Porn Goes Public

Published: November 3rd, 2000

The row of single-story, aluminum-clad buildings that serve as Vivid Entertainment’s headquarters in Van Nuys, Calif., is unprepossessing – except for the Porsches and Corvettes that jam the parking lot. Inside, the main office is divided into rows of computer workstations. The only hint of the nature of Vivid’s business is the occasional moan that escapes from speakers in the editing bays.

Vivid is the country’s leading producer and distributor of pornographic videos. For 15 years, it has cranked out hundreds of hard-core sex flicks with names like Mission Erotica, Interactive Parts and Devi’s Blackjack. Vivid’s revenues this year are expected to exceed US$80 million, up from $25 million just three years ago. Less than half that amount comes from the sale of videos and DVDs; 35 per cent comes from cable pay-per-view; and the rest comes from the company’s network of Web sites such as XXXAsianhardcore and XXXscreentest. Nearly 25 per cent of the company’s pretax income is profit, Vivid president and COO Bill Asher says.

Around $5.1 billion of the porn industry’s $11 billion annual sales is from videos, according to Adult Video News, a trade publication. But, Asher says, “we can’t keep selling movies forever.” Cable and the Internet are challenging the very fundamentals of the skin trade. With broadband and its interactivity slowly gaining a foothold, simple video watching is no longer going to cut it with consumers. Why settle for pay-per-view when you can click into a virtual date with an onscreen lover who responds to your wishes? That’s the promise of broadband, and that’s why Asher estimates that Vivid’s video revenues will drop nearly 50 per cent in the next few years.

So it’s change-or-die time for Vivid and its competition, not unlike the late ’70s, when the VCR wiped out an entire generation of pornographers unable or unwilling to evolve. “Going forward, you’re either going to have to have something that’s so outrageous that people are talking about it at the water cooler, or something that’s more personal that people won’t tell their own friends that they’re doing it, almost like an illicit love affair,” says Asher. He’s talking about the holy grail of online porn – live one-on-one porn teleconferencing. “For $19.95 a month, you’re in love.”

To survive, Vivid’s executives are determined to transform broadband into the company’s salvation. In order to build or buy the technology to exploit broadband interactivity, Vivid needs money. And so Vivid, according to Asher, will go where few in pornography have gone before: to the public markets. Company executives say they are still in the early stages of the IPO process; in fact, they haven’t signed an underwriter, but Asher says that will happen in the next few months. He declines to name the shortlist of candidates.

With the capital and currency from its offering, Vivid hopes to either purchase or develop technology to deliver high-quality, low-cost, live, nude chats over broadband. Vivid won’t abandon its film roots entirely; it will offer videos online and has already begun streaming a portion of its feature-film archive online through its sites Vividvideo.com and Vividtv.com. But viewing the movies online is hardly ideal, as the video quality is relegated to a tiny Web applet box. Over broadband, however, these movies will be close to TV quality.

In the five years since pornography established itself as a Net mainstay, online sales of videos, DVDs, site subscriptions and sex toys have been brisk. This year, they’ll total $1.4 billion, up from about $980 million in 1998, according to Datamonitor. That puts online porn revenues on par with online sales of books and way ahead of airline tickets.

A new generation of dot-com porn sites with names like New Frontier and Cybererotica are raking in the profits. Perhaps the best known is Internet Entertainment Group, whose CEO, Seth Warshavsky, has said his company cleared $50 million in revenues and $15 million in profits in 1998. (The FBI and IRS are currently investigating IEG’s accounting practices and charges of credit-card fraud against the company; citing his legal troubles, Warshavsky refuses to update his revenue and profit numbers.)

It’s easy to see why Vivid wants to build up its online operations. The company already has a year-old Web business, offering the usual mix of photos, videos and toys, but to set itself apart from the saturated online porn market and to maintain its industry leadership, it needs to develop interactive broadband content. On the cable side, Vivid is betting cable providers like AT&T (T), Cablevision and Cox, to which Vivid currently supplies content for pay-per-view, will figure out so-called convergence plays, which combine conventional TV programs with interactive functions. When that happens, Vivid wants to be prepared to provide content.

