IPO. Demand Media’s market valuation now matches the scale of its content business, which pumps out more than 7,000 new articles a day. At the current share price, Demand Media is valued at $1.5 Billion – more than the New York Times is worth.

Demand Media’s IPO is the largest the tech market has seen since Google’s in 2004. Which appears to have stirred the giant grizzly bear in Mountain View. In a recent blog post, Google assured the world that it is dealing with content farms – which it describes as "sites with shallow or low-quality content." I’m not sure that the market fully appreciates how risky a bet Demand Media is, if Google decides to crack down on content farms.

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Demand Media has a simple but highly effective formula: create a ton of niche, mostly uninspired content targeted to search engines, then make it viral through social software and make lots of money through ads. In addition, it operates a very large domain name business. As CNN Money reported, "about half of the Demand’s revenue comes from its Internet registry business, where it manages 10 million domain names."

There are risks though. As well as staving off the Google bear, Demand Media has found itself defending dubious accounting practices. It spreads the costs of its writers over 5 years, which is not how other content businesses account for such costs. Effectively this increases Demand Media’s reported annual profits, since the cost of producing the content is perceived to be much lower than what Demand Media is actually paying. Demand Media justifies this approach by saying that its content is "evergreen" and lasts for over 5 years. But the fact is, they pay the writers for it upfront – not over 5 years. So it should be treated as an immediate cost in its accounting books.

The Bear Roars… Or at Least Comes Out of its Cave

At the end of 2009, I posited that if Google doesn’t do something about content farms, then it risks users moving away from their reliance on search and onto other methods of finding quality content. That might be through social media (Facebook and Twitter both grew significantly over 2010), subscriptions to quality media (we’ve discussed that this week in regards to iPad magazine and newspaper subscriptions), or other methods.

Google’s dominance over the search market will continue for some time, but it knows it has to evolve. Google’s Matt Cutts remarked in the blog post that "people are asking for even stronger action on content farms and sites that consist primarily of spammy or low-quality content."

Google’s post was essentially a reinforcement of its principles, it didn’t address how (or even if) it will take "stronger action" on content farms. This was more like a bear clearing its throat than roaring. Still, Google knows it can maul content farms – or at least paw with them a bit.

Would You Buy Demand Media Stock?

Personally I wouldn’t invest in Demand Media. I don’t like its accounting practice in regards to costs and I think it’s too vulnerable to the whims of Google. Also I prefer reading content from The New York Times.

What do you think, am I being too much of a bear on Demand Media?

Discuss