T I C K E R : D M D

A N D R E W D . J O N E S , C F A

Short: Demand Media Inc.

1 . F L A W E D B U S I N E S S M O D E L

2 . I N V E N T I V E A C C O U N T I N G

3 . B A D G O V E R N A N C E

P R I C E T A R G E T : $ 5 . 0 0

P O T E N T I A L R E T U R N : 3 0 0 %

Anatomy of a Short Candidate

“ S H * T D O E S N ' T J U S T D I S A P P E A R ! ”

- B E N S T I L L E R I N E N V Y

Flawed Business Model

Company Overview

Demand Media

Content Creation

(55% of revenue)

Registrar

(45% of revenue)

Content creation comprises a number of sites that offer content based on what people are searching for on the internet

o eHow.com; Livestrong.como Content is produced by a stable of 13,000 “freelance” writers

Registrar business is second-largest to GoDaddy.com Demand is the 16th biggest web property by unique visitors as of December

2010

The Content Creation Process

Demand mines data from search engine providers using a

proprietary algorithm to determine key phrases

that people are searching for

These results are sent through another

algorithm that generates story ideas based on key

phrases

Story ideas are sent to editors who make sure that titles make sense

The Content Creation Process

Titles are downloaded into database where

writers can reserve up to 10 stories and

40 videos

Stories are sent to series of editors to

ensure accuracy and authenticity

Stories published on a variety of websites

Types of Articles on eHow.com

The Arbitrarily Location-Specific Article

“How to pick blueberries in Iowa”

The Suspiciously Product-Specific Article

“How to unscrew the iTouchless pepper mill”

The Article That Blows a Problem Out of Proportion

“Ideas for organizing scrunchies”

The Benignly Racist Article

“Best colors for mediterranian men to wear”

Types of Articles on eHow.com

The Article Meant for Aliens Who Just Landed Here

“Types of push buttons”

The Article Offering Advice That Shouldn’t Be Followed

“How to dress like a hipster”

The Article for People in the Narrow Band of Humanity Who

Are Smart Enough to Know About Google But Not Smart

Enough to Figure Out How to Do the Thing They’re Googling

“How to name a kids’ soccer team”

Are these examples of quality content?

How to calculate age from birth date

Types of hats for kids

How to put on a Speedo

How to buy Canadian Molson

How to buy condoms that fit

Are these examples of quality content?

How to understand Ukranian women

How do I manually fill an ointment tube?

How to belch

What are the benefits of cleanliness on job sites?

Are Demand’s 13,000 freelancers really experts?

Demand’s CEO claims that many of the content creators are “professionals”

75% have been published in magazines and newspapers

25% have written a book

25% have held professional marketing roles

Collectively, Demand produces over 4,000 pieces of content per day

There are signs that author matters to search engines like Google

From patent #7,765,209, filed by Google: Claim 1: …second information, associated with the blog, from a source

different than the posts included in the blog; creating, by one or more processors associated with the one or more server devices, a hybrid document by combining the first information and the second information; and using, by one or more processors associated with the one or more server devices, the hybrid document to determine a relevance of the post to a search query.

The method of claim 1 where the extracting the second information includes: extracting, from a feed, at least one of a title of the blog, an author of the blog, or a profile of the author of the blog.

The method of claim 3 where the extracting the second information further includes: extracting, from the blog, at least one of a profile of the author of the blog or a blogroll.

The method of claim 5 where the document includes a profile of an author of the blog.

What does that mean?

Basically, as a person posts articles on the internet, and people visit or link to these posts, they become associated with that topic in the eyes of Google’s search engine

They become an “expert” in that topic and anytime they show up on a webpage with content related to that topic, that page ranks highly in Google search

How can Demand’s freelancers ever become “experts” in the eyes of Google if they are just pumping out content?

What are the incentives for contributors?