Vivid will not be the first porn company to go public. Among the handful of dot-coms that have done so is New Frontier Media (NOOF), an Internet and cable technology shop based in Boulder, Colo., which has been traded on the Nasdaq’s small-cap market since November. There’s also Nuweb Solutions, a Pompano Beach, Fla., shop that designs and operates adult sites Girlshouse.com and Clubxxx.com. Nuweb began trading over the counter in June. Digital Rooster, which develops and operates adult sites from its offices in Toronto, is currently trading on the Canadian Dealers’ Network. Digital Rooster co-founder Anthony Korculanic says the company retained legal counsel in June to investigate the possibility of trading on the Nasdaq.

What sets these companies apart from Vivid is the path they took to the public markets: All went public through a reverse merger. In this process, companies that may expect resistance of some sort to a traditional IPO seek to merge with a publicly traded bankrupt or shell company. To generate cash, they do a second stock offering after the merger. It’s an easy way to tap into the public capital markets without having to navigate the thickets of financial preparation and disclosure before the public offering.

Access to public capital, even through reverse mergers, does not guarantee success. New Frontier Media’s stock enjoyed a brief run-up, hitting a high of $12.37 before April’s correction, and currently trades at around $3 a share. New Frontier is also fighting a $25 million lawsuit filed by a former investor. Similarly, NuWeb, which was formed through the merger of Webnet Designs and the bankrupt Continuum Group, was forced to execute a one-for-40 stock split to stay listed. Drastic measures, however, have failed to lift Nuweb stock, which trades at 37 cents a share, down from a high of $3.

There’s good reason why porn companies have avoided the traditional IPO route. “Someone like a Goldman [Sachs] wouldn’t touch our business,” says Asher. Certainly, more conservative funds would never carry Vivid’s stock. But investment bankers say the climate in the investment world is slowly shifting. “Three years ago, the first response [to investing in porn] would have been no,” says one New York-based investment banker who requested anonymity. “Now I think people are thinking closely.”

Still, it’s not unprecedented for a porn company to go public in the traditional fashion. The best-known example is Playboy Enterprises (PLA), a porn pioneer that went public in 1971 and filed to spin off its dot-com division late last year. The online adult industry has paid close attention to Playboy in hopes that it would open the market to the rest of the industry. But Playboy pulled back from its IPO after the April stock market downturn. Even if its spinoff had gone out, the company would not have been a good index of Wall Street’s receptiveness to hard-core porn. Over the past four decades, Playboy has steadily positioned itself away from the hard core and has rebranded itself as a “men’s lifestyle” company.

For a time, Metro Global Media (MGMAE), a video and magazine publisher that recently expanded onto the Internet, looked like the breakout company. Based in California’s San Fernando Valley – known as “Silicone Valley” because so many porn businesses are headquartered there – Metro Global Media has traded on the Nasdaq since 1996. But a series of setbacks eventually got the company delisted from the exchange late last year. In June 1999, Metro Global’s accounting firm, Grant Thornton, filed a suit charging that the company had mob ties. Metro Global investor relations representative Jennifer Houston denies those allegations. By November, a class-action suit was filed charging Metro Global with questionable accounting practices. Grant Thornton did not return calls for comment.

Vivid’s potential IPO, then, is the first reliable barometer of public acceptance of online-porn content companies and is being watched closely by the rest of the online porn industry. “You will not see an adult company blatantly flying above radar,” says Lee Noga, who operates Ontheropes.com, a resource site for Webmasters of porn sites. “Vivid is such a huge name in so many different areas. [Its IPO] would make sense.”

Asher concedes that a company like Vivid will be an extremely tough sell on the Street. “If I were the owner,” he says, “I would consider [staying private] simply because it’s a nice, easy way to go.” But Asher’s not Vivid’s owner; he’s the president. Steve Hirsch is Vivid’s owner.

