I read their financial statements with interest. They have a charge in the $2X million range for the latest year for amortization of non-tangible property. Here's some semi-informed speculation for you: when you or I buy a domain name for $8.95 a year, we can generally get away with deducting 100% of that on our taxes for this year (IRS guidance is unclear and, hey, nobody cares about 30% of $8.95). When you buy a domain name portfolio for $40 million, all of a sudden the accountants get cautious about rules. One cautious treatment of that purchase is to treat the $40 million as a capital investment and amortize it over a period of years.
This is based on the assumption that capital improvements, like say a factory, have a certain defined useful life, and that spreading out the cost over the useful life of the capital improvement gives a better picture of the actual state of the company.
The problem with amortization for domain names is that domain names don't really have a useful life and, to the extent that they depreciate, they depreciate negatively. The economics of large domain portfolios that are not just garbage and virtually any developed domain means that the domain gets more valuable over time. They also can be maintained, indefinitely, for a pittance per year.
What this means concretely for Demand Media is that when they buy a property -- let's say SchmeeNow for $10 million based on their current revenue of $500k a year -- they book 10 years of $1 million accounting charges. That will help to decrease their apparent profits for the next 10 years, but in those years the money will not be actually leaving their pockets (modulo quirky financing deals which sometimes happen in the high-end domain market).
Software is dealt with in a similar fashion, although I think software tends to be closer to factories in terms of having a measurable useful lifespan.
The above comment ignores Demand Media's single risk factor, which is that there are probably a few dozen people in Mountain View which could, given management approval, end their company with a mouse click.
And speaking of domain names, registrars have to recognize revenue over the life of a domain registration. If they're wholesale registrars like eNom, I bet that's a long time--big buyers would want a long-term registration for the SEO value.
But it means that the faster they grow, the more of their revenue is deferred, even though they get the cash right away.
Nice analysis. While Google's forbearance is their imminent and everpresent risk factor, other trends in search and content-creation could also put them at risk, in the 3-10 year timeframe. I'm thinking better peer production, better search, and ad models that evolve away from the kinds of placements that drench their portfolio sites.
That is just the most obvious path, too. Not only is Google their traffic lifeline, they are also their largest advertising customer. Merely "Smart Pricing" eHow or turning off Youtube rev share for ExpertVillage would likely also be fatal, or close to it. More broadly, any substantial opening into Google search keyword data would put DM within striking range of any YC startup sized company that wanted them -- search prediction is the only hard part of the puzzle.
Luckily for DM, Google would switch all employees to Windows ME, code only in BASIC, and sell out a million dissidents prior to allowing the world to organize their data.
Just a guess, but maybe with "profitable" they meant that if they stopped acquiring sites and just ran with what they have now, they would be profitable on that $200 million revenue. Instead they choose to put those profits right back into growing their business.
Demand Media is negative because they used their money to acquire perpetuities (aka. cash-cow niche content sites). What do you think happens when they stop acquiring sites?
If they would have been profitable without these assets as either a liability or cash flow item on balance sheet - I think that counts as profitable.
Eg - If you're in the printing business and profit 500k but buy a 750k printer that you don't need to be operationally profitable but will help you be MORE profitable in future years - you lost money but you're still soundly profitable
Happy to see these web polluters losing money; hope their IPO is pulled or disappointing. Maybe Google can push an index update in the weeks before the IPO that drops their traffic 50% or more? (No neutrality -- for SEO spablum.)
Isn't this the shady company that is doing something similar to Jason Calacanis' Mahlo? Mainly that they have machine generated pages designed to return minimal data that returns high results in search engine rankings?
Once search engines optimize their algorithms to ignore these sites, won't the money stop flowing?
This is based on the assumption that capital improvements, like say a factory, have a certain defined useful life, and that spreading out the cost over the useful life of the capital improvement gives a better picture of the actual state of the company.
The problem with amortization for domain names is that domain names don't really have a useful life and, to the extent that they depreciate, they depreciate negatively. The economics of large domain portfolios that are not just garbage and virtually any developed domain means that the domain gets more valuable over time. They also can be maintained, indefinitely, for a pittance per year.
What this means concretely for Demand Media is that when they buy a property -- let's say SchmeeNow for $10 million based on their current revenue of $500k a year -- they book 10 years of $1 million accounting charges. That will help to decrease their apparent profits for the next 10 years, but in those years the money will not be actually leaving their pockets (modulo quirky financing deals which sometimes happen in the high-end domain market).
Software is dealt with in a similar fashion, although I think software tends to be closer to factories in terms of having a measurable useful lifespan.
The above comment ignores Demand Media's single risk factor, which is that there are probably a few dozen people in Mountain View which could, given management approval, end their company with a mouse click.