Twitter raises a few red flags in my mind. Not the concept. Not its popularity. Not how it is used. But I do have questions about the speculative vagueness of its valuation.
So far, investors have put about $150 million into Twitter. A month ago, the Associated Press reported that Twitter is still sitting on a significant portion of this nest egg and is no a rush to expand its advertising base. So far. its only two revenue streams consist of:
- Selling its internal analytical data. I’ve seen no detailed information on what data are sold to whom—and how much Twitter is making from this revenue stream.
- Promoting Tweets–an innovative concept announced on April 13. This experiment in advertisingmay or may not work; it’s impossible to tell, because there’s no track record to go on. Plus, the Wall Street Journal reported that Twitter will split those “advertising revenues equally with smartphone and Web partners”, which will cut into this new income stream.
Twitter’s revenues so far may be minimal, but that’s not reflected in its valuation—according to the most commonly cited figure, the company is worth—1 billion dollars.
This valuation is not based on publicly scrutinized or audited figures, but on numbers floated to the media by Twitter and its potential suitors. Gamesmanship and internal agendas likely played a role in that $1 billion figure. Keep in mind that several corporations have gone down in flames in the past few years because their actual cash flows did not come close to the sexier figures that they publicly trumpeted.
On Sept. 18, 2009, Digital Beat noted that at least six values for Twitter have been calculated by outside parties–ranging from $263 million to $ 5 billion. Digital Beat wrote:
“Think about that for a second: the largest estimate is twenty times the size of the smallest one. It all goes to show that valuing early-stage companies is like taking a shot in the dark, especially in a field where the public markets provide no cues and other comparable private companies are only beginning to reach profitability. As much as investors and observers try to provide a definitive answer, this is as much an art as a science.”
Let’s assume that a corporation is willing to pay $1 billion for Twitter. It most likely will have to borrow the $1 billion. Imagine the annual interest payments on a $1 billion loan. Can Twitter earn $100 million (assuming 10 percent annual interest) a year just to make interest payments? Such loans and interest payments have crippled several major corporations in many fields in the past 10 years, including newspaper chains such as the Tribune Co. and the McClatchy Co. Even The Seattle Times has been burned by borrowing a lot and finding its debt load too big.
Making such an investment can be a gamble, because predicting the financial viability of young companies is extremely difficult; as Aswatth Damodaran, finance professor at the Stern School of Business at New York University wrote in a 2009 article posted on the Social Science Research Network:
“Even those young companies that are profitable have short histories and most young firms are dependent upon private capital, initially owner savings and venture capital and private equity later on. As a result, many of the standard techniques we use to estimate cash flows, growth rates and discount rates either do not work or yield unrealistic numbers.”
However, Twitter does avoid a couple additional pitfalls; its product use has grown immensely, plus its management investors appear focused on the long-term picture rather than immediate returns. That’s important because, strangely, generating a revenue stream can actually lower the estimated value of a company, as was noted in a Sept. 9, 2009 TechCrunch story:
“Some of the biggest blockbuster acquisitions on the Internet have been pre-revenue companies. YouTube to Google for $1.65 billion in 2006 is one example. Reaching back further, Hotmail to Microsoft for $265 million in 1998 is another. Neither had any revenue to speak of, but both “owned” a new and fast growing market. (…) The problem is, once you have revenues it’s impossible for…investors and potential buyers to just make stuff up. They look at those revenues and growth rates and trend out from there. They can’t add a different long term growth rate without a solid reason to do so. (…) So when Twitter talks about turning on revenue, it isn’t such a small decision. They have no idea how much money they can make off the service. Selling data to search engines, display ads. Search based ads. Premium/business accounts, etc. There are no comparable revenue streams at other companies that they can fully rely on.”
Will Twitter’s internal revenue projections match reality? No one really knows and I certainly don’t pretend to know the answer—but I wouldn’t put my money on estimates that seem to have been pulled out of the air.
John Stang is a longtime newspaper reporter who joined the MCDM program to become relevant again.