Authors load their queues with titles they can produce quickly and with the least amount of effort

Writers earn about $15 per story while videographers earn about $20 per clip

Paid weekly via paypal

Demand is highly dependent on Google for pageviews and advertising revenue

Nine Months thru

September, 2010

% advertising revenue atrributable to GOOG 28.0%

% of traffic from other search engines 8.2%

% of traffic from GOOG 32.8%

% of revenue from eHow 23.0%

% of eHow traffic generated by GOOG 66.0%

Owned and Operated page

Thousands of page views 6,000,000.0

page views attr. To GOOG 1,968,000.0

other page views 4,032,000.0

Revenue per thousand page views $12.60

Total Revenue $75,600,000.00

Network of customer pages

Thousands of page views 9,300,000.0

page views attr. To GOOG 3,050,400.0

other page views 6,249,600.0

Revenue per thousand page views $3.24

Total Revenue $30,132,000.00

Google is moving to eliminate low-quality content from search results

From Google’s official blog, 1/21/2011:

This would greatly affect the future prospects for Demand

From Google Chrome’s official blog, 2/14/2011:

While some have argued that Demand is not a content farm, Google has offered specific examples related to Demand’s sites

The article Google references as low-quality content is on eHow.com

Source: eHow.com

The article Google references about content farms is from PBS.org and references Demand heavily

From PBS.org:

This is a first-hand account of a former Demand freelancer

Source: PBS.org

What would be the impact on revenue if Demand is tagged as a content farm?

Nine Months thru

September, 2010 Adjusted

% advertising revenue atrributable to GOOG 28.0%

% of traffic from other search engines 8.2%

% of traffic from GOOG 32.8% 20.0%

% of revenue from eHow 23.0%

% of eHow traffic generated by GOOG 66.0%

Owned and Operated page

Thousands of page views 6,000,000.0 5,232,000.0

page views attr. To GOOG 1,968,000.0 1,200,000.0

other page views 4,032,000.0 4,032,000.0

Revenue per thousand page views $12.60 $12.60

Total Revenue $75,600,000.00 $65,923,200.00 ($9,676,800.00)

Network of customer pages

Thousands of page views 9,300,000.0 8,109,600.0

page views attr. To GOOG 3,050,400.0 1,860,000.0

other page views 6,249,600.0 6,249,600.0

Revenue per thousand page views $3.24 $3.24

Total Revenue $30,132,000.00 $26,275,104.00 ($3,856,896.00)

($13,533,696.00)

Demand’s Competitors

About.com

Mahalo

Answers.com

wikiHow

AOL

Yahoo!

" I ' M B E G I N N I N G T O T H I N K N O T O N L Y D I D H E I N V E N T T H E I N T E R N E T , B U T H E

I N V E N T E D T H E C A L C U L A T O R A S W E L L . I T ' S F U Z Z Y M A T H . "

- P R E S I D E N T G E O R G E W . B U S H

Inventive Accounting

You Capitalize WHAT?

“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…”

“In determining whether content embodies probable future economic benefit required for asset capitalization, we make judgments and estimates including the forecasted number of page views and the advertising rates that the content will generate. These estimates and judgments take into consideration various inherent uncertainties including, but not limited to, our expected ability to renew at favorable terms or replace certain material agreements with Google that currently provide a significant portion of our revenues…”

You Capitalize WHAT?

“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.”

Capitalizing content acquisition costs sounds a little strange

Prior to Demand’s IPO, the Securities and Exchange Commission approved a controversial accounting technique allowing the firm to amortize its content costs over five years.

Demand says the “evergreen” content it creates will garner internet traffic for a longer period of time than traditional news articles, which tend to expire on the next day.

Demand has not even been around for 5 years, so how can they know this?

Leaves the door open for large writedowns going forward

M A Y I H E L P Y O U D R . . . ?

F L E T C H : O H , I T ' S M E , D R . R O S E N P E N I S . I ' M J U S T H E R E T O C H E C K O U T A L A N S T A N W Y K ' S F I L E .

D R . W H O ?

F L E T C H : D R . R O S E N R O S E N , I ' M H E R E T O G E T T O T H E R E C O R D S R O O M .

W H A T W A S T H A T N A M E A G A I N ?

