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Greenberg: Why Demand Media’s IPO May Be One for the Books

There has already been a ton written about Demand Media, next week’s big IPO.

It’s likely to get a lot of attention, if for no other reason than: At its expected price range of $14 to $16 valuation of around $1 billion, it's the highest Internet/media company valuation since Google

, according to Paul Bard of Renaissance Capital.

First, what Demand does, not easy to say in a sentence—always a red flag.

But in a nutshell: Demand bills itself as a content company that owns and operates 500,000 websites. Its best known site is ehow.com, but it has also partnered with Lance Armstrong on livingstrong.com (Armstrong got a ton of warrants as part of the deal) and it provides content to the likes of USAToday.

Demand creates its own content using freelancers, but also claims to pair the content using “proprietary algorithms and processes” to “identify, create, distribute and monetize-demand, long-lived content.” (Their words, not mine.)

Not touted as boldly: 41 percent of its revenue comes from the lowly domain-name registration business.

At the helm: Serial entrepreneur/promoter CEO Richard Rosenblatt, who is perhaps best known for selling MySpace to News Corp. He’s less known for running dot-com disaster Dr. Koop.com, which went straight from the ICU to bankruptcy.

Among issues likely to (or that should) gain attention:

  • Like so many Internet media companies of yesteryear, it’s not making any money (not that profits mean much these days in offerings).
  • Insiders, including Rosenblatt, Armstrong, one of the venture-capital backers and other officers and directors, are selling an enormous amount of stock. Of 7.5 million shares, insiders are selling 3 million. You never want to see big insider sales on the offering. Never. Ever. Especially when the company is profitless. Especially when it’s less than five years old.
  • It’s heavily dependent on advertising revenue, and 28 percent of that comes from Google—an uncomfortably big concentration of revenue from one source.
  • Unlike most content companies, which expense for the cost of content when acquired, Demand spreads it out 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.” Or so says the company in its prospectus.

Capitalizing any normal expense is a red flag, but don’t take it just from me. The notion of capitalizing the cost of content “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,” says venture capitalist Bo Peabody of Village Ventures, who has backed various media/content ventures.

“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.” (Peabody wrote that in a piece last November, in Business Insider.)

Also from Peabody: “I personally would never invest in Demand Media. I don’t even think the company will be able to get the deal done.”

We’ll know soon enough.

Questions? Comments? Write to HerbOnTheStreet@cnbc.com

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