This Might Be the Market's Best Short Opportunity

Unless you Rip Van Winkled your way through yesterday's market news, you know that Demand Media (NYSE: DMD  ) is the Next Big Thing in hot IPOs.

Investors who bid the stock 33% higher in its first day of trading must love the idea of buying into a network of sites that produces more than 100 million monthly page views, including Cracked.com, eHow.com, and Trails.com. Too bad they're missing the point.

When it comes to Demand Media, investors should focus on just two numbers: 2 million and 13,000. The network published 2 million pieces of content from 13,000 freelancers last year. Yahoo! (Nasdaq: YHOO  ) , through Associated Content, and AOL (NYSE: AOL  ) , through Seed, are trying a similar model.

But Demand Media is the poster child for this type of business, which my freelance colleague Erik Sherman over at BNET calls a content mill. Here are three reasons why I believe investors should consider shorting the stock:

  1. Demand's numbers don't support its mission. In its prospectus, Demand Media says it profits by aggregating and distributing professional content. Sounds good, right? Sure, but doing the math you would find that Demand pays its freelancers a maximum of $60 to $70 per article. However, its service costs include a number of factors, meaning the actual pay to writers should come in well below that number. Some reports have put content pay as low as a penny per share for most articles. How many pro writers and videographers do you know who work for rates that low? I've done it, but not on a regular basis. I like food too much.
  2. Nor does Demand produce professional content. The trick is that Demand seeks and pays peanuts for content that's (a) easy to create, and (b) evergreen. If only it acquired more content worth reading. Click through to Jeff Bercovici's article at Forbes to see what I mean. Try not to laugh. I dare you.
  3. Search engine marketing is under attack. But these are relatively minor threats compared to what Google (Nasdaq: GOOG  ) has planned. Last week, The Big G announced plans to cut back on search spam. Junk that ranks high in a search when websites "cheat their way into higher positions" than they should occupy.

There's a phrase for this: search engine optimization (SEO). Few companies have ever profited from SEO as much as Demand Media has. But don't take my word for it. Here's what the company says about search engines in its prospectus:

Our proprietary technology and algorithms are dependent on analyzing existing Internet search traffic data ... The failure of our proprietary technology and algorithms to accurately identify content that generates traffic ... would have an adverse impact on our business, revenue, financial condition and results of operations. [Emphasis added.]

Whoops.

Demand Media may very well figure out how to attract top creative pros, produce award-winning content, or figure a way to placate Google. I just wouldn't bet on it. I'd rather bet against it, which is why I've shorted the stock in my CAPS portfolio.

Now it's your turn to weigh in. Do you think Demand Media has a winning business model? Please vote in the poll below and then leave a comment to explain your thinking.

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Interested in more info on the stocks mentioned in this story? Add AOL, Demand Media, Google, or Yahoo! to your watchlist.

Both our Motley Fool Inside Value and Motley Fool Rule Breakers services have recommended subscribers buy shares of Google. Yahoo! is a Motley Fool Global Gains recommendation. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Tim Beyers is a member of the Rule Breakers stock-picking team. He owned shares of Google at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. You can also get his insights delivered directly to your RSS reader. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool owns shares of Google and is also on Twitter as @TheMotleyFool. Its disclosure policy would like a shot at the title, yes.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 29, 2011, at 4:55 PM, sagefool22 wrote:

    Tim,

    What are you talking about? Yes, DMD is a pile of garbage.

    But:

    Junk that ranks high in a search when websites "cheat their way into higher positions" than they should occupy.

    SEO is a legitimate practice, and if you had taken more than 10 minutes to actually research the practice, you would find that the Fool itself engages in on page SEO. In fact, I would be willing to bet that you have 2-3 people whose sole job it is, to make sure that your site ranks well.

    They track results, conversions for your newsletter, and do keyword research to make sure that your site "optimized" for maximum search results.

    That's what the "O" in SEO stands for. It's an acronym for "Search Engine Optimization".

    Search Engine Marketing is not under attack. Google sends Matt Cutts to every single search conference there is, to make sure that Google's guidelines on what legitimate and illegitimate SEO practices are.

    Your conclusion is correct, but your research on the subject is garbage. I've already told my investor friends to short the living daylights out of this stock.

    The next time you decide to libel an entire industry, make sure you don't lump everybody in with the crap content creators like Demand Media.

  • Report this Comment On January 31, 2011, at 7:44 PM, RRobertsmith wrote:

    Like REDF (india) as a short just put the chart of that and goog up next to DMD and it still is a better short....although DMD seems to be standing on quick sand also...good call.

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