F L E T C H : I T ' S D R . R O S E N , I W A N T T O C H E C K T H E R E C O R D S R O O M .

D R . W H O ?

F L E T C H : D R . R O S E N . W H E R E ' S T H E R E C O R D S R O O M ?

Bad Governance

Eric Estrada Richard Rosenblatt

CEO Richard Rosenblatt has a less than savory track record

1993: Richard Rosenblatt set up a company that offered a $3,000 web-design seminar that came with a custom-built website The company, iMall, went public at $18 en route to $112 FTC investigated the company’s claim that its clients’ sites were

earning $11,000 per month (they weren’t, surprisingly) The company killed the seminar division, losing 95% of its $16

million in annual revenue Rosenblatt sold iMall to Excite@Home for $500 million

2000: Rosenblatt took over drkoop.com, an online site tied to C. Everett Koop Wanted to turn the Koop into a brand like Martha Stewart or Walt

Disney Created a line of Dr. Koop Men’s Prostate Formula pills The company folded

C. Everett Koop

Rosenblatt’s history even includes outright devious behavior

2004: Rosenblatt was tapped to run eUniverse (later renamed Intermix Media), an internet conglomerate that happened to own MySpace

NYAG Elliot Spitzer charged Intermix with bundling adware and spyware with its free games and screensavers

The company settled immediately for $7.5 million (the entire cash holdings of Intermix)

Elliot Spitzer

The Board is not as independent as you would think at first glance

Demand Media Board of Directors

Name Notes

John Hawkins

Victor Parker

Joshua James

Gaurav Bhandari Goldman Sachs MD (lead underwriter)

Peter Guber

Robert Bennett

Richard Rosenblatt

Fredric Harman

James Quandt Served on Intermix board with Rosenblatt

Valuation

Key Statistics

Market Cap: 1.64 billion

Enterprise Value: 1.54 billion

EV/Revenue: 6.55x

EV/EBITDA: 35.93x

Current Price: $20.00

Target Price: $5.00

Potential Return: 300%

Expected future content revenues

2008 2009

Nine Months thru

September, 2010 2010E 2011E 2012E 2013E 2014E 2015E

Owned and Operated page

Thousands of page views 5,900,000.0 6,800,000.0 6,000,000.0 8,000,000.0 9,600,000.0 12,000,000.0 15,000,000.0 18,750,000.0 23,437,500.0

15.3% 17.6% 20.0% 25.0% 25.0% 25.0% 25.0%

Revenue per thousand page views $10.56 $10.69 $12.60 $12.60 $11.50 $11.75 $12.00 $12.25 $12.50

Total Revenue $62,304,000.00 $72,692,000.00 $75,600,000.00 $100,800,000.00 $110,400,000.00 $141,000,000.00 $180,000,000.00 $229,687,500.00 $292,968,750.00

Network of customer pages

Thousands of page views 5,400,000.0 10,000,000.0 9,300,000.0 12,400,000.0 15,500,000.0 19,375,000.0 24,218,750.0 30,273,437.5 37,841,796.9

85.2% 24.0% 25.0% 25.0% 25.0% 25.0% 25.0%

Revenue per thousand page views $4.04 $3.45 $3.24 $3.24 $3.25 $3.25 $3.25 $3.25 $3.25

Total Revenue $21,816,000.00 $34,500,000.00 $30,132,000.00 $40,176,000.00 $50,375,000.00 $62,968,750.00 $78,710,937.50 $98,388,671.88 $122,985,839.84

Total Content Revenue $84,120,000.00 $107,192,000.00 $105,732,000.00 $140,976,000.00 $160,775,000.00 $203,968,750.00 $258,710,937.50 $328,076,171.88 $415,954,589.84

27.4% 31.5% 14.0% 26.9% 26.8% 26.8% 26.8%

Pieces of content created per day 4,000.0 5,479.5 6,500.0 7,500.0 9,000.0 11,000.0 13,000.0

