Fit and Set to Split

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Fit and Set to Split
Richard Rosenblatt and Dan Brian

Demand Media Inc. has given the public its first look at a company in transition, and the results look promising to analysts.

The Santa Monica Web publisher and online domain registrar debuted first quarter earnings last week that beat Wall Street’s projections and showed the way forward for a company that’s about to split in two.

Net income for the quarter ended March 31was $700,000, or 1 cent a share, compared with a loss of $1.8 million (-2 cent) during the same period a year earlier. Total revenue during the quarter was up 17 percent to $100.6 million, beating Wall Street estimates of $99.6 million. The earnings report sent Demand shares up more than 3 percent May 8 to close at $8.85; shares were up more than 7 percent for the week.

Much of the focus on Demand has been about the decision by executives earlier this year to spin off its domain registration business, eNom, into a standalone company. The process is scheduled to be completed by the end of the year at the earliest.

During an earnings call, Demand Chief Executive Richard Rosenblatt took pains to point out that each side of the business was seeing steady growth.

“We believe that a separation will better position each of our businesses to pursue its unique strategic priorities and opportunities,” Rosenblatt said.

This strategy of separating a business’s publishing unit, which often has volatile growth and razor-thin margins, from the rest of the company is becoming increasingly common, said Laura Martin, an analyst at Needham & Co. in New York. She points to recent moves such as Time Warner Inc. spinning off its magazine unit as a way a company can organize its business and appeal to different types of investors.

“The goal in splitting Demand is to find an investor base that loves the registration business, which is growing consistently and has lots of free cash flow, and leave the growth side of publishing to float freely,” Martin said. “Investors of growth stocks don’t care about the predictability of the registration business.”

The timing of the registrar business’ split from Demand coincides with the moment the domain registration industry will be given a significant boost. By the end of the year, the Internet Corporation for Assigned Names and Numbers will release more than 1,000 new online addresses as “generic top level domains” or gTLDs. Rather than the traditional addresses ending in .com or .org, these will be industry specific, such as .hotel or .attorney. ENom has been amassing dozens of these, which, once they’re available for use and sold on a wholesale basis, will be another source of revenue for a newly created company.

“The gTLD opportunity is what will tip the scales (for eNom),” said Sameet Sinha, an analyst at the San Francisco office of B. Riley and Co. “It was a sleepy little business for a while and now all of a sudden the business could be at an inflection point.”

Sinha maintained his “buy” rating for the stock, setting a price target of $13.

Other strategies

While domain registration is poised to transform significantly later this year, the publishing arm, which still accounts for almost two-thirds of Demand’s revenue, is also seeing big changes.

Demand had traditionally generated sales by charging for advertising on its network of Web properties. Sites such as how-to service eHow.com and lifestyle brand Livestrong.com are still seeing increases in traffic. During the first quarter, total page views of Demand properties increased 20 percent from the year earlier, reaching 3.8 billion.

But the cost of acquiring this traffic and the ongoing fear that Google Inc. could once again derank Demand’s pages (as it did in early 2011) has caused the company to explore other strategies.

To that end, Demand in March acquired Creativebug, a do-it-yourself crafting site, marking the company’s first foray into paid content. Rather than the mass-produced – and often criticized – content that has been Demand’s trademark, videos and articles on Creativebug are made strictly by professionals in the field and largely available to paid subscribers.

Demand is also expanding the premium subscription effort into the Livestrong brand, with a series of high intensity workout videos.

In an interview with the Business Journal prior to the earnings call, Dan Brian, who heads up Demand’s content initiatives as executive vice president of media, said the premium services aren’t a sign the company isn’t about to abandon its freelance model of yore.

“This is really more a signal of getting into a new business model and reinforcing our belief in high-quality content,” Brian said.

Needham analyst Martin pointed out that many Internet companies are exploring subscription model options at the moment. YouTube Inc., long the paragon of free video sharing, last week announced a subscription option for certain channels. To Martin, it’s the reality of an online environment where ad rates are in flux and any new revenue streams are welcome.

“There’s a race to the bottom for ad rates, so these kinds of moves are a good experiment,” she said. “Internet companies are always iterative. What they don’t do is build a business model and just stick with the plan.”

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