The trouble with Twitter’s IPO

As Twitter gets ready to go public next month, the microblogging service remains very much a tale of two realities.

To those who get it, it’s an addictive, low-overhead Internet early warning utility that’s quickly become an indispensable means of communication and connection. To those who don’t, it all seems like a lot of hype over a service that, seven years after it first went live, still doesn’t explain itself very well.

The need to explain why it matters is key to a successful IPO, and convincing investors that Twitter has revenue-growing staying power is a crucial pillar of its current preparations for its debut as a publicly traded company. Twitter is showing clear signs of having learned from last year’s tumultuous Facebook offering, with initial valuation numbers that more realistically reflect the company’s size, impact and near- and longer-term growth prospects.

Conservative pricing strategy

Twitter yesterday confirmed in a filing with the U.S. Securities and Exchange Commission that it plans to sell 70 million shares at between $17 and $20 U.S. apiece – an offering that would raise upwards of $1.4 billion. The plan values the company at $10.9 billion, or 9.5 times its projected 2014 sales. Facebook’s current share value is 12.9 times sales, while LinkedIn’s market value gives it a multiple of 13.4. What it means for investors is Twitter is pricing itself 26 and 29 per cent, respectively, below its primary social media competitors.

It promises to be the largest Internet IPO since Facebook went public in May 2012. That offering raised $16 billion and valued the company at $104 billion based on fully diluted share count. With a final strike price of $38, its pricing was 107 times fully-diluted trailing earnings over the previous year, and made it among the most expensive companies – top 1 per cent – in the Standard & Poor’s 500 Index.

Facebook’s share value quickly sank after the IPO and eventually lost half of its value before recovering to parity this past August. It now trades in the $52 range, but the roller coaster experience shook the investment community’s confidence in Internet-sector stocks. Onetime-high-flyers Zynga and Groupon didn’t help matters, as their share values crashed to earth amid sinking revenues and growing doubts over consumer retention and advertiser buy-in to their respective models. A smooth Twitter offering could convince investors that ad-supported social media platforms are indeed sustainable.

Revenue, user concerns

Twitter’ answer is relative-bargain pricing strategy, coupled with a road show schedule specifically designed to avoid hype. But even that may not be enough to completely wipe away the doubts. In its S-1 filing on October 3, the company confirmed that in its entire history, it has never been profitable, and has lost a total of $417 million. While its revenues for January-through-June 2013 of $253.6 million were up 107% over the year-ago period, heavy investment in infrastructure to fuel growth pushed net losses over the previous six months up 41 per cent to $69.3 million.

Its user growth and engagement numbers are troubling, as well. The company tweeted in December 2012 that it had 200 million monthly active users (MAUs) every month. Its 231.7 million MAUs – compared to Facebook’s 800 million – confirmed in a supplemental S-1 filing on October 15th could signal a slowdown in this key metric. Twitter has also struggled with fake and abandoned users, with Reuters reporting 36% of accounts are dormant, and 7% have deleted them. Facebook’s inactivity rate is only 7%, and only 5% have closed their accounts.

Conservative IPO planning aside, Twitter remains challenged to convince new users to try it out, existing users to stick with it, and advertisers and investors to make long-term bets.

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