37.0% 18.6% 15.4% 20.0% 22.2% 18.2%

Total pieces of content created 1,460,000.0 2,000,000.0 2,372,500.0 2,737,500.0 3,285,000.0 4,015,000.0 4,745,000.0

Total page views per piece of new content 11.5 10.2 10.6 11.5 11.9 12.2 12.9

Projected Income StatementProjected Income Statement for Demand Media Inc.Dollars in millions, except per share

2010-2015

2008 2009 2010 2011 2012 2013 2014 2015 CAGR

Revenues 170.3 198.5 239.1 $265.3 $316.0 $378.7 $456.6 $553.5 18.27%

16.6% 20.5% 10.9% 19.1% 19.9% 20.6% 21.2%

Content 84.8 107.7 141.5 $160.8 $204.0 $258.7 $328.1 $416.0

27.0% 31.4% 13.6% 26.9% 26.8% 26.8% 26.8%

Registrar 85.4 90.7 97.7 104.5 112.0 120.0 128.5 137.5

6.2% 7.6% 7.0% 7.2% 7.1% 7.1% 7.0%

Cost of Sales 98.2 114.5 126.9 145.9 172.2 204.5 244.3 293.3

Gross Profit 72.1 83.9 112.2 119.4 143.8 174.2 212.3 260.1 18.31%

SG&A 43.4 48.5 58.5 66.3 77.4 90.9 107.3 127.3

Product Development 14.3 21.7 25.5 26.5 31.6 37.9 45.7 55.3

Amortization of Intangibles 33.2 32.2 32.6 33.0 33.0 33.0 33.0 33.0

Other Operating Expense/(Income) 0 0 0 0.0 0.0 0.0 0.0 0.0

EBIT (18.8) (18.4) (4.4) (6.5) 1.8 12.4 26.4 44.5 #NUM!

Plus: Depreciation & Amort. 43.7 47.1 49.9 48.0 48.0 48.0 48.0 48.0

EBITDA 24.9 28.7 45.5 41.5 49.8 60.4 74.4 92.5

Interest Expense (2.1) (1.8) (0.7) (0.7) (0.7) (0.7) (0.7) (0.7)

Interest Income 1.6 0.5 0.0 0.0 0.0 0.0 0.0 0.0

Other Non-operating Inc./(Exp) (0.3) (0.0) (0.2) (0.2) (0.2) (0.2) (0.2) (0.2)

Unusual Items 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Income Taxes (4.6) 2.8 3.2 (1.6) 0.4 3.1 6.6 11.1

Minority Interest 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Net Income ($14.9) ($22.5) ($8.5) ($5.7) $0.4 $8.5 $18.9 $32.5 #NUM!

Diluted Shares Outstanding 72.8 72.8 92.0 92.0 92.0 92.0 92.0 92.0

EPS ($0.20) ($0.31) ($0.09) ($0.06) $0.00 $0.09 $0.21 $0.35 #NUM!

Discounted Cash Flow Analysis for Demand Media Inc.Dollars in millions, except per share

0 1 2 3 4 5 2010-2015

2008 2009 2010E 2011 2012 2013 2014 2015 CAGR

Sales $170.3 $198.5 $239.1 $265.3 $316.0 $378.7 $456.6 $553.5 18.3%

EBITDA 24.9 28.7 45.5 41.5 49.8 60.4 74.4 92.5

EBITDA Margin 14.6% 14.5% 19.0% 15.7% 15.7% 16.0% 16.3% 16.7%

Depreciation (43.7) (47.1) (49.9) (48.0) (48.0) (48.0) (48.0) (48.0)

EBIT (18.8) (18.4) (4.4) (6.5) 1.8 12.4 26.4 44.5 #NUM!

