The Lesson of Demand Media (And AOL): The Online Content Business Is a Looooong March to the Big Time

After news of the Demand Media IPO filing came out late last week, I was not that surprised to get an email from someone deeply involved in building an online content business.

“If they are worth over a billion with those financials, I can’t wait to find out what we are worth. What am I missing?”

Well, nothing actually, as Demand’s filing to raise $125 million in an initial public offering at a reported $1.5 billion valuation showed that making it big in the online content business was still slow going.

That said, Demand is surely going and, in fact, growing smartly from $170.3 million in revenue in 2008 to $198.5 in 2009 to possibly reaching–based on six months of 2010 results–well above $230 million in 2010.

That’s due to its increasing growth in traffic, largely via Demand’s popular eHow site and a network of others. According to the most recent numbers from comScore (SCOR), Demand’s properties make it the 17th-largest in the U.S., with 54.6 million unique monthly visitors.

But the media business at Demand is still small, relatively speaking to other big content companies, with the content and media part of the revenue representing almost 60 percent of the business (a domain registrar business makes up for the rest).

And, most importantly, it is still unprofitable.

The Santa Monica, Calif.-based start-up said that, for the six months ended June 30, the company posted a loss of $22.3 million on revenue of $114 million. It was an improvement over a loss of $28.9 million on revenue of $91.3 million in the same period of 2009.

Using less strict accounting, on an operating basis, the picture is better, with the company’s loss cut to $4.7 million from $12.3 million in the same six months.

And using even less stringent non-GAAP financial rules, called, “Adjusted OIBDA,” Demand said in its regulatory filing with the Securities and Exchange Commission Friday that it made $25.6 million in profits.

As MediaMemo’s Peter Kafka wrote over the weekend:

Some investors may balk at these non-GAAP numbers, but Demand, Goldman Sachs (GS) and its other underwriters clearly think there’s a market for them. And there’s certainly a hunger in the tech world for a big, brand-name IPO to break the dry spell. You can feel people willing this thing to work.

If Demand did, say, $55 million in OIBDA this year, it would need a multiple of 18 times trailing 12 months earnings to get to a $1 billion valuation. It would need 27x to get the $1.5 billion number that people are whispering to reporters.

Another way to get to $1.5 billion: Project OIBDA of $100 million for 2011, and ask for 15x on that number.

That’s a good thing since Demand, which has raised $355 million in funding since its founding in 2006, has only $33.6 million in cash left in its kitty–probably plenty to keep going–but it’s likely to need more investment to crossover to where it would not need any more money. (There is a $100 million untouched line of credit, but Demand is unlikely to want to dip into that right now.)

Hence, the IPO, which will give it both cash and stock to use to grow itself, either organically or via acquisition, all while keeping the costs of content creation lower and lower via innovative technology.

For Demand CEO Richard Rosenblatt–who has a series of notable financial wins so far, selling such Internet properties such as iMall and MySpace for big windfalls–it will be interesting to see if he can build the business for the long term, which he has said is his intent.

He might want to pay attention to the travails of AOL (AOL) CEO Tim Armstrong, who has plotted a very similar course in the content arena in order to turn around the long-suffering Internet icon.

The former Google (GOOG) exec is facing strong headwinds in doing so, with his legacy subscription access business dying faster than expected, while his advertising revenue remains frustratingly flat.

Armstrong has his hands full building up that content business while also fixing all the various maladies of AOL’s past.

Last week, in AOL’s most recent quarterly report, that was eminently clear, with revenue and earnings below already low Wall Street expectations.

“Nobody likes to show up to these calls and report down numbers in an up market,” said Armstrong in the investor call after the results were released, noting that AOL was in the midst of a long turnaround and “eventually” investors would be able to see results.

Eventually is a good way to put it.