Should you invest in Twitter?

When a household name makes its shares available to investors for the first time, many people who normally steer clear of the stock market feel the urge to take part. Witness Royal Mail. This is particularly true of high-profile internet and technology firms. The stock market debuts of Facebook and Google, for example, attracted huge attention

The same is likely to be true of Twitter, the website that allows users to publish short messages to their ‘followers’ and the wider world. It debuts on the New York Stock Exchange today

But should you consider buying the shares? Investors who previously bought into high-technology firms at the first opportunity have enjoyed mixed fortunes

Facebook shares, for example, started falling almost the moment they became available, although they have recovered more recently and now trade above their flotation price. Google and LinkedIn, the social network based around professional relationships, have both produced respectable returns for shareholders, although they pale next to the gains that Apple and Amazon investors have enjoyed

How Twitter makes its money

In case you’ve never used Twitter, it’s a ‘microblogging’ site. You set up a Twitter account for free. You can then write messages of up to 140 characters long - known as ‘tweets’ - and broadcast them to your followers. You can also choose whose Twitter accounts you want to follow

That’s how Twitter works. But how does it make money?

The primary revenue stream is from advertising. Advertisers can pay for a tweet to be placed in timelines, or they can pay to promote a particular Twitter account - perhaps one that is linked to a product

There’s also potential to run an advertising campaign that links Twitter with traditional media

So if a reality TV show triggers lots of Twitter activity (people gossiping with one another online, basically), then Twitter can sell special deals that cover both media. Twitter has formed partnerships with several TV companies for this purpose

Advertising accounts for 90% of the company’s revenue. Then, on top of that, it’s also making some money by selling data about its users - for example, what they’re interested in and when. So if, for example, there were lots of tweets about barbecues, a supermarket would know to order sufficient barbecue supplies

The combination of advertising and data sales meant that Twitter generated revenue of $254m in the first half of this year

Twitter hopes to increase that figure by signing up smaller companies as advertisers and also by boosting revenue outside North America. Currently 77% of active users are outside the US, but they’re only generating 25% of the revenue

What’s more, Twitter’s revenue per user figure is relatively low at $2. At IPO, for example, Facebook’s equivalent figure was more than twice that, at $4.28

Twitter also has lots of scope to increase the number of active users – currently there are around 230 million active users around the world

Is Twitter a good bet?

It’s easy to see how Twitter has potential for significant growth. Most of us know a fair number of people who are completely obsessed with it, and spend hours a day on the site. As long as that remains true, there must be a good chance Twitter can significantly boost revenue

However, in spite of all these plus points, is Twitter’s valuation too rich?

Twitter’s float price will be $26 a share (announced, appropriately enough, via a tweet!), which values the company around the $18bn mark. That could be considered high in view of that first-half revenue figure of $254m

What’s more, Twitter is still losing money. The first-half loss was $69m. That’s very different to previous internet successes like Google, Facebook and Linkedin. All of the latter companies were making a profit when they went public. The valuations may have looked high for each company when they floated, but at least you knew that they could all actually make money

It’s also a concern that Twitter’s user base in the US is growing more slowly than was once the case. At that sort of price, the company can’t afford for growth to show any signs of peaking

On the other hand, proponents argue that Twitter’s losses reflect a well-reasoned decision to put growth ahead of profitability for now. So it has expanded its work force tenfold since January, 2010, to help fuel that growth. (It now has about 2,000 people on staff.) If Twitter surpasses $1-billion in revenue next year, they say, the company will be materially profitable

Of course, hitting $1-billion in revenue means the company has to continue its pell-mell expansion. Many observers worry that the growth rate of Twitter’s user base is slowing. It expanded 44 per cent in the past year, a big drop from 78 per cent the year before that

But that may just be a natural result of getting very large. By any standard, 44-per-cent growth is still remarkable

Considering how easy it is to set up a Twitter account, and how important the platform has become as a source of breaking news, growth should continue at a double-digit rate for quite a while

Twitter has less than 10 per cent penetration among the world’s 2.4 billion Internet users, so there is plenty of room for expansion

Looking forward, assuming that the growth rates of the past couple of years taper a bit, Twitter could reach $2-billion in revenue in 2015. If so, that could result in a $500-million annual profit

Suddenly an $18 billion market capitalization doesn’t seem insane. It would value the company at about 36 times 2015 earnings. That’s high, but Google also looked expensive when it went public in August, 2004, with an initial market capitalization of about $23 billion. Nine years later it’s been one of the top performing S&P 500 stocks

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