Less: Taxes @ 25.0% 4.6 (2.8) (3.2) 1.6 (0.4) (3.1) (6.6) (11.1)

Tax-Effected EBIT (14.2) (21.2) (7.6) (4.9) 1.3 9.3 19.8 33.4

Plus: Depreciation 43.7 47.1 49.9 48.0 48.0 48.0 48.0 48.0

Less: Capital Expenditures (20.1) (15.3) (22.1) (20.0) (20.0) (20.0) (20.0) (20.0)

Less: Purchase of Intangibles (19.3) (22.7) (45.9) (30.0) (30.0) (30.0) (30.0) (30.0)

Less: Changes in Working Capital 1.7 3.3 2.6 5.7 6.9 8.2 9.9

Unlevered Free Cash Flow (10.4) (22.3) (4.2) 5.0 14.2 26.0 41.3 #NUM!

Unlevered Free Cash Flow Growth Rate 114.6% (81.1%) (219.7%) 181.9% 83.2% 58.7%

Perpetuity Growth Method EBITDA Multiple Method

Discount rate 15.0% Discount rate 15.0%

Net present value of free cash flow $45.7 Net present value of free cash flow $45.7

Growth rate of FCF after 5th year 3.0% Exit multiple 4.0x

Terminal Value $354.3 Terminal value $369.9

Present value of terminal value $179.2 Present value of terminal value $187.0

Terminal value as a % of enterprise value 79.7% Terminal value as a % of enterprise value 80.4%

Enterprise value $224.8 Enterprise value $232.7

LESS: Debt, pref. stock & minority interest ($11.9) LESS: Debt, pref. stock & minority interest ($11.9)

PLUS: Cash & equivalents $105.0 PLUS: Cash & equivalents $105.0

Equity value $317.9 Equity value $325.8

Diluted shares 92.0 Diluted shares 92.0

Equity value per share $3.46 Equity value per share $3.54

Discounted Cash Flow

What if the income statement was adjusted for a loss in Google traffic and content acquisition costs were expensed?

Projected Income Statement for Demand Media Inc.Dollars in millions, except per share

2010-2015

2008 2009 2010 2011 2012 2013 2014 2015 CAGR

Revenues 170.3 198.5 239.1 $265.3 $316.0 $378.7 $456.6 $553.5 18.27%

Revenue lost from Google $13.3 $15.8 $18.9 $22.8 $27.7

Cost of Sales 98.2 114.5 126.9 145.9 172.2 204.5 244.3 293.3

Gross Profit 72.1 83.9 112.2 106.1 128.0 155.3 189.5 232.5 15.68%

SG&A 43.4 48.5 58.5 66.3 77.4 90.9 107.3 127.3

Content Acquisition 11.0 10.5 26.0 10.9 12.9 15.3 18.3 22.0

Product Development 14.3 21.7 25.5 26.5 31.6 37.9 45.7 55.3

Amortization of Intangibles 31.0 30.1 27.4 30.8 30.4 29.9 29.3 28.6

Other Operating Expense/(Income) 0 0 0 0.0 0.0 0.0 0.0 0.0

EBIT (27.6) (26.8) (25.2) (28.5) (24.4) (18.8) (11.1) (0.8) -49.99%

Plus: Depreciation 43.7 47.1 49.9 48.0 48.0 48.0 48.0 48.0

EBITDA 16.1 20.3 24.7 19.5 23.6 29.2 36.9 47.2

Interest Expense (2.1) (1.8) (0.7) (0.7) (0.7) (0.7) (0.7) (0.7)

Interest Income 1.6 0.5 0.0 0.0 0.0 0.0 0.0 0.0

Other Non-operating Inc./(Exp) (0.3) (0.0) (0.2) (0.2) (0.2) (0.2) (0.2) (0.2)

Unusual Items 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Income Taxes (4.6) 2.8 3.2 (7.1) (6.1) (4.7) (2.8) (0.2)

Minority Interest 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Net Income ($23.7) ($30.9) ($29.3) ($22.2) ($19.2) ($14.9) ($9.2) ($1.5) -45.04%

Diluted Shares Outstanding 72.8 72.8 92.0 92.0 92.0 92.0 92.0 92.0

EPS ($0.33) ($0.42) ($0.32) ($0.24) ($0.21) ($0.16) ($0.10) ($0.02) -45.04%

Adjusted DCFDiscounted Cash Flow Analysis for Demand Media Inc.Dollars in millions, except per share

