Porn Valley- [english.ohmynews.com]- Porn isn’t going away. While it has become a part of mainstream culture, adult entertainment remains on the public finance sidelines. The business is dominated by small owner-operated companies, obscuring financial details and stifling growth. To grow aggressively, the porn industry needs money, but the business has a long way to go before most companies are large enough even to consider IPOs.

Gentlemen’s clubs have demonstrated the strongest performance, with double-digit revenue growth and triple-digit profit gains. Retailers, on the other hand, show flat sales growth while posting double-digit profit growth, and content companies, typically, have lagged.

As smaller public companies, listed adult entertainment businesses are subject to wild movements based on small events. A mildly positive press release can send the stock price soaring, and one quarter of substandard revenue growth could send it back the other way. Unusually high P/E ratios result, especially in relation to fantastic (or fantastically dismal) year-over-year earnings changes. The average adult content company, for example, trades at more than 400 times earnings, despite showing revenue declines of more than 60 percent.

Meanwhile, gentlemen’s clubs show fantastic earnings growth on average (almost 470 percent) and a sky-high P/E (91.72), but a low average market cap of $51 million means that they still are vulnerable to the whims of investors, especially large shareholders and insiders. Branded product and retail companies appear to be the most stable, mostly likely a result of the $222 million average market capitalization for the sector, which shows a bit more maturity.

There is room for porn on public capital markets, but porn itself has to change first. A wave of industry consolidation would have to precede any meaningful adult industry IPO trend. According to Francis Koenig, President and CEO of adult-oriented private equity firm AdultVest, it will take time.

Koenig indicates that gentlemen’s clubs have the most potential, because of limited market penetration and the fact that the largest national chains are still private. Following the clubs in Koenig’s estimation are diversified adult entertainment companies, such as Adam & Eve (PHE) and Hustler (LFP), which have revenue streams ranging from films to novelty items and licensing deals. In addition to delivering income from multiple sources, diversification shows an operational maturity that would be helpful in public markets.

The potential exists, and some companies have the right business models. The problem remains size.

While this has not stopped some adult entertainment companies from going and staying public, it does limit new entries to the stock exchanges. Going public is neither easy nor inexpensive, and the mechanics of listing on an exchange require the support of attorneys, investment bankers and accountants. It is easy for the price tag to reach millions of dollars, with hundreds of thousands of dollars in annual expenses to comply with stock exchange and Securities and Exchange Commission (SEC) regulations.

But, there is another way.

Smaller businesses can go public via the Over-the-Counter (OTC) system, which has a more manageable regulatory structure and as a result lower compliance costs. The cost of going public OTC can be as low as US$100,000 up front, with recurring annual fees of tens of thousands of dollars.

Payment processing company IBD is traded OTC, attracting capital from public investors without the rigor of formal stock exchanges. IBD is the smallest of the world’s publicly traded adult entertainment companies, with US$6.9 million in annual revenues and a market capitalization of US$2.2 million. Given its size, OTC is the ideal venue, as IBD does not meet the revenue minimums of most stock exchanges.

Going public OTC is not without risk. The OTC environment attracts fewer investors, making it less liquid than the exchanges. A good quarter will send the stock price soaring, but disfavor with investors can lead to catastrophic declines. Be prepared for a few tough years at first. Over time, maturing operations, comfort with public capital markets and investor awareness are likely to offer a bit more stability.

Entering public capital markets can be exciting, lucrative and unnerving. Wealth is created and rescinded in minutes, and the pressure to perform is extraordinary. For the adult entertainment business, public capital is on the horizon. The ability to grow eventually will be limited by the availability of capital, and public markets are the only viable long-term solution. You may be able to go to the bank for millions, but you have to go to the public for billions.

It will take some time for porn to go public. Consolidation must come first, creating a critical mass that makes the stock exchanges attainable. While OTC is an option, it will not draw the industry as a whole to public investors; the environment is not robust enough. A few big splashes will be necessary to trigger a trend, requiring big companies to go public on exchanges. After a few years of mergers, though, porn will enter the mainstream portfolio; the industry doesn’t have a choice.