Internet Firms Swap Ad Space, Then Count It as Revenue
MARKET PLACE
A Whole Other Type of E-Trade
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Internet Firms Swap Ad Space, Then Count It as Revenue
By EDWARD WYATT
ince the first cave man exchanged his favorite club for a neighbor's animal pelt, barter has been an accepted form of commerce. Now some Internet companies have turned themselves into virtual trading posts, making barter a way of life.
Consider Sportsline USA, whose sports-related Internet site is relentlessly promoted during broadcasts of football games and other sporting events on CBS, the television network that owns a stake in Sportsline.
In the first half of this year, nearly a fifth of Sportsline's $24 million in revenue involved no cash payments. Instead, Sportsline gave to other companies that amount of advertising space on its site in exchange for advertising and other services and goods on their World Wide Web sites.
These types of exchanges have become so common that they may be skewing the financial picture for the Internet industry.
Since these new companies rarely have profits, revenues are often the key determination of their value. Strong revenue growth, thus, can translate into higher stock prices.
Barter accounted for more than 10 percent of revenues at Internet companies including Ivillage, Salon.com, Earthweb, Verticalnet and Edgar Online in the second quarter, the companies reported.
Over all, it represented 7 percent of the $693 million in Internet advertising recorded in the first quarter of the year, double the percentage of just three years ago, according to a survey of Internet advertising conducted by PricewaterhouseCoopers and the Internet Advertising Bureau, a trade group.
Some Internet analysts say these numbers are far too low. Were companies to take into account deals in which two Internet companies simply agree to scratch each other's back -- selling equal dollar amounts of advertising to each other for cash -- barter would account for more than 15 percent of all Internet ads, the analysts estimate.
In few cases do investors have any idea how big barter has become. Most companies that include barter deals in their reported revenue, like Sportsline, do not mention the practice in their earnings news releases. Only by reading far into a company's quarterly report to the Securities and Exchange Commission would an investor find disclosures about such transactions. The S.E.C. requires companies to break out the deals if barter accounts for 10 percent or more of revenue.
"Something about the practice doesn't smell right to me," said Robert A. Olstein, portfolio manager of the Olstein Financial Alert fund, a $350 million mutual fund that tries to find undervalued stocks by parsing companies' financial statements.
"It may be okay according to generally accepted accounting principles, but I'm not sure anything truly economic is happening in these transactions," he said. "I like to see independent transactions where cash is exchanged, and the company that receives it can consciously decide where to spend every dollar."
Major accounting firms all sign audited financial statements of Internet companies that recognize some barter transactions, giving the practice legitimacy. And the exchange of advertising is important to companies trying to get their names before the Web-surfing public.
But because of the peculiar characteristics of the Internet business, accountants and securities regulators are taking a closer look at the issue. On Monday, the S.E.C.'s chief accountant, in a letter to the Financial Accounting Standards Board, requested that the board's special task force on emerging issues take up the issue of accounting for barter transactions, calling it one of four "priority level 1" issues accounting and securities regulators face.
Accounting for barter transactions has long been governed by an old rule that says the deals must be recorded at the "fair value" of the goods exchanged.
Fair value of advertising is easily determined for established media companies that sell nearly all of their advertising space for cash. But an Internet company may now collect payments on only a small fraction of its space. Much of the rest goes unused, so exchanging a part of it with another Internet company has little downside.
"In some cases, I don't know what fair value is on the Internet," said George Neble, a partner in the high-technology practice in Arthur Andersen's Boston office. "Current practices by companies are all over the place. Given the infinite amount of space on the Internet, I think you have to demonstrate that you can get cash for these spots from independent parties and that you have a pattern of doing it."
Neble added, "Valuations for these companies are being driven by revenues, and barter creates the potential for distortion in a company's revenues."
Lynn Turner, the S.E.C.'s chief accountant, says he, too, has grown uncomfortable with some companies' extensive use of barter. "We want to make sure that the information being reported gives investors a true notion of what is really going on with revenues and that they are reliable numbers," he said. "We're always concerned that someone will push the envelope too far."