0 1 2 3 4 5 2010-2015

2008 2009 2010E 2011 2012 2013 2014 2015 CAGR

Sales $170.3 $198.5 $239.1 $265.3 $316.0 $378.7 $456.6 $553.5 18.3%

EBITDA 16.1 20.3 24.7 19.5 23.6 29.2 36.9 47.2

EBITDA Margin 9.5% 10.2% 10.3% 7.4% 7.5% 7.7% 8.1% 8.5%

Depreciation (43.7) (47.1) (49.9) (48.0) (48.0) (48.0) (48.0) (48.0)

EBIT (27.6) (26.8) (25.2) (28.5) (24.4) (18.8) (11.1) (0.8) (50.0%)

Less: Taxes @ 25.0% 4.6 (2.8) (3.2) 7.1 6.1 4.7 2.8 0.2

Tax-Effected EBIT (23.0) (29.6) (28.4) (21.4) (18.3) (14.1) (8.3) (0.6)

Plus: Depreciation 43.7 47.1 49.9 48.0 48.0 48.0 48.0 48.0

Less: Capital Expenditures (20.1) (15.3) (22.1) (20.0) (20.0) (20.0) (20.0) (20.0)

Less: Purchase of Intangibles (19.3) (22.7) (45.9) (30.0) (30.0) (30.0) (30.0) (30.0)

Less: Changes in Working Capital 1.7 3.3 2.6 5.7 6.9 8.2 9.9

Unlevered Free Cash Flow (18.8) (43.1) (20.7) (14.6) (9.2) (2.1) 7.3 #NUM!

Unlevered Free Cash Flow Growth Rate 129.3% (51.9%) (29.7%) (36.8%) (77.2%) (449.1%)

Perpetuity Growth Method EBITDA Multiple Method

Discount rate 15.0% Discount rate 15.0%

Net present value of free cash flow ($33.2) Net present value of free cash flow ($33.2)

Growth rate of FCF after 5th year 3.0% Exit multiple 1.5x

Terminal Value $62.9 Terminal value $70.8

Present value of terminal value $31.8 Present value of terminal value $35.8

Terminal value as a % of enterprise value (2,246.8%) Terminal value as a % of enterprise value 1,376.9%

Enterprise value ($1.4) Enterprise value $2.6

LESS: Debt, pref. stock & minority interest ($11.9) LESS: Debt, pref. stock & minority interest ($11.9)

PLUS: Cash & equivalents $105.0 PLUS: Cash & equivalents $105.0

Equity value $91.7 Equity value $95.7

Diluted shares 92.0 Diluted shares 92.0

Equity value per share $1.00 Equity value per share $1.04

Sum-of-the-parts

Revenue Total Value Per Share

Content

2008 $84.8

2009 107.7 27.0%

2010E 141.5 31.3%

2011E 160.8 13.6% 5.0 803.9 8.74

Registrar

2008 85.4

2009 90.7 6.2%

2010E 97.7 7.6%

2011E 104.5 7.0% 2.0 209.0 2.27

Enterprise Value $1,012.9

Less: Debt, pref. stock & contractual obs. (386.0)

Plus: Cash 105.0

Equity Value $731.9

Diluted Shares Outstanding 92.0

Equity Value per share $7.96

1 . D M D I S I N A B U S I N E S S T H A T I S D E P E N D E N T O N L O W - Q U A L I T Y C O N T E N T T H A T I S U N D E R S C R U T I N Y B Y I T S B I G G E S T S O U R C E O F R E V E N U E

2 . D E M A N D U S E S A C C O U N T I N G P R A C T I C E S T H A T A R E D U B I O U S A T B E S T

3 . D E M A N D ’ S C E O H A S A L E S S T H A N S A V O R Y P A S T A S A B U S I N E S S M A N

•P R I C E T A R G E T : $ 5 . 0 0

•P O T E N T I A L R E T U R N : 3 0 0 %

Conclusion