Facebook, Twitter, and the Battle Over Value


Source: http://www.flickr.com/photos/johanl/

For better or worse, Twitter Inc. (NYSE:TWTR) is now a public company. Shares started trading on the New York Stock Exchange on Thursday at $45.10 each, about 73 percent higher than the $26 price set by underwriters the night before. Demand for shares was, unsurprisingly, enormous — the stock was oversubscribed as much as 30 times over — and the price peaked at $50.09 before settling down to $40.50 on Monday morning.

There’s a lot to like about Twitter, but at its current valuation — approximately 22 times expected 2014 sales — investors are willing to pay more per dollar of Twitter sales than per dollar of Facebook Inc. (NASDAQ:FB) or LinkedIn Corp. (NYSE:LNKD) sales. This, many observers have noted, seems unreasonable. Facebook and LinkedIn are both sitting on demonstrably functional earnings-generating business machines, while Twitter is sitting on $300 million in losses over the past three years, with a $65 million loss in the most recent quarter alone.

Twitter’s valuation is largely a function of speculation. Many investors — or, perhaps more accurately, traders — who were allocated shares at the IPO price likely cashed out after the 73 percent opening day pop, while others are expecting the business to grow into its sky-high valuation. Most analysts hold 12-month price targets in a range between $30 and $40 per share, with profitability expected in 2015.

So what will Twitter look like as it grows into its valuation? Facebook and LinkedIn managed to win over Wall Street when they demonstrated that they not only had highly engaged and growing user bases, but that they could effectively monetize their user bases, primarily through advertising. Twitter falls into this same bucket and by and large will have to demonstrate the same things to investors.

As of September 30, Twitter claimed 232 million monthly active users, up 39 percent on the year, but only about a fifth of Facebook’s monthly active user base. Timeline views, a measure of engagement, increased about 53 percent on the year to 158,758 for the quarter ended September 30.

Revenue has grown enormously alongside user base and engagement metrics. Revenue for the nine months ended September 30 were up 106 percent on the year to $422.2 million. “Although we do not generate revenue directly from users or platform partners,” Twitter said in its S-1 filing, “we benefit from network effects where more activity on Twitter results in the creation and distribution of more content, which attracts more users, platform partners and advertisers, resulting in a virtuous cycle of value creation.”

Twitter’s net loss in the same period, though, widened from $70.7 million to $133.9 million. This loss, coupled with the enormous valuation, may be what is most troubling about Twitter as an investment right now. Twitter’s growth prospects look good, but the path forward is by no means set in stone. As with any social media company, Twitter faces very real risks.

“We generate a substantial majority of our revenue based upon engagement by our users with the ads that we display,” Twitter said in its S-1 filing. “If people do not perceive our products and services to be useful, reliable and trustworthy, we may not be able to attract users or increase the frequency of their engagement with our platform and the ads that we display. A number of consumer-oriented websites that achieved early popularity have since seen their user bases or levels of engagement decline, in some cases precipitously. There is no guarantee that we will not experience a similar erosion of our user base or engagement levels.”

With this risk so clearly spelled out, it becomes paramount for any would-be investor in Twitter to believe that the company will not fall victim to user atrophy.

There are a number of ways to do this, and pretty much all of them involve Twitter infiltrating what Yahoo Inc.(NASDAQ:YHOO) CEO Marissa Mayer may call the daily habits of users: entertainment, news, and, of course, social networking.

Twitter has made no secret of its efforts to become the go-to, real-time second screen for everything from television to breaking news. Twitter’s IPO prospectus highlights examples of historic tweets by people like President Barack Obama.

Given how thick the atmosphere is with hype and speculation, it may be best to understand Twitter by its risks and how it stands to avoid succumbing to them. It is important to remember that Facebook is still the biggest kid on the playground, with more than 1 billion users. If Twitter is to remove the risk of being overshadowed by the social networking giant, it will have to make good on its efforts to distinguish itself as the real-time conversation platform.

In its IPO prospectus, Twitter highlighted four value propositions for its users: sharing content with the world, discovering unique and relevant content, breaking news and engaging in live events, and participating in conversations. The real-time aspect of Twitter is perhaps what separates it the most from competitors like Facebook, though Facebook is arguably leagues ahead of Twitter in categories such as content sharing and discovery.

Its ability to make good on this value proposition is what will set Twitter apart from Facebook.

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