Time to short Demand Media, Inc. (NYSE:DMD)?

I’m definitely not buying Demand Media (DMD) shares right now, but I’m not convinced they’d make a good short, either. A company doesn’t exist in a vacuum, and they’re continually tasked with adjusting to a changing market.

Late Thursday night, Google, Inc. (NASDAQ:GOOG) uploaded a fairly innocuous-sounding blog post titled “Finding more high-quality sites in search.” In the post, Google wrote that “in the last day or so we launched a pretty big algorithmic improvement to our ranking — a change that noticeably impacts 11.8% of our queries.”

The update was targeted at reducing search results for low-quality sites. Sounds reasonable. What Google doesn’t specifically say though is that the move is widely viewed as a response to a chorus of reporters and bloggers who have complained about “content farm” pollution on Google.

One of the chief targets of that content farm rage is Demand Media, Inc. (NYSE:DMD) – a company that had its IPO on the NYSE late last month. Demand Media pays an army of freelancers to churn out short articles that are written to rank highly in Google’s search results. Specifically, Demand Media produces “How To” articles for eHow.com to capitalize on the large number of “How To” searches that web users perform online.

The net result is you can type in just about any “how to” query into Google and see an eHow.com page near the top of Google’s search results. Because Demand Media pays just $15 per article, a lot of Web surfers complain about the quality of the articles. Google’s “algorithmic improvement” appears to be targeted at Demand Media and related sites including Yahoo! Inc.’s (NASDAQ:YHOO) Associated Content. The implicit message is, eHow and Associated Content articles are going to start appearing lower in Google’s search results. That means far fewer page views, and fewer page views means fewer ad clicks, which could hurt the bottom line for both companies.

For its part, Demand Media quickly responded to Google’s blog post with a post of its own. “It’s impossible to speculate how these or any changes made by Google impact any online business in the long term – but at this point in time, we haven’t seen a material net impact on our Content & Media business,” writes Larry Fitzgibbon, Demand Media’s EVP of Media and Operations.

Fitzgibbon goes on to say that the company isn’t reliant on Google alone for search. People looking for How To articles sometimes skip Google altogether and go directly to eHow.com, Fitzgibbon says. Repeat visits and visits from social networking sites like Facebook make up another big chunk of visits to the site, too. Still, it’s undeniable that Google plays an outsize role in Demand Media’s success.

During Q3 2010, search engines generated 41 percent of Demand Media’s traffic, according to IPO documents, most of which came from Google. Ad arrangements with Google also accounted for 28 percent of the company’s revenue. Those are big numbers that could mean the difference between a profitable company and a sinking ship.

I’m definitely not buying Demand Media shares right now, but I’m not convinced they’d make a good short, either. A company doesn’t exist in a vacuum, and they’re continually tasked with adjusting to a changing market. If eHow’s results get pushed off the first few pages of Google’s search results, I’d be running for the hills, but a move like that makes little sense for Google. Google’s tasked with providing relevant search results. For obscure searches like “How to Fix a Dishwasher That Makes Weird Noises,” eHow’s content might be the most relevant and informative content online. So long as their content is worthwhile for at least a handful of surfers, Demand’s pages will continue to be returned in Google’s search results.

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