Demand Media Earnings: Revenues Keep Growing... and So Do Losses

Last Updated Aug 9, 2011 6:47 PM EDT

Content farm and Internet registrar Demand Media (DMD) beat analyst quarterly revenue forecasts in its earnings announcement today. And yet, the stock still remains in the dumps compared to where it was in January 2011. Why has the company begun to resemble Rodney Dangerfield in its inability to command respect?

Because it has an issue: specifically, scaling. Demand has tried to portray itself as a true child of the Internet media revolution. Unfortunately, it faces the same problems as any other media outlet. Good content costs money to create, and that's a people-intensive process.

Sliding down the stock chart
To better see the reception Demand Media has received from the markets, here is a stock price chart from Yahoo (click to enlarge):


That's better than a two-thirds drop from the stock's high near its IPO. The consolidated statements of operations show why (click to enlarge):


Look at the six month view. Even as revenue increased by more than 39 percent, the company's loss increased by 19 percent. That's because expenses rose almost as fast as revenue, with some categories easily outpacing that figure:
  • marketing climbed by 82 percent
  • product development was up by 50 percent
  • general and administrative (overhead) rose by 77 percent
If it were just marketing, you might write the loss off as the price of rapid expansion to get beyond competitors. But when overhead and product development see enormous jumps, you're not looking at a business model that leverages basic expenditures. No matter how cheap the content, there are costs to create it. Sell more content, see higher expenses.

Gotta get better
When Google adjusted its search engine algorithms to filter out junk content, Demand was hit and had to refocus its content for higher quality. Apparently, the company is about to purge a good chunk of its writers because they don't meet the company's evolving standards. That will eventually mean either higher costs of creation or not enough qualified incoming people to offset the churn. At a few dollars for most articles, the work isn't inviting.

As I've said about other companies, there's a difference between an Internet business and a business that uses the Internet. The former has a business model that heavily leverages technology investments to create more revenue without driving expenses at the same rate. A company that merely uses the Internet doesn't have that advantage.

That's why Demand has seen long-term decline in its stock price. It's losing money and likely will continue to do so over time, even as it tries to focus on something it calls adjusted OIBDA (operating income before depreciation and amoritization), because that amortizes current costs of creating content (money paid to writers and editors) over multiple years.

It's a highly unusual way to account for the costs of media creation. Moreover, it doesn't matter. Costs will continue to accrue in real time. Unless Demand can develop some way to get more quality content at increasingly cheaper prices -- and it's tried for years -- the business might always be running to catch up with expenses that can grow just as fast as revenue.

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    Erik Sherman is a widely published writer and editor who also does select ghosting and corporate work. The views expressed in this column belong to Sherman and do not represent the views of CBS Interactive. Follow him on Twitter at @ErikSherman or on Facebook.

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