Twitter, #Whatsitworth in an IPO?

Twitter move markets, but it can’t make money. That’s a problem if it wants to avoid a Facebook-like flop.

Kacper Pempel / Reuters

Astronaut Chris Hadfield snapped to attention when hailed by William Shatner during his recent mission aboard the International Space Station. Was he tweeting from space? “Yes, Standard Orbit, Captain. And we’re detecting signs of life on the surface,” Hadfield responded, warming the hearts of sci-fi geeks everywhere. Twitter CEO Dick Costolo, apparently a Star Trek fan himself, called the moment “just amazing.”

There’s no question that Twitter has become a ubiquitous, if somewhat unexpected, part of life on 21st-century Earth—and beyond. The seemingly impractical 140-character message format is used by 215 million people a month to broadcast the minutiae of their daily lives, share links to important news events and pass around photographs and videos. (“Not feeling so great today. Stuffed up,” Justin Beiber tweeted last week, to his 46 million followers.)

With words like “hashtag” and “retweet” now firmly part of the lexicon, Costolo and Twitter’s board have decided to cash in. An initial public offering, or IPO, is planned for next month, with some analysts predicting a potential valuation for the company of about $12 billion. That would make Twitter’s IPO the biggest tech offering since Facebook’s in early 2012—although it’s not yet clear whether that’s a good thing. Facebook’s stock debuted at $38, only to immediately sink like a rock (it finally regained the lost ground in August and now trades at $54). Several other social media IPOs, including deal site Groupon and mobile games-maker Zynga, also made their debut amid much fanfare, but ultimately left investors underwhelmed.

Robert Peck, an analyst at SunTrust Robinson Humphrey, thinks Twitter will be different. He recently slapped a “buy” recommendation on the non-existent shares, forecasting rapid growth of ad sales, the potential for lucrative TV tie-ins and Twitter’s massive and relatively untapped database of information about its 215 million active monthly users. But others warn that, unlike Facebook, Twitter is launching its IPO before recording a single profitable quarter. Moreover, it’s not obvious where future ad-sales growth is supposed to come from, given its comparatively tiny user base. (Facebook, by contrast, has more than a billion global users.) “This is not a safe bet,” says Karsten Weide, a San Francisco-based analyst at research firm IDC. “The reach for advertisers is relatively small.” That doesn’t mean Twitter won’t be a successful company one day—only that it’s not there yet. And for investors eager to get in on the ground floor, that could mean another Facebook-sized disappointment.

Twitter has struggled over its seven-year existence to turn its popularity into profits. In the third quarter of this year, its losses widened to $64.6 million from $21.6 million in the year-earlier period, according to documents filed with regulators. Sales, however, more than doubled to $168 million. The red ink was blamed mostly on rising R&D and sales and marketing costs, painting a picture of a company that’s still in the midst of developing a business model. “Making it into a viable business is a whole different game than gaining that initial traction with users,” says Ben Dickie, a senior consulting analyst at Info-Tech Research Group. “And squeezing the money out of the stone is, I think, going to be a challenge in this case.”

At present, nearly all of Twitter’s revenue comes from selling advertising on the network. Potential advertisers have the option of buying promoted tweets (paid ads that show up in users’ streams), promoted trends (paid items that appear where Twitter lists its most talked-about topics) and promoted accounts (paid-for accounts suggested to users so they can follow them). Advertisers generally pay based on how much interaction their ads generate—how many times they are clicked or retweeted to other users. Whereas Facebook uses its store of personal information about users to help marketers target ads, Twitter relies more on the timeliness of their tweets. A user tweeting about a delayed flight, for example, is probably a good candidate to receive a promotion run by an airport spa service.

Most of Twitter’s ads—about 70 per cent—are viewed on mobile devices. That poses both an obstacle and an opportunity. Everyone agrees the future of the web will be on smartphones and tablets. But, as Dickie points out, nobody has really figured out a good way to deliver ads to mobile users without clogging up their phones with banners. “There’s just not much screen real estate,” he says.

Attracting more eyeballs could also be a challenge. Twitter users often set up an account and then wonder what they’re supposed to do next. Only once they’ve built up a network of people to follow, and have amassed followers themselves, does the power of Twitter make itself apparent. In fact, some estimates have suggested that the total number of registered Twitter accounts are in excess of 500 million, but that more than 40 per cent of accounts are effectively dormant.

A potentially more valuable long-term business for Twitter is data mining. The company estimates that 100 million users are active every single day, sending out more than half a billion tweets. Already, there are several third-party companies that sift through all those posts in order to determine impressions of companies and their products. Twitter said data sales for the first six months of this year amounted to $32 million.

There may also be lucrative opportunities for stock traders. In a world where electronic trading allows profits to be made in the blink of an eye, Twitter increasingly acts as a sort of early-warning system for natural disasters and political unrest—the type of events that have a tendency to move markets. This explains why a fake tweet from the Twitter account of the Associated Press earlier this year about explosions at the White House immediately sent markets into a tailspin.

But while selling data accounted for the bulk of Twitter’s sales as recently as 2010, it was a fraction of Twitter’s total sales of $254 million in the first six months of this year. “The data business is super-interesting for Twitter, but it’s difficult to grow,” says Weide.

TV also holds promise for Twitter—again, mostly unrealized. The company is attempting to capitalize on the fact that millions of users tweet while watching television programs. Its TV ad-targeting service allows advertisers to monitor when their ads run on TV and engage users, via their Twitter feeds, when they tweet about the sitcom or reality show they’re watching. “We believe a user engaged enough with a TV show to tweet about it very likely saw the commercials, as well,” the company wrote on its blog. It also recently unveiled a service called Amplify, which allows broadcasters to include short, ad-supported video clips in their feeds. “It’s a very interesting approach, because Twitter is like a live social censor for public sentiment,” Weide says. “So it’s totally conceivable to have a show running on TV and track what people are saying about it. The challenge is how to automate it so you can analyze all that data on the fly.”

What is clear is that Costolo and Twitter’s board are eager to avoid the missteps of Facebook’s IPO. The lead underwriter for Twitter’s IPO is Goldman Sachs, not Morgan Stanley, which led Facebook’s controversial offering. Twitter has also broken with Silicon Valley tradition by opting to list on the New York Stock Exchange instead of the tech-heavy NASDAQ Stock Market.

Perhaps the biggest difference between the way Twitter and Facebook approached their public debut is that Twitter is so far planning to raise $1 billion, whereas Facebook sold $16 billion worth of stock. The strategy, it seems, is to limit the number of shares hitting the market, helping to keep initial demand high. If everything goes as planned, that should propel Twitter’s stock into orbit. Whether it stays there, however, will depend on how adept Twitter’s executive team is at defying the laws of gravity—at least as it pertains to recent IPOs of social media networks.

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