Demand Media's IPO–Which Won't Happen Until After the New Year Now–Depends on How It Accounts for Content
Yesterday, Demand Media submitted another amended S-1 to the Securities and Exchange Commission, part of its march to an initial public offering many had expected to take place sooner rather than later.
What’s taken so long, said multiple sources familiar with the situation, has been discussions between government regulators and the Santa Monica, Calif., online content company about how to more fully explain to investors–which it did so in the new S-1–how it expenses the costs of making its content.
Currently, using a concept of “long-lived” content, Demand has been amortizing those expenses over five years, since it says it continues to generate revenue on that material over that much time.
As the company noted in its S-1 filing:
“Capitalized media content is amortized on a straight-line basis over five years, representing the Company’s estimate of the pattern that the underlying economic benefits are expected to be realized and based on its estimates of the projected cash flows from advertising revenues expected to be generated by the deployment of its content. These estimates are based on the Company’s plans and projections, comparison of the economic returns generated by its content of comparable quality and an analysis of historical cash flows generated by that content to date.”
That’s different from many companies in the publishing business, which typically account for costs of creating content immediately as they are incurred or over a much shorter time period.
Demand has determined that its content has a more evergreen nature, compared to more topical–and perishable, from a revenue point of view–material produced by others.
Obviously, since this accounting treatment results in more attractive financial results, the longer expense period is of great interest to many other online content creators–such as AOL and Yahoo–which are watching the Demand IPO closely.
While the SEC has not asked Demand to make changes to its accounting practices, the amended S-1 is more detailed about them.
To be allowed to expense over five years, Demand said, the company has to use a sophisticated algorithmic platform–which other content creators do not have–to provide proof of “probable economic benefits” from that content over that time.
Since Demand has long claimed that it has a new and innovative approach to content creation, it is making the case to investors that it needs to have the correct accounting for that approach.
Said Demand in its amended filing:
“In determining whether content embodies probable future economic benefit required for asset capitalization, management has reviewed, and intends to regularly review the operating performance of content published.”
But, it warned:
“Changes from the five year useful life we currently use to amortize our capitalized content would have a significant impact on our financial statements. For example, if underlying assumptions were to change such that our estimate of the weighted average useful life of our media content was higher by one year from January 1, 2010, our net loss would decrease by approximately $1.6 million for the nine months ended September 30, 2010, and would increase by approximately $2.4 million should the weighted average useful life be reduced by one year.”
Sources said Demand’s road show for investors will not start until the SEC gives its final approval, pushing its IPO into next year.
Demand’s initial filing was to raise $125 million at a reported $1.5 billion valuation. It had said it hoped to have DMD as its ticker symbol on the New York Stock Exchange.
There is no price range yet for the offering, which is being led by Goldman Sachs and Morgan Stanley.
Until it all happens, here’s one key section on these issues in the latest S-1 to peruse:
Capitalization and Useful Lives Associated with our Intangible Assets, including Content and Internal Software and Website Development Costs
We publish long-lived media content generated by our content studio which we commission and acquire from third party freelance content creators. Direct costs incurred for each individual content unit that we determine embodies a probable future economic benefit are capitalized. The vast majority of direct content costs represent amounts paid to freelance content creators to acquire content units and, to a lesser extent, specifically identifiable internal direct labor costs incurred to enhance the value of acquired content units prior to their publication. Internal costs not directly attributable to the enhancement of content units acquired prior to publication are expensed as incurred. All costs incurred to deploy and publish content are expensed as incurred, including the costs incurred for the ongoing maintenance of websites on which our content resides. We acquire content when our internal systems and processes, including an analysis of millions of historical Internet search queries, advertising marketing terms, or keywords, and other data provide reasonable assurance that, given predicted consumer and advertiser demand relative to our predetermined cost to acquire the content, the content unit will generate revenues over its useful life that exceed the cost of acquisition. In determining whether content embodies probable future economic benefit required for asset capitalization, management has reviewed, and intends to regularly review the operating performance of content published.
We also capitalize initial registration and acquisition costs of our undeveloped websites and our internally developed software and website development costs during their development phase.
In addition we have also capitalized certain identifiable intangible assets acquired in connection with business combinations and we use valuation techniques to value these intangibles assets, with the primary technique being a discounted cash flow analysis. A discounted cash flow analysis requires us to make various judgmental assumptions and estimates including projected revenues, operating costs, growth rates, useful lives and discount rates.
Our finite lived intangible assets are amortized over their estimated useful lives using the straight-line method, which approximates the estimated pattern in which the underlying economic benefits are consumed. Capitalized website registration costs for undeveloped websites are amortized on a straight-line basis over their estimated useful lives of one to seven years. Internally developed software and website development costs are depreciated on a straight-line basis over their estimated three -year useful life. We amortize our intangible assets acquired through business combinations on a straight-line basis over the period in which the underlying economic benefits are expected to be consumed.
Capitalized content is amortized on a straight-line basis over five years, representing our estimate of the pattern that the underlying economic benefits are expected to be realized and based on our estimates of the projected cash flows from advertising revenues expected to be generated by the deployment of our content. These estimates are based on our current plans and projections for our content, our comparison of the economic returns generated by content of comparable quality and an analysis of historical cash flows generated by that content to date which, particularly for more recent content cohorts, is somewhat limited. To date, certain content that we acquired in business combinations has generated cash flows from advertisements beyond a five year useful life. The acquisition of content, at scale, however, is a new and rapidly evolving model, and therefore we closely monitor its performance and, periodically, assess its estimated useful life.
Advertising revenue generated from the deployment of our media content makes up a significant element of our business such that amounts we record in our financial statements related to our content are material. Significant judgment is required in estimating the useful life of our content. Changes from the five year useful life we currently use to amortize our capitalized content would have a significant impact on our financial statements. For example, if underlying assumptions were to change such that our estimate of the weighted average useful life of our media content was higher by one year from January 1, 2010, our net loss would decrease by approximately $1.6 million for the nine months ended September 30, 2010, and would increase by approximately $2.4 million should the weighted average useful life be reduced by one year. We periodically assess the useful life of our content, and when adjustments in our estimate of the useful life of content are required, any changes from prior estimates are accounted for prospectively.