Twitter IPO: Should You Invest? (Part 1)

This week will undoubtedly see an enormous amount of interest in the Twitter (TWTR) IPO scheduled for Thursday, Nov. 7th. Most individual investors who have expressed an interest are already aware that they will be disappointed. They have placed orders with their broker, but it is likely that many have already been told to expect only a small percentage of the stock they requested, if any. If you are one of those people, should you buy immediately or wait? Over the next couple of days, I will take a look at the potential problems that TWTR will face and, based on the history of similar IPOs, what this might mean for those intending to invest.

Of course, each public offering in a new company is different, but there have been three remarkably similar IPOs in the past. Google (GOOG), LinkedIn (LNKD) and Facebook (FB) also went public when their popularity was riding high amid a frenzy of interest. In each case, however, those not caught up in the buzz saw a problem at the time of the offering that was similar to that faced by Twitter this week. They were already household names, riding an incredible wave of popularity, but as anybody who follows the fortunes of companies knows, popularity can only take you so far.

Companies don’t exist to be popular, they exist to make money. GOOG, LNKD and FB each had a huge, dedicated following, but at the time of their IPO, none of them had fully worked out how to turn users who received the service for free into cold, hard cash. Or, rather, there was uncertainty as to how they could continue to grow revenue and profits enough to satisfy investors. TWTR faces the same problem. If anything Twitter’s problem is even more urgent, as they are not yet profitable. GOOG, LNKD and FB had all crossed into profitable operation prior to their IPOs.

Obviously not making a profit is no barrier to the success of a tech stock in the modern world (If you doubt me, have you looked at Amazon (AMZN) lately?), but it does make comparative valuations a little more difficult. It is hard to arrive at a multiple of earnings when there are none. Success for the company, and therefore the stock, depends on growing revenue exponentially, while controlling costs.

Conducting an Initial Public Offering at or near the perceived peak of your popularity means that the law of large numbers is obviously going to come into play when it comes to increasing the number of users. Even 10% growth in that metric is difficult to sustain as you get closer to saturation of your natural market. For revenues to grow significantly then, the company must increase the engagement of existing users, expand into other areas, increase the revenue generated from each user, or ideally all three.

Google has shown that great things can be achieved if you hit the trifecta. They solved the initial problem of generating cash from a free service by charging companies each time a potential customer clicked on a link to their website generated by a Google search, combined with selling data to potential advertisers that indicated to them users’ interests. They then used that cash to expand into other areas.

Facebook has remained free for users and is dependent on advertising revenue and the same sort of data mining that allows advertising to be targeted at users, based on each user’s likes and interests. LinkedIn derives some revenue more directly from users with a paid Premium service. One assumes that TWTR will follow the FB route, but the timing of the TWTR IPO presents a problem in itself.

The Facebook offering was in May of 2012, just over 18 months ago. This doesn’t seem like a long time to many, but in that time the “mobile revolution” has gained pace rapidly. Monetizing mobile use has been a challenge for Facebook and one could argue that the heavy lifting in that area has already been done for TWTR, but I believe they face a few additional disadvantages.

First, and in a general way, it would seem that the public is becoming weary of online advertising in any form. What were once attention grabbing, if somewhat annoying, static ads are now often tuned out and are difficult to display effectively on a relatively small mobile screen. The trend is toward a kind of advanced pop-up that you must sit through before seeing your destination page. Given that Twitter is all about immediacy, I can’t see users putting up with that. That immediacy also translates to less actual “eyeball time” on the screen than for Facebook, so ads must make a quick, effective splash.

The key for TWTR, then, is going to be data mining, and I’m sure I’m not the only one for whom that is concerning. Google and Yahoo (YHOO) were upset about recent revelations of NSA interception of their data for a reason. It just highlights the fact that somebody, somewhere is quietly gathering data on us and selling it. Until now, we the people have been OK with that, but it isn’t hard to envisage a reaction and subsequent problems for those that gather that data.

I am hesitant to be too pessimistic, however, as the history of GOOG, LNKD and FB tells us that when enough brilliant minds focus on a problem, even one as tricky as generating revenue from a free service, a solution will be found. We can’t know if that solution will be effective in the long term, but the chances are it will be based on an idea or technology that doesn’t even exist yet. Many believe this will come from a link with television given Twitter’s ability to instantly measure reaction and sentiment of an audience and that will probably play a part.

So, just as with previous high profile tech IPOs, there will be legitimate concerns initially as to the long term ability of TWTR to grow revenue at the desired pace. Investing for the long term means having faith that innovative solutions to the problems will be found. The simple fact is that investing early in any one of GOOG, LNKD or FB looks pretty smart now with 20/20 hindsight. Tomorrow I will take a look at entry strategies for those who believe TWTR will look the same in a few years.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

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