I usually comment only on British companies (as investments, that is), but I also like to keep an eye on tech and internet companies, and on anything that illustrates a point. Demand Media falls in to both categories.
There has been a lot of enthusiasm about Demand Media’s growth track record. As always with growth stocks the problem is guessing at what point the growth will stop. Is it likely that Demand Media’s sites will become as ubiquitous in search engine results as Wikipedia, or even more so? Where does the growth stop.
A very high growth rate in needed to justify the high multiple: the company is not profitable, and the IPO price currently being talked about will put it on 6× revenues.
Not only is this high growth uncertain, it is also mostly at the mercy of a single company: Google. I find it hard to believe that Google will allow more and more places in its listing be taken by Demand Media’s sites (such as eHow) and other “content farms”: many users dislike these sites. It is most likely to adjust its algorithm to rank these sorts of sites lower.
I also do note believe that the founder’s track record, impressive though it is, should encourage investors. Yes, he has built very successful businesses, but the buyers did not necessarily do well. I can find no record of iMall’s performance after he sold to Excite, but the dismal record of MySpace after the founders sold to Murdoch is well know. He is smart enough to sell at the top.
The SEC filing is also very vague about what will be done with the cash. We should have more details before the IPO, but it is very hard to imagine what could be done. Generating more content for existing sites will hit diminishing returns somewhere, and increase the risk of a reaction from search engines. More acquisitions are a possibility, but I have never been a fan of acquisitive growth, even from a company that has succeeded with its previous acquisitions.
This company does not strike me as another Amazon. It is not something that will build a loyal customer base. I cannot see it doing anything irreplaceable. Demand Media is brilliant at using SEO (search engine optimisation – getting sites high positions in search engine results) and ownership of well established sites to get cheap content to rank high in search engine results. That is a fragile business model.