The Innovators
January 26, 2011

Demand Media IPO Pops

Posted by Max Chafkin at 4:10 PM

Well, the stock market just closed, so I guess it's time to eat crow:

After pricing its shares at $17 last night, Demand Media went public this morning with an initial public offering. After only a few hours on the market, Demand Media, Inc. was trading at $25 a share—it's since fallen to the $23 per share range, but that is still considerably higher than was anticipated. With 8.9 million shares available, trading in that range puts the company's market cap near $2 billion, more than that of the New York Times and in the same general ballpark as IAC and AOL, two big (and established) players in the digital space. That's as crazy as it sounds.

That's from Nicholas Jackson at the Atlantic. For its first day, the company's stock closed 33 percent above its IPO price, meaning that those who bought the company's story about search engine optimization and super low cost editorial content look pretty smart.

I was not among them—and I remain skeptical of Demand Media's long-term prospects—but the company deserves credit for a great IPO today. Demand still isn't turning a profit—by normal accounting standards—but the strong showing suggests that a lot of smart people think that it will.

Demand is worth watching because it represents an increasingly popular business model: It tries to anticipate topics that users will be searching for, and commissions low-cost (and often low quality) how-to guides designed to rank at the top of Google's results. It sounds good as long as Google doesn't change its algorithm drastically, writes New York's Nitasha Tiku: "It's going to be a rude awakening when Google 2.0 under Larry Page tweaks its algorithm to drive Demand's spammy content further down your search stream. But hey, the bubble's just getting started."

As an aside, this is great news for the IPO market, which was all but dead during the recession, and which lately seems to be gaining steam. 

Please comment with your I-told-you-sos and your thoughts on Demand's prospects. Does it deserve to be as valuable as the New York Times? 

January 24, 2011

What Norwegian Socialism Looks Like

Posted by Max Chafkin at 6:16 PM

So the big Norway story went live late last week and the response has been pretty overwhelming. There's a lot of great stuff in the comments—and I'll do a few more Norway posts in the coming weeks, but I wanted to address an objection that has appeared in a number of comments and also in this blog post by Kauffman's Tim Kane. Namely, Norway isn't really a good example of socialism:

Now let's step back and question the premise.  Is Norway socialist?  It may be relatively high tax, but it is more capitalist than the U.S. in many respects.  Indeed, most northern European nations are closet free market hubs.  It's the southern countries that are socialist on the freedom index (the Italys, Greeces, Spains, Portugals ... and yes, Frances).

Yes, the brand of socialism in Norway is very different from that in France and Spain, but come on, let's not get carried away here. Norway has universal, socialized health care, a universal socialized pension system, and universal socialized education. There are, as commenters have pointed out, virtually no private schools or private hospitals in the entire country.

If Obama proposed any one of these during his State of the Union Address, more than half of our country would be screaming the S-word and Rick Perry would be preparing articles of secession. There would be talk of how these reforms were going to destroy capitalism as we know it. 

Oh wait. All that stuff actually happened—in protest of a much, much weaker health care plan than the one in place in Norway.

I bring this up because I think that some people have read this story as a defense of socialism. It is not. The point I was trying to make is not that socialism is a good idea, just that certain policies, particularly progressive taxation—and Norway does have very high taxes—are often derided as being socialistic but may not be inherently bad for entrepreneurship. I'm not saying we should turn our country into France or Greece or even Norway, just that we need not be so religious about our economic policy.

Meanwhile, I'd like to thank DeadMule, a Norwegian who has been on fire in the comments, offering his own two cents (he disagrees with my central argument) while clearing up repeated misconceptions about Norwegian economic policy, most of which were addressed in the article but which angry commentators have been ignoring. Thank you, DeadMule for your civility and for backing me up on the whole fish smell issue.

January 20, 2011

Google Founder Back as CEO

Posted by Max Chafkin at 4:44 PM

This is probably great news for founders—and for the movement, which seems to be gathering steam among Silicon Valley's investor class, of letting founders take charge of their own companies.

From Google's CEO Eric Schmidt, announcing today that he'd will step down as CEO and turn over day-to-day responsibilities to co-founder Larry Page:

Larry will now lead our product development and technology strategy, his greatest strengths, and starting from April 4 he will take charge of our day-to-day operations as Google's Chief Executive Officer. In this new role I know he will merge Google's technology and business vision brilliantly. I am enormously proud of my last decade as CEO, and I am certain that the next 10 years under Larry will be even better! Larry, in my clear opinion, is ready to lead.

Or, as Schmidt put it, beautifully, in a tweet: "Day-to-day adult supervision no longer needed!"

January 20, 2011

Norway's Capitalist-Socialists

Posted by Max Chafkin at 4:03 PM

It's taken as an article of faith that socialism—high taxes, government regulation, robust social safety nets—are bad for entrepreneurs and bad for economic growth. But one of the world's most entrepreneurial economies—with more entrepreneurs per capita than even the U.S.—is also heavily taxed, highly regulated, and fully welfared-up.

In this month's Inc. magazine, I investigate what in the world is going on in the far North:

If you care about the long-term health of the American economy, this should seem strange—maybe even troubling. After all, we have been told for decades that higher taxes are without-a-doubt, no-question-about-it Bad for Business...Few have dared to argue against tax cuts for businesses and business owners. Questioning whether entrepreneurs really need tax cuts has been like asking if soldiers really need weapons or whether teachers really need textbooks—a possible position, sure, but one that would likely get you laughed out of the room if you suggested it. Or thrown out of elected office...

