Is Demand Media (DMD) another case of great company but a terrible stock?
What Demand Media has accomplished is astounding. Their revenue and traffic growth is phenomenal. Their ability to acquire and digest growing properties is good. Their partnership capabilities seem top-notch. Their ability to attract talented executives is impressive. If you work for Demand, congrats on the IPO and the stellar execution over the past few years!
The bulls must believe the company's acquisition driven growth spurt can continue forever. In addition, while traffic growth been impressive, the engine, eHow.com, has many competitors - including WikiHow (from the people who built eHow), Mahalo, and About. DMD's stock feels eerily reminiscent of Marchex back in 2005.
Demand Media valuation is wildly out of whack. Its blockbuster IPO is a clear sign that bubble era valuations are back.
If you bought at the IPO or are otherwise able to sell your shares, I would recommend selling. It may go higher, but more likely it will go much lower.
- At $22.65 a share, Demand has a valuation in excess of $2 billion (92+ million fully diluted shares) - bigger than the New York Times (NYT)
- Demand, currently unprofitable, trades at close to 10x trailing 12 month revenue. Companies with this multiple almost never have a positive return over the next 12 months.
- Demand's traffic is largely driven by search engines, which can change their algorithms. In fact, Demand's growth business - content farming - is under attack by Google (GOOG) their largest traffic source.
- Demand's largest individual business is a registrar called Enom. This is a commodity business that has a zillion competitors - old stars like Register.com, Yahoo! Domains (YHOO), and Network Solutions are all small players now. According to Webhosting.info, Go Daddy is the biggest player in the industry with over 31% market share. Enom is second with 8.5%. Tucows (TCX) has 6.6% - about 20% fewer than Enom. Tucows is publicly traded and has an enterprise value of... wait for it... $36 million. It trades at less than 0.50 times revenue.
- As for comps for the content side of demand's business, try: IACI (Ask.com), ANSW (answers.com) and MCHX (lots of high traffic domains). IACI, with an EV of $1.6 billion (less than DMD), trades at an EV/Revenue of 1. ANSW, with an EV of $40 million, trades at an EV/Revenue less than 2. MCHX, with an EV of $300 million, trades at an EV/Revenue of 3.3.
Since Demand is still unprofitable, the easiest way to value it is with revenue comps. Content & Media had TTM net revenue (ex-TAC) of $125 million. The Registrar had TTM revenue of $97 million. Lets be generous with Demand and give it an EV/Revenue of 5 for the Content & Media and 2 for the Registrar. That gives us an EV of $820 million. Add back $105 million in cash ($76.5 mil from IPO and $29 mil on balance sheet) and you get $925 million. That equates to about $10 a share. It looks much worse if you use realistic comps - I could make a case for <$5 a share.
Once again, Demand has generated lots of revenue and traffic growth. It may continue to do so and, heck, start profiting too. Nonetheless, the stock is massively overvalued in any scenario.
While I wouldn't recommend IACI, MCHX, or TCX - they seem like bargains compared to DMD - ANSW seems like it will be on DMD's acquisition target list real soon.