On August 8, 2014 Demand Media (Skate’s Art Stock Index company since this September) acquired Saatchi Online (recently renamed into Saatchi Art), one of the market leading art e-commerce platforms focused on low-end contemporary art and prints. Saatchi Online (further called Saatchi Art in this report) came as the 9th top-rated art business by digital score according to Skate’s Art E-Commerce and Media Report published on September 15, 2014 and as such, the acquisition by Demand Media was a very interesting transaction to look into as it provided for benchmark valuation of art e-commerce platforms.

Demand Media paid a purchase price of $17 million for a 100% ownership interest in Saatchi Art, made of $5.7 million in cash and 1,049,964 shares of Demand Media (traded at $9.77 per share at the time when transaction had closed). On the surface, it looked like a fully priced deal given that no disclosure of Saatchi Art financials was made at the time of the transaction.

Then, more information transpired, making the deal look far less exciting for sellers than what the $17m price tag implied.

First, Demand Media share price tanked since the deal was closed – as of October 24, the stock was trading at $7.06 or a 28% below the price at which Saatchi Art sellers exchanged their ownership in the company for Demand Media shares (and very likely they were on lock-up and could not sell the shares since then).

Second, on Friday, October 24, Demand Media published complete financial disclosure on Saatchi Art and this allowed putting the $17m purchase price in the context of Saatchi financials. Saatchi Art had $5.2m in cash as of December 31, 2013, this is after it burned another $5.7m in cash in 2013. This cash-burn only accelerated in 2014 with Saatchi Art depleting its cash position by $4.2m in the first six months of 2014 alone and having $0.99m in the bank as of June 30, 2014, or 5 weeks before the sale to Demand Media had been consummated. In other words, Saatchi Art had been clearly sold to Demand Media on a cash-free basis with selling shareholders making a decision to exit as an alternative to putting more cash into the loss-making business.

Saatchi Art disclosures published by Demand Media reveal that Saatchi Art shareholders invested $12.3m in cash and three million dollars in IP licenses into Saatchi Art before selling it to Demand Media and received just $3.1m in cash in August (and not $5.7m as originally announced when the deal closed in August – the difference is explained with working capital adjustments and $1.7 million placed in escrow for a year to remedy for possible post-closing indemnifications). Assuming stock options and other dilutive effects and transaction costs, Saatchi Art shareholders lost on average 75 cents on each dollar invested on a cash basis and can only recoup their investment if and when they can sell Demand Media stock (received in exchange for ownership interest in Saatchi Art) at over $9.5 per share.

Well, the deal is neither spectacular for the buyer (Demand Media). Demand Media booked $10.4 million goodwill on this transaction, creating a solid chance of impairment-driven, non-cash losses to flow out of this transaction soon. The size of the business acquired turns out to be ridiculously small – Saatchi Art made just $2.46 million in 2013 revenues (and produced $5.67m loss against it) thus suggesting that Demand Media acquired a cash-burning e-commerce venture with no proven business model yet at a revenue multiple of 7.

The acquired firm’s cost structure is another testimonial for the lack of viable business model – Saatchi Art spent $5.56m in 2013 on sales & marketing and G&A expenses, or 2.3 times more than the revenue the firm generated.

Exhibit 1

Demand Media Share Price vs Skate’s Art Stock Index & S&P 500

Demand Media Share Price vs Skate’s Art Stock Index and S&P 500

Skate’s is very curious how Demand Media is going to grow Saatchi Art into a business of a meaningful size without ballooning the loss even further. The starting point looks scary – in the first six months of 2014 Saatchi Art saw its topline growing by 142% to about $2 million, however its loss almost tripled for the same period of time (compared to the first six months of 2013), from $1.5m to $4.2 million. Alas, what might be scary for some perhaps is not a big deal for Demand Media – the firm’s own six months of 2014 were also firmly in red, Demand Media recorded $25.3m net loss on $179.5m in six months (2014) revenues.

Demand Media published on October 24 a very helpful set of pro-forma consolidated accounts, and made it very clear what impact Saatchi Art makes. Based on the 6 months of 2014 financials, the newly acquired subsidiary of Demand Media is responsible for about 20% of the group’s losses ($4.2m loss by Saatchi Art versus $21.1m overall loss of Demand Media) and just 2.2% of the group’s sales ($2.0m in six months revenue by Saatchi Art versus $90.1m in total revenue of Demand Media).

Given these numbers, Demand Media clearly has a lot of faith in Saatchi Art. Skate’s is thrilled to see the turnaround miracle.