Remember that old drawing that, depending on your perspective, could be a young woman turning her head to look at a bright future or a haggard old lady with a tired gaze? Reading through Twitter’s prospectus, I half-expected to see that chestnut included there. Because it’s the perfect illustration of how this company’s outlook is portrayed in its own words.
Twitter’s S-1 document is full of financial data, as you would expect from any responsible company planning to list its shares on the public market. Yet what you take away from it seems to depend even more on how you interpret that information. Is this an undercooked startup trying to go public without earning a penny? Yes! Does its potential to scale up into massive global growth make it an alluring investment? Okay!
In a way, this isn’t surprising. When it comes to investing in tech IPOs, there have always been two primary schools of thought: Invest in proven profits, or invest in promised growth. One of these approaches is prudent but can shut you out of huge returns. The other is intoxicating but can end in tears when a stock plunges from manic highs.
Nathaniel Mott outlined several dualities that Twitter embodies. In the community of tech-stock investors, it is illuminating, and even exacerbating, one more: the age-old debate between fundamental investing and momentum investing. There is ample fuel in its prospectus to fire up arguments on both sides.
Skeptics need only point to the income statement to make their case. Since 2010, Twitter has brought in $705 million in revenue. To do that it’s had to spend more than a billion dollars in marketing, R&D and other expenses. In other words, Twitter has had to spend $1.50 for every dollar of revenue it’s seen in the past three and a half years.
What’s more, Twitter’s revenue in the first half of 2013 more than doubled from the same period a year earlier to $254 million. But expenses rose 89 percent in that same period to $316 billion. Compare that to 2011, when the revenue growth rate was 198 percent and the expense growth rate was 69 percent. Revenue appears to be decelerating while spending seems to be accelerating. Not a promising trend for a company going public to be caught in.
A Twitter bull would point to the reasons Twitter gives (on page 69 of the S-1) for that increased spending: Twitter is building out its data centers aggressively. And it’s hiring just as aggressively, while paying for new office space for a growing work force. In other words, Twitter is investing to scale up to the kind of growth that could bring in revenue, and eventually profits, for many years.
Further down (page 107), Twitter outlines that growth strategy: Grow users, expand geographically, enrich the platform – especially its mobile app. Three fourths of Twitter’s users accessed the service from mobile devices, and 65 percent of its ad revenue came from mobile. That would help Twitter reach out to more advertisers, many of which are still unsure about social network ads, let alone mobile ads. Twitter plans to improve ad targeting, build stronger partnerships with media companies and, again, reach out to overseas advertisers. The company says that 77 percent of its users last quarter came from outside the U.S., while only 25 percent of its ad revenue did.
There is just as much disagreement over the growth that Twitter is already seeing. On the one hand, revenue per user has increased to 60 cents last quarter from 50 cents a year earlier. On the other, it still lags the $1.60 revenue per user of Facebook and LinkedIn’s $1.90 figure. That could suggest Twitter lacks the revenue potential of two of its peers or that it’s still early in the monetization process.
Another example: Twitter’s monthly active users has grown to 218 million in the most recent quarter from 151 million a year earlier. But its user growth rate has slowed to 7 percent last quarter from 18 percent in early 2012. That could suggest Twitter growth is stagnating, or it could be the growth has slowed because the company is getting better at shutting down spam accounts.
On balance, the bullish case seems to be the more credible one, although that may not make the stock an attractive buy. That will depend more on how the deal is priced. If Twitter is valued at $12.8 billion, it could be worth 20 times its 2013 revenue. That’s four times Google’s price-to-sales ratio, but on par with Facebook’s and LinkedIn’s. But those two companies have a history of profits, and Twitter won’t be profitable this year, and many not even be profitable for another year or so.
The Twitter IPO is an important one because it comes right as the market for tech stocks stands at a crossroads between these two investment modes. Consumer Web stocks have been rallying ever since Facebook’s most recent financials showed it’s possible to monetize mobile ads in a way that grows profits.
The needle seemed to be moving toward momentum-driven investing based on promise rather than profits: Stocks like Yelp and Zillow are surging even though they’re not expected to be profitable in 2013. If investors embrace Twitter’s promising growth story, it could throw another log onto the fire burning under Web stocks.
If, however, it turns out Twitter can’t monetize its mobile platform as successfully as Facebook, the alluring young company that many investors are seeing inside the company may be unmasked as just another tired old business model. And that disappointment could dampen the broader rally in Web stocks.