Hirsch and his two siblings grew up in Cleveland, steeped in the adult entertainment industry. His father, Fred, a former stockbroker, operated a business selling 8mm stag films in the 1970s. For several years, the children were shielded from the realities of dad’s occupation, but that didn’t last as the police repeatedly raided Fred’s office and charged him with distributing obscene material.

The younger Hirsch joined the family business as a teenager. By 1985, he teamed with adult-industry colleague David James to form Vivid.

Like most porn companies, Vivid used to operate quietly. But in the last few years the company set out to build its brand and gain mainstream notice. The company began pushing its lineup of “Vivid girls” – stars such as Janine, Taylor and Devon. Vivid girls Kobe Tai and Dyanna Lauren sang background vocals for Marilyn Manson’s Mechanical Animals album. Blink-182 features Vivid’s Janine in the video for their hit, “What’s My Age Again.” Publications such as the Economist, Rolling Stone, Time and the Wall Street Journal profiled Vivid and its campaign for public exposure.

“Most people in our industry just wanted to make money,” says Hirsch. “We looked at it in a totally different way. We don’t have a problem with what we do. We’re proud of our movies. We actively went out … and courted journalists from all over the world … that’s how you build brand recognition.” And that’s how you build a business.

Vivid’s decision to seek public backing couldn’t come at a worse time. Since April, Wall Street has turned its back on Net-based content plays, sending a company like Playboy.com back to the drawing board. The field, furthermore, is littered with the corpses of online media firms such as Digital Entertainment Network, Pseudo and Pop.com.

Also, broadband has not hit critical mass. While 41.5 per cent of U.S. homes have Internet access, only 10.7 per cent of homes have access to high-speed Internet services, according to an October U.S. Department of Commerce study. Only about four per cent to five per cent of homes actually subscribe to such services, however, reports the Yankee Group.

Complicating matters, online porn has attracted the eye of regulators and politicians, who are paying special attention in an election year. Federal lawmakers, including Senate Commerce Committee Chairman John McCain (R-Ariz.) are calling for mandatory porn filters in public schools and libraries as a condition of receiving federal funding.

The federal commission created by the Child Online Protection Act of 1998 has spent the past few months grilling members of the adult media industry in its search for methods to protect minors from accessing adult content on the Net. The commission submitted a list of recommendations to Congress two weeks ago, but stopped short of recommending a dedicated adult domain – .xxx or .adult were both floated – which would have let employers and schools essentially switch off access to these sites. That move would have dramatically reduced the amount of traffic to porn sites. The commission recommended that schools, libraries, Internet companies and technology companies voluntarily address the matter.

The FBI, IRS and credit-card companies also are clamping down. American Express (AXP) decided earlier this year to decline charges made to porn Web sites. Porn sites regularly pay up to $100,000 in penalties because many customers dispute charges made to the sites.

The political, legal and financial threats aside, Vivid faces some of its harshest criticism within its own industry.

Going public “is the worst idea they can be thinking about right now,” says Flying Crocodile CEO Andy Edmond, whose company operates a portal that plays host to hundreds of free sites and whose traffic analysis software Sextracker is used by more than half of the top 10 adult sites. A former RealNetworks (RNWK) executive, Edmond is one of the more vocal members of the online adult industry. “I know they think it’s the greatest thing,” he says, “but all it’s going to take is a Pat Robertson, who controls media sources, financial markets, a lot of stuff, to take a great day for Vivid and turn it into a bad day.”

“Porn is not mainstream,” says Jonathan Silverstein, president of Cybererotica, one of the earliest and most successful online adult companies that sells subscriptions to its network of paid sites. But, he adds, “everyone will be watching them closely.”

Vivid’s Hirsch and Asher won’t be dissuaded. Says Asher: “The owners of the company feel that we should either get out of the business at this point and sell it to somebody else, or you should expand. This is an industry that’s exploding.”



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