Decade's deals get Digital River's revenue flowing

No eyebrows were raised last month when Eden Prairie-based Digital River bought e-commerce company California-based Bitpass.

During the past 10 years, Digital River, which distributes software over the Internet for customers from Best Buy Co. Inc. to Symantec Corp., has acquired about two dozen companies and become so large that it no longer has significant competitors in the online software sales market, analysts say.

Digital River is "the last man standing," said Safa Rashtchy, an analyst at Minneapolis-based Piper Jaffray. "They have so much expertise that it's very difficult for a new company to compete."

However, Digital River's growth has gone largely unnoticed locally because much of its business involves managing e-commerce for others without using its name. For example, customers of Symantec, the security software firm best known for its Norton Antivirus program, may think they are downloading software from Symantec's website. But they are really downloading it from a Digital River website designed to match Symantec's site. Symantec last year accounted for 45 percent of Digital River's revenue.

Digital River will have a similar arrangement with Microsoft, which is expected to become a big customer in 2007. It will distribute downloadable copies of the new Windows Vista operating system.

But so little-known is Digital River that it recently bought advertising billboards near Minneapolis-St. Paul International Airport in hopes of raising its profile so it could attract new employees.

At least Wall Street has been taking notice. Digital River's stock has jumped from the mid-$30 range a year ago to about $60 in November and early December. On Dec. 22, the company disclosed that the Securities and Exchange Commission (SEC) had asked for documents about Digital River's option-granting practices during the previous eight years. The SEC inquiry followed two shareholder lawsuits, both later withdrawn by plaintiffs, alleging backdating of stock options. By last week, the stock had retreated. Shares closed at $50.66 Friday, up 52 cents, on the Nasdaq Friday.

The company's independent directors also are studying option timing. Digital River won't comment on the situation except to say it has provided documents at the SEC's request.

So far, the SEC investigation hasn't affected Digital River's business operations, which include 1,100 employees, 600 of them at its Eden Prairie headquarters. The company runs six data centers around the world, including two in the Twin Cities.

Digital River was founded in 1994 by CEO Joel Ronning. His idea: deliver software via the Internet instead of U.S. Post Office.

The company held an IPO in 1998 and survived the dot-com meltdown of 2000, although its shares dropped as low as $2.38 in December 2000.

Digital River fought back by developing proprietary e-commerce software that honed its ability to download software for hire. The strategy paid off when there was a sharp increase in the number of consumer broadband connections, which make downloading software faster and thus more practical. The company had its first profitable fiscal year in 2003.

Digital River also began swallowing competitors. In 2004, it bought German firm Element 5, which provided Digital River with an established e-commerce arm in Europe. The following year it bought California-based Commerce 5. Its steady stream of smaller acquisitions, including U.S. e-commerce firms SWREG in 2004 and eSellerate last year, and Fireclick (Web traffic analysis) and BlueHornet Networks (e-mail marketing) in 2004.

'Out-executed everybody'

Digital River "got this big because they out-executed everybody," said Robert Breza, an analyst at RBC Capital Markets in Minneapolis. Besides acquiring competitors, "they created strategic partnerships with the biggest players in the software industry," including the largest security software firms and several large traditional retailers such as Best Buy.

Digital River gets a percentage of the price of downloaded software. Breza projects Digital River's 2006 revenue, to be reported Thursday, will hit $307 million. Microsoft could contribute $20 million to $30 million to 2007 revenue, projected to grow to $380 million, Breza said.

Even less visible than Digital River's software-downloading business in the United States is its growing presence in international markets.

"Digital River can take you worldwide instantly," Breza said. "They have people who speak Korean, and they have multiple payment methods in China. They take the fraud risk, collect the money and understand the tax laws. It's hard to understand why most client companies would want to do that themselves."

Privacy concerns

Two other businesses, virtually invisible, could be controversial. The company conducts e-mail marketing campaigns for clients, and tracks consumer Internet activity by planting computer code in a consumer's Web browser. Both practices raise privacy questions. Unwanted e-mail ads could be considered "spam," and computer code that allows Web browsing to be tracked is sometimes considered "spyware."

Bob Kleiber, Digital River's investor relations vice president, said in a recent interview that the company respects consumer privacy and sends e-mail advertising only to those who have agreed to accept it, although he said some consumers may not realize they opted in. Such details often are buried in the fine print of Web marketing offers, he said.

In addition, Kleiber said Web tracking software that puts "cookies" or other identifiable software in browsers is intended only to monitor how consumers use the websites of some Digital River customers. Consumers can prevent the code from being put on their computers by raising the Web browser's security level.

Digital River's lack of public visibility has one drawback: It's harder to hire people if they've never heard of you, Kleiber said. Thus its recent public awareness campaign.

Kleiber won't disclose how many people the company intends to hire this year but said it routinely seeks people with skills in software development, Web design, sales, finance and foreign languages.

"We're one of the good places to work in the Twin Cities," Kleiber said. "But we need to get more visible."