Demand Media traffic drop, outlook cut slams stock

NEW YORK (AP) -- Shares of Demand Media slid Tuesday after the company cut its revenue outlook for its second quarter, due to a decline in traffic that was sparked by a change in Google's search formula. The move led to an analyst downgrade, which contributed to the stock's decline.

THE SPARK: After Demand Media reduced its revenue forecast and announced an acquisition aimed at boosting its e-commerce business, Jordan Rohan of Stifel Nicolaus lowered his rating on Demand Media stock to "Hold" from "Buy" and removed his $15 price target. He also trimmed his forecasts for earnings and revenue for the current fiscal year and 2014.

THE BACKGROUND: Demand Media assigns thousands of freelancers to produce stories about frequently searched topics and then sells ads alongside the content at its own websites, which include eHow. The Santa Monica, Calif., company said in May it is buying Creativebug, which makes how-to videos for viewers learning skills like sewing, knitting, jewelry-making and printmaking, for an undisclosed amount.

Late Monday, Demand said that it also bought Society6 in a $94 million cash-and-stock deal. Society6 allows customers to buy art that can be put on various products. But the company also cut its second-quarter revenue forecast, because traffic driven to its websites from search engines dropped in May and June.

Demand now anticipates revenue of $100 million to $101 million. Its prior outlook was for $105 million to $107 million. Analysts polled by FactSet predicted revenue of $106.2 million. Demand Media kept its profit outlook of 8 to 9 cents per share, which is below analysts' estimate of 10 cents per share.

Demand Media Inc. has been working on boosting the quality and variety of its offerings. Shortly after Demand Media went public in 2011, Google Inc. changed its influential search formula to weed out websites featuring content deemed to be shallow or deficient by its ranking system. The move relegated much of Demand Media's material to the back pages of the search results that provided much of its traffic.

The company has been adapting to the changes by producing longer articles and setting up how-to video channels on YouTube and other online outlets.

THE ANALYSIS: Rohan said in a note to clients that the traffic drop due to Google's changes has led to the loss of some advertising revenue.

The analyst is also taking a wait-and-see approach to Demand's acquisition of Society6, which allows artists to upload digital images to its web site for consumers to buy and put on items such as t-shirts and iPhone covers. Rohan thinks that Society6 may complicate Demand's content business.

But B. Riley's Sameet Sinha has a different view. The analyst thinks that the acquisition of Society6 should help to drive growth and diversify Demand's business. Sinha predicts Society6 could add approximately $45 million to Demand's 2014 revenue.

Sinha kept a "Buy" rating and $13 price target.

A representative for Demand did not immediately respond to an email seeking comment.

SHARE ACTION: Down $1.74, or 21.3 percent, to $6.43 in midday trading. The stock dropped to $6.21 earlier in the session, its lowest point in more than a year. The stock ended Monday down 12 percent since the start of the year.