Demand Media, after 4th-quarter loss, projects better 2012

Feb. 16, 2012 5:34 PM PT

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The Internet can be a cruel mistress.

Demand Media Inc. found that out the hard way. A year ago the Web company, awash in traffic, was the darling of Wall Street, valued at $1 billion in a Jan. 26 initial public offering.

Three months later, Google Inc., which had sent millions of visitors a day to Demand’s websites, modified its search results to de-emphasize destinations deemed to have lower-quality content. The change throttled the Santa Monica company’s traffic nearly 25% between January and July.

Wall Street turned against the company, driving its stock from a lofty $24.57 in March to $5.62 by October.

On Thursday the company — whose properties include Livestrong, eHow and Cracked.com — reported a $6.4-million loss on $84.4 million in revenue in its fourth quarter, which ended Dec. 31. It had posted a $1-million profit on $73.6 million in sales a year earlier.

“The business that they took public changed fundamentally when Google changed its algorithm,” said Patrick Walravens, an analyst with JMP Securities. “The business model they had for producing content no longer works. So what’s the new model?”

In an interview discussing Demand’s fourth-quarter financial results, co-founder and Chief Executive Richard Rosenblatt outlined the company’s plan for restoring its once formidable online audience, some of which had been put into place late last year. “The hardest part about building a Web business is how to build an audience and maintaining it,” he said.

Among Demand’s initiatives: a greater emphasis on videos and photos, as well as the type of content such as humor that’s less reliant on search engines finding them and more likely to be shared on social networks such as Facebook.

“We had built an ecosystem based on what people were looking for using search engines,” said Rosenblatt, who had once been chairman of Myspace. “Now our customers want mobile, social and video content, and we’re adapting to that.”

Founded in 2006, Demand developed its business on the notion that each piece of online content had a return on investment, and that return was quantifiable. Demand built sophisticated algorithms that assigned a value for articles that contained specific keywords. An article on “planting tomatoes in your garden,” for example, would hypothetically generate enough traffic from search engines to earn a projected amount in advertising revenue over several years.

The company built up a network of more than 7,000 writers who cranked out 5,000 articles and videos a day for $10 to $20 apiece, based on popular keywords typed into search engines. The result was a bonanza of traffic and advertising revenue. But Demand’s brutally efficient methods rankled many in the established media, who derisively called the company a content farm.

“Google felt that these content farms diluted the quality of its search results. So they tried to address that,” said Greg Sterling, senior analyst at Opus Research in San Francisco.

Google’s changes, dubbed “Panda” after the nickname of a senior Google engineer, demoted sites that had repetitive content. EHow, which had hundreds of thousands of pithy how-to articles, was caught in the dragnet because it had multiple articles on the same topics — such as how to tell whether a Rolex watch is a fake.

As a result, visitors plunged from 75.5 million in January 2011 to just under 57 million in July, according to ComScore Inc.

‘A business built on where Google search was at a particular point in time is not a solid business,’ said Jay Rosen, professor of journalism at New York University.

Alarmed, Demand executives scrambled to improve the quality of eHow’s articles by requiring those contract writers to have subject matter expertise. They also weeded out thousands of redundant articles. And they cut in half their spending on creating inexpensive how-to articles and placed more resources behind semi-professional videos.

Demand’s audience began to trickle back, climbing above 59 million in August and September.

In January, as its audience hit 61.3 million and its stock drifted above $7, three co-founders abruptly quit without explanation. They included Larry Fitzgibbon, who had spearheaded Demand’s efforts to grow its overseas audience; Joe Perez, executive vice president of product; and Steve Kydd, who headed the company’s video business.

Days later, Morgan Stanley downgraded Demand’s stock and issued a devastating report questioning the company’s new strategy.

Demand’s shares, which fell 31 cents, or 5%, to $5.94 in regular trading Thursday, perked up 9 cents to $6.03 in after-hours trading following the earnings release.

“People thought our business wasn’t growing,” Rosenblatt said. “But today we’re reporting that all of our sites have grown, as did our revenue. Both Livestrong and Cracked.com’s traffic are up 100% year over year. That’s because we know how to use data. We know how to create content. And we can build audience.”

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-- Alex Pham