The Demand Media IPO: How Desperate Are Investors for Internet Companies?

the wizard of oz curtain The Demand Media IPO: How Desperate Are Investors for Internet Companies?The romance between tech and Wall Street is booming in a way not seen since the early 2000s. IPO fever is swirling around companies like Groupon and Facebook, fueling a growing hunger for all things social and mobile. So it is with some irony that the next onslaught of initial public offerings is being spearheaded by Demand Media, one of the shoddiest-looking companies in the space.

The company most famously runs content farms like eHow, generating articles on everything from staying on a diet to fixing your garage door. Its content-generation model — pay very low rates to freelancers who churn out content at a frenetic pace has a way of turning the stomachs of workaday journalists. Demand also generates a substantial portion of its revenue by registering online domain names — not exactly a revolutionary concept from a new media standpoint.

Of course, investors don’t have to care very much about how a company treats its employees; what matters most is the bottom line. But on this count, too, there isn’t a great deal to cheer about.

Less-than-glowing analysis continues to emerge as the company prepares to unleash its shares on the general public by the end of this month. CNBC’s Hank Greenberg, who says that the company is looking at a share price of $14 to $16 and an overall $1 billion valuation, has a straightforward look at some of the most salient sticking points. Among them: Insiders are preparing to sell their own stakes in the company; the company is vulnerable to the advertising market; and Demand’s profitability remains for the moment a theoretical proposition.

Qualms about demand date back to last summer. Since Demand filed for its initial public offering on August 6, reporters and analysts have been poring over its registration statement with the Securities and Exchange Commission, and red flags have been cropping up ever since. Although it’s not necessarily damning for a company to undergo an IPO without being profitable, management’s credibility has been significantly tarnished once Demand’s financials came to light.

Before the company made its solicitation for public money, CEO Richard Rosenblatt had repeatedly touted Demand’s profits, but when the firm filed with the SEC, it became clear that it had never generated a profit since its founding. The revelation prompted The Wall Street Journal’s Scott Austin to wonder, “Where Did Demand Media’s Profits Go?” It’s perhaps also worth noting that Rosenblatt is perhaps most famous for his role in the 2005 sale of MySpace to News Corp. for more than half a billion dollars. As chairman of MySpace parent Intermix Media, it’s fairly safe to say that as a seller of shares, Rosenblatt was on the winning end of that deal.

All that aside, what’s happened in the past isn’t necessarily an indication of where a company is headed. Unfortunately, the future doesn’t look too bright, either. For one thing, Demand is engaging in the quirky accounting practice of amortizing its production costs over five years, claiming that much of its content has a long shelf life and therefore costs should be spread out over a long period to account for recurring revenue. As Kara Swisher at AllThingsDigital points out, this is an uncommon practice among publishing companies, and by Demand’s own admission this accounting model has created a much more appealing financial picture.

So: Will Demand Media get swept up in the current Internet company frenzy despite unconventional accounting methods and management’s propensity to mislead with regard to profits? Maybe investors will look past these apparent problems and see a company with an audacious strategy to dominate in the provision of servicey, how-to content on the backs of low-paid aspiring journalists. Either way, Demand’s offering will serve as an important barometer for how enthusiastic investors are about all things internet.

mtaylor [at] observer.com | @mbrookstaylor