And so the case of Norway—one of the most entrepreneurial, most heavily taxed countries in the world—should give us pause. What if we have been wrong about taxes? What if tax cuts are nothing like weapons or textbooks? What if they don't matter as much as we think they do?

Before you blow your top, have a look at the article and the lively (and mostly civil) discussion going on in the comments. Felix Salmon wrote a nice post with his thoughts, and there are interesting comments coming from Reuters readers. HuffPo readers are all over this too. I'll be back with some more detailed posts as comments and questions come in.

January 11, 2011

MySpace Going the Way of Friendster

Posted by Max Chafkin at 2:02 PM

Back when I was writing about how the leading social network somehow crashed and burned, I couldn't imagine that it would happen again. Back then, I bemoaned the fact that Friendster didn't become MySpace. Well, three and a half years later, after a blockbuster acquisition and impressive profits, it looks like MySpace has become Friendster:

MySpace CEO Mike Jones today announced a "significant organizational restructuring that will result in a 47 percent staff reduction across all divisions globally and impact about 500 employees," confirming many rumors that the News Corp.-owned social network would be going through heavy layoffs before possibly seeking a new buyer.

Even more so than in 2007, social networking looks like a winner-take-all kind of business, and the $50 billion winner looks to be Facebook. For now.

January 6, 2011

Demand Media's Magical Thinking

Posted by Max Chafkin at 10:34 AM

Regular readers of this blog know that I've been skeptical of Demand Media, which has for years been crowing about its profits—cowing the likes of Wired to describe the company as "profitable as hell"—when it in fact lost tens of millions of dollars in 2009.

This came to light earlier this year when the much-ballyhooed company, which produces low-cost how-to content, filed to go public. Oops: It turned out that Demand, despite paying almost nothing for the articles it distributes, was only profitable if you used an invented accounting system not recognized by the SEC or by normal GAAP practices.

For most of 2010, Demand refused to explain exactly how it figured itself to be profitable, but just before the Christmas holiday (read: a perfect time for burying awkward news) the company amended its IPO filing with a more detailed explanation: Unlike most media companies Demand is amortizing its editorial expenses over five years. The reason for this, as Kara Swisher explains, is that "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."

In other words, Demand (and its boosters) think that articles like "How to Belch" will have longer-lasting value than, say the Washington Post's Walter Reed expose. And then there's the question of how Demand decided that five years was the right number. As the company notes in the filing, a minor change in this estimate would have a dramatic impact on its business:

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.

That's a lot of uncertainty for a company that is supposedly printing money. The venture capitalist (and Tripod founder) Bo Peabody explains why this is problematic, and predicts that the company will eventually withdraw its IPO and rely on private funding until it can get its revenue model right.

Demand claims that because their content is so valuable over such a long period of time the costs of producing it should be recognized over that same period of time. This time period is decided by Demand, which allows them to make their current cost structure look as good as they need it to.[Five years] might make sense if Demand broke out its advertising revenue by time (it could certainly do this) and demonstrated that the revenue associated with each piece of content follows this same five-year amortization schedule. But Demand doesn't do that because it's likely not true. Rather, given the very nature of Demand's arbitrage, it's likely that the majority of the revenue generated by each piece of content is realized within the first year of its life, if not sooner. The long tail of content is interesting. The long tail of revenue is a myth.

UPDATES: I missed it, but Matt Quinn was all over this news. Meanwhile there's some really interesting stuff going on in the comments of this Henry Blodget screed. Some people who claim to be Demand freelancers point out that a lot of the content, for instance, "How to Download Music to a Cell Phone," won't last anywhere near five years. 

 

January 3, 2011

Is Facebook Already a Public Company?

Posted by Max Chafkin at 4:23 PM

Once again, Mark Zuckerberg has said that Facebook, the wildly popular social network, will not go public any time soon, until 2012 at least. But the question, at least from Zuckerberg's point of view, seems increasingly meaningless. Last night, the New York Times reported that Facebook has hauled in $500 million in an investment round led by Goldman Sachs. The deal values Facebook at a jaw-dropping $50 billion, and it opens the door for other investors to put money into the company:

As part of the deal, Goldman is expected to raise as much as $1.5 billion from investors for Facebook at the $50 billion valuation, people involved in the discussions said, speaking on the condition of anonymity because the transaction was not supposed to be made public until the fund-raising had been completed.

In a rare move, Goldman is planning to create a "special purpose vehicle" to allow its high-net-worth clients to invest in Facebook, these people said. While the S.E.C. requires companies with more than 499 investors to disclose their financial results to the public, Goldman's proposed special purpose vehicle may be able get around such a rule because it would be managed by Goldman and considered just one investor, even though it could conceivably be pooling investments from thousands of clients.

The deal is significant, first and foremost as a validation of Facebook's prowess. As the Times story notes, the company now attracts more monthly visitors than Google and is more valuable than tech and media heavyweights like Time Warner, eBay, and Yahoo.

But it's also interesting as validation of a model that's becoming increasingly popular: Companies that are private only in name. Facebook shares have long been actively traded on SecondMarket, a New York financial services company that allows early stage investors and employees to sell their shares in privately held start-ups. (Inc. first wrote about SecondMarket two years ago.) The Goldman valuation of Facebook roughly corresponds to its valuation on SecondMarket. So much for valuations of privately held companies being some big mystery.

The SEC will surely have something to say about the idea of skirting reporting requirements with special purpose vehicles, but the deal seems like a watershed moment for SecondMarket, which is a fascinating success story on its own, and other buyers and sellers of privately held companies.