While most Internet companies engage in some form of barter, some refuse to recognize those transactions as revenues.
"Personally, I think it's fraudulent," said Alan M. Meckler, chief executive of Internet.com, which runs a network of Web sites, electronic newsletters and discussion groups.
Meckler has been around the Internet for almost as long as the Internet has been around. And as the former publisher of Internet World magazine, the organizer of Internet trade shows and the creator of the online magazine Iworld, he is no stranger to the arenas of publishing and advertising.
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Investors may not know it, but barter is part of how Web businesses operate.
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But when he looked into the vortex of barter transactions for Internet advertising, Meckler said he saw a sort of black hole.
"No company would possibly take barter for something they could sell, unless they were getting something back that is worth more," he said. "What's more, advertising on the Internet has no shelf life -- and if it has no shelf life, it has no value that should be recognized as revenues."
Though Internet.com engages in some "immaterial" amounts of barter, it does not record any revenues or expenses for those transactions.
Most barter transactions are recorded as even exchanges, meaning that equal dollar amounts of revenue and expense are recorded. Thus, the transactions do not affect a company's bottom line, its cash flow or taxes. But companies that recognize barter transactions generally say they are valid because they both give and receive something of value.
Barter helps young companies, because it gets a company's name and brand in front of more people without expending any cash. Salon.com, the online magazine, said that barter rose to 16 percent of revenues in the year ended March 31, up from 7 percent the previous year and zero percent the year before.
"Salon believes that these barter transactions have been important to the establishment of the Salon brand and expects to continue to engage in these transactions in the future," the company said.
Not all companies appear at ease with the recognition of barter revenues, though. In Sportsline's case, CBS, its largest shareholder, gets royalties of 15 percent of revenue -- calculated by excluding any revenue received in the form of barter.
Larry Wahl, a Sportsline spokesman, declined to discuss why barter accounts for so much of the company's revenue. "We don't disclose anything additional with regard to barter, even our rationale, beyond what's in our financials," he said.
Typically, a company that barters advertising records two transactions of equal value. For the advertising space on its own site that it gives away, a company records a given dollar amount of "expenses." At the same time, it records an equal amount of "revenues," representing the value of the ad space on another company's Web site that it received in exchange.
Some companies report that barter is quite important to their financial health. Ivillage, the Web site dedicated to women's news and information, said in its S.E.C. filings it "is dependent on barter transactions which do not generate cash revenue," but which still accounted for 20 percent of 1998 revenue and 12 percent of the $14.6 million in revenue it posted in the first half of this year.
Jason Stell, a spokesman for Ivillage, said that because the company breaks out the amount of its barter transactions, "people can take that into account when they do their models" to value the company.
For many Internet companies, preserving precious cash is nearly as important as getting their brand name in front of Internet users. "Many Internet companies don't have the resources to purchase content or advertising and promotion," said Debbie A. Simon, a vice president at Houlihan Lokey Howard & Zukin, a Los Angeles investment banking firm, who specializes in Internet transactions. "So we definitely are seeing an increasing trend toward barter deals."
A liberal use of barter can work against companies as well, said Rich LeFurgy, chairman of the Internet Advertising Bureau.
"If you're willing to barter, it's hard to sell ads at the full rate," he said.
Peter Petrusky, director of the new-media group at PricewaterhouseCoopers, said that though barter has doubled as a percentage of total Internet ad spending in the last three years, he believed it would fall back to about 5 percent, as larger companies come to dominate the industry's ad spending.
Other analysts are not so sure. Marissa Gluck, an advertising analyst for Jupiter Communications, thinks barter accounts for a far larger percentage of online advertising -- at least 15 percent, or up to three times the trade group's estimate.
"There is a significant chunk of revenues out there that are probably barter, where it looks like money is changing hands," Ms. Gluck said, but where in fact two companies simply buy equal amounts of advertising on each other's Web site. "It's a somewhat insidious practice that is hard to track." |
