Do you remember when Google floated on the stock market back in 2004?
Many folk – including me – thought the company was ludicrously overvalued. The price/earnings ratio was 80!
But if you had invested $1,000 at the offer price, your holding would now be worth close to $12,000.
It was a similar story when business networking site Linkedin floated in 2011. Once again, the valuation seemed very rich, but if you had invested $1,000 at the beginning, your Linkedin holding would now be worth over $5,000.
Even Facebook – deemed a huge flop when it listed in 2012 – has worked out fine. The share price tumbled immediately after the float, but patient investors who bought at the Initial Public Offering (IPO) are now sitting on a 36% profit.
Now there’s another big internet IPO looming. Current internet darling Twitter will float next month.
So should you buy in?
How Twitter makes its money
My mistake with Google was that I didn’t understand the business model properly in 2004. So I’ve tried to get a good understanding of how Twitter currently makes money and whether it is likely to make more in the future.
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.
It’s very useful for keeping an eye on financial news, and for finding interesting content on the internet. Most of the MoneyWeek team ‘tweet’ regularly – you can follow us here if you’d like to find out more about what all the fuss is about.
Anyway, 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.
"The only financial publication I could not be without."
John Lang, Director, Tower Hill Associates Ltd.
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.
Twitter is just too expensive for my liking
I can see how Twitter has lots of room for growth. I’ve seen a fair number of people become 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, the valuation is still too rich for my liking.
Twitter’s float price will be somewhere between $17 and $20 a share, which values the company around the $11bn mark. That’s lower than some pundits had expected, but it still looks high when you remember 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.
So, yes, Google, Linkedin and Facebook have all performed well for early investors. But I can’t still see myself buying into Twitter at an $11bn valuation. Regardless of its potential, that’s just too high a price for a company at such an early stage on its journey.
If you’re in the mood for a speculative punt, you’d be better taking a look at this. Or if you are genuinely interested in small companies at very early stages of development, then you could investigate crowdfunding further.
Our recommended articles for today
Bengt Saelensminde looks at an investment with a near-guaranteed return that could dramatically cut your energy bills without affecting your quality of life.
Technological advances are transforming our farms. Matthew Partridge examines the sector, and picks six stocks set to profit.
• Metals & Miners is a regulated product issued by Fleet Street Publications Ltd. Your capital is at risk when you invest in shares; never risk more than you can afford to lose. Past performance is not a reliable indicator of future results. Please seek independent financial advice if necessary. Customer Services: 020 7633 3600.