(Reuters) - Demand Media Inc said on Tuesday it is exploring the separation of its media business from its domain name service, a disclosure that sent its shares up nearly 20 percent in after hours trading.
The company said the potential move would be a tax-free distribution to U.S. stockholders of new publicly traded stock and could be completed in nine to 12 months.
"The catalyst is the level of investment we see and we don't want to handicap either business from realizing their full potential," Demand Media CFO Mel Tang said in an interview, referring to the fact that the registrar business requires more capital expenditure than the media business.
As Demand Media grows its top level domain business it will need to invest money into building out its technology and operational infrastructure, said Tang about the split.
Demand Media has two sources of revenue. In its media business, freelance writers, photographers and videographers provide articles and videos designed to appear at the top of Internet searches that in turn generate advertising. The other is a growing registrar business that maintains top level generic web domains.
The intention to split the company could attract buyers for its registrar business since companies that deal in web domain services have been hot commodities in recent years.
One of Demand's registrar rivals The Go Daddy Group Inc - the company known for its racy SuperBowl ads - was snapped up by private equity firms KKR and Silver Lake for $2.25 billion in 2011.
"On the registrar side there is potential for mergers and acquisitions," said Sameet Sinha, an analyst with B. Riley Caris.
Once a slow growing business, that changed when the body that regulates domain names decided to open up the web to different choices beyond ".com" and ".net."
Demand has been actively applying for applications for "generic" names such as ".actor" and ".social."
Sinha said new, open generic top level domains "is going to rejuvenate an industry that has historically been commoditized."
Revenue from its registrar business represents about one-third of total revenue. Tang estimated that a stand-alone registrar business could roughly generate about $150 million in revenue with margins approaching 20 percent - that does not include the generic top level domain names.
"I think it's worth more as a separate public company than it is today," said Demand Media Chairman and CEO Richard Rosenblatt on a call with analysts about the registrar business.
Demand's media sites that include eHow, Livestrong and Cracked are estimated to make about $250 million in revenue with margins in excess of 30 percent, said Tang.
"I think both businesses are going in different directions," said Doug Arthur, an analyst with Evercore Partners. "Historically there was some cross pollination. I see the logic behind it."
Demand Media announced the potential split in conjunction with its earnings report, where it forecast 2013 revenue between $435.0 million and $443.0 million and adjusted EPS of 39 cents and 43 cents per share.
Analysts are expecting 2013 revenue of $413.8 million and EPS of 46 cents per share.
Demand executives said on the call that expenses will grow faster than revenue as they invest in the business.
Fourth-quarter revenue rose 22 percent to $103.1 million.
The company said adjusted for items including stock-based compensation, net income rose to $10.8 million, or 12 cents per share, from $6.8 million, or 8 cents per share, in the same period a year ago. Analysts were expecting 11 cents per share, according to Thomson Reuters I/B/E/S.
The spike in shares came in after hours trading after closing at $7.84 on Tuesday.
Additional reporting by Liana Baker in New York; Editing by Peter Lauria, Bob Burgdorfer, David Gregorio and Andrew Hay