The Bull Case for Demand Media–And Why Wall Street May Not Buy It

There’s no debate that changes Google has made to its search engine’s ranking formula have taken a toll on Demand Media.

How big a toll? That one’s up for debate: Richard Rosenblatt’s company says the changes, which affect the traffic that Demand’s sites get from Google, aren’t significant enough for the company to change its guidance.

Most of Wall Street disagrees, and has been hammering Demand shares for the last couple of weeks. DMD is now trading around $16.70, down from a peak of more than $27 earlier this year.

In a note published today, Stifel Nicolaus analyst Jordan Rohan argues that investors are overreacting (Stifel helped take Demand public in January), and keeps his “buy” rating intact. A worst-case scenario, he says, is that the Google changes will clip Demand revenues by 10 percent and EBITDA by 20 percent–but Wall Street has pummeled Demand much more than that.

Rohan (and many others) are very interested to see what Demand says on its May 5 earnings call:

EHow and Demand Media had a great deal of momentum all the way through the first quarter and into the second quarter. But there is now this new variable with which to contend–it is hard to forecast traffic if there is volatility in index rank. How does that all balance out? To the extent that is possible to broaden the range of possible outcomes for the year, without abandoning the guidance altogether, we believe that would be incrementally positive, at least compared to current levels of fear. Maintaining guidance for full year revenue and EBITDA would be even sweeter, if possible. The “what can be done” part of this is key, in our view–own up to the weaknesses, identify the steps required to address those weaknesses, and correct course. Quickly.

Which sounds great. The problem for Demand (and many other publishers, including the New York Times, which said that its About.com had been beaten up by algorithm changes, too) is that it’s entirely possible that Google isn’t done adjusting its search formulas.

And what if it’s just beginning to overhaul search?

If so, every Google-dependent publisher is going to have a very hard time responding to each and every change the search giant makes. Which means that Demand Media’s fortunes will be in flux for some time. And it will be very hard to make Wall Street feel good about that.

http://www.facebook.com/tim.beidel Tim Beidel

Google is *always* tweaking its algorithms. SE performance is always volatile. Granted, this change was more dramatic than most, but investors should know that Google is always going to try to “reward” good content, not tricks. Google maintains its dominance by giving people what they are looking for – not by serving up rigged pages.
http://profiles.google.com/sarokin David Sarokin

Totally agree with Tim Beidel’s post. Google’s constant tweaks are all about looking for ways to put good quality content at the top of its search results. Companies that focus on “quality” in the old-fashioned sense of the term — rather than trying to second-guess Google’s algorithm — are going to do well over the long haul. Demand still has a ways to go to clean up some of its older, poorer-quality content, but going forward, I believe they are committed to the kind of high-quality work that is not only going to survive, but to do well. As a shareholder, I certainly hope so.
Anonymous

David, as a shareholder (by way of being a former employee) I hope that you are correct about the quality increase. However, one thing to note is that with higher quality comes higher cost and in the cheap, poor quality model DMD’s media business was far from profitable. The profit pool for the company comes from the Registrar, which is not scaling with the rest of the company. So, my concern is where will a continuously more Media heavy DMD deliver profit? 178 days until those who are locked up can sell…and then all bets are off.
http://mediamemo.allthingsd.com/ PKafka

Tweaks are one thing. Big changes like Panda, which have affected a large swath of publishers in a significant way, are another.
Anonymous

lots of good points here
http://pulse.yahoo.com/_JQS7XQJ2DTBTV26LD6GDI3QNEM Michael

I seriously doubt they are just losing 10% of their traffic from the Panda update. Sites that got hit hard generally lost 50-70%.

In fact, generally sites either got pummeled or they gained/negligible difference. Very few had a -10% increase. Story doesn’t jibe…
http://www.siliconvalleywatcher.com/ Tom Foremski

Demand Media can implement the new SEO, whatever it is that now Google looks at, across all of its content. This is SEO at scale.

Also, Demand Media hasn’t yet begun to monetize its content in other ways, there’s more ways to make revenues than just Google Adsense. But if you can be profitable just off of Adsense then the rest is gravy.
http://mediamemo.allthingsd.com/ PKafka

Very true that DMD has just started its ad sales effort – should have noted in the piece. That’s a big part of the bull case – look how well they’re doing w/AdSense alone; wait until they sell real ads, etc.
As far as responding to the new SEO – we’ll see. If Google is done tweaking, I’m sure they can respond to the new rules. But as I said – if Google makes these big pivots a recurring event, then that’s going to be tricky even for the savviest folks like DMD.

The Bull Case for Demand Media–And Why Wall Street May Not Buy It

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