Twitter will be worth buying, just not out of the gate

Tech IPOs are too volatile

(Steve Jennings/Getty)

Twitter CEO Dick Costolo (Steve Jennings/Getty)

It was the tweet heard round the world. On Sept. 12, Twitter blasted out a 112-character message from its own account, announcing that it had filed a “confidential” S-1 form to the Securities Exchange Commission for an initial public offering. In a matter of minutes, the message was retweeted more than 14,000 times, and Twitter feeds around the world filled up with snarky comments about the social network. But for growth-hungry investors who have been waiting for this moment for some time, this simple missive heralded a rare chance to buy a piece of a rapidly expanding brand name in the hottest sector going.

The announcement couldn’t have come at a better time. Facebook, which floundered out of the IPO gate, finally blew past its initial listing price three weeks earlier, and other social networks, such as LinkedIn, have seen massive gains this year. It’s also coming at a time when people are looking for more growth-oriented stocks, and there aren’t many companies that have the potential to grow as much as Twitter does. Ian Ainsworth, a senior vice-president at Mackenzie Financial and co-lead of the company’s growth team, says that he’s going to give the company a close look when it lists, likely in late 2013 or early 2014.

The company, which lets its 200-million-plus users post messages of up to 140 characters to their followers, is “interesting,” he says, because it appears to have succeeded where Facebook initially failed: in mobile advertising. Twitter sells “promoted Tweets” to businesses, which is an ad that gets inserted into people’s mobile feeds. No one other than Twitter and the SEC know exactly how much the company is making off these ads—a confidential S-1 lets a business with less than $1 billion in revenue file without making its numbers public—but market researcher eMarketer pegs Twitter’s 2013 mobile revenues at US$309 million, or 54% of its estimated $583 million in total revenues. EMarketer thinks Twitter can nearly double both those figures in 2014. When Facebook launched its IPO, by contrast, its mobile revenues were nearly non-existent. In its S-1 filing, which was public, it said “[mobile] usage does not currently directly generate any meaningful revenue.”

That lack of mobile dollars was partly responsible for Facebook’s 30% drop in 2012, so it’s unlikely Twitter will experience the same fate. Plus, Facebook’s rebound could actually help Twitter’s yet-to-be determined stock price stay buoyant after its IPO. In July, the company announced that mobile ads brought in US$656 million in revenues, which accounts for 41% of Facebook’s total second-quarter haul. Scott Kessler, head of technology research with S&P Capital IQ, says Facebook’s mobile growth proves that Twitter is on the right track. “Twitter has been and continues to be a mobile-oriented platform,” he says. “People don’t have as many concerns about that with them, and not just because Facebook has figured it out. It’s been in mobile for a long time.”

Twitter-chartMobile revenues, though, can only go so far. To sustain long-term price appreciation, Josh Olson, a tech-sector analyst with Edward Jones, says the company must figure out other ways to monetize its service; the return on investment on those promoted tweets is unclear. “Markets need to know what they’re getting for their dollar,” he says. It’s also not apparent where additional revenues will come from. Nate Elliot, a vice-president with Forrester Research who works with marketers, notes that the promoted tweets are the only meaningful advertising options for his clients, and he doesn’t see anything else on the horizon. Brands can set up profile pages and post content like any user, but that doesn’t cost anything. Marketers would likely be willing to pay for other ways to get in front of users, though, he says. “If they have to pay for something to make their interactions more successful, then most marketers will do that.” Companies see potential in Twitter, he says, but the exact value of what’s currently available is still up in the air.

It’s a good sign that the company is starting off with a solid revenue base, says Ainsworth, and he has faith it will find other money-making sources over time. “They have $500 million in revenues without expanding much into video or other formats that have historically improved engagement,” he says. If Twitter can enlarge its user base and ramp up engagement, then there will be a “dramatic increase” in advertising rates.

When Twitter’s financial results are revealed, and its executives go on an investor road show, Ainsworth will take a close look at how the company is generating revenues. On growth stocks like this one, investors have to forecast the company’s ability to generate cash for the shareholder. He wants to see growth in revenue, net of growth in expenses. User growth is also important. The goal, he says, is to see if the present value of the cash it generates is greater than the stock price. He also wants to see if management has a good understanding of what drives the business and where they think they’ll find more growth opportunities.

Even with the likelihood Twitter will avoid Facebook’s follies, Olson says investors may want to think twice about buying the company out of the gate. Technology IPOs are extremely volatile in the first six months, he says, and valuations could be too rich for most investors. People have been saying that the company could be worth $10 billion, which Ainsworth thinks is high. If it’s too expensive, then it will be that much riskier. “If it’s trading at 100 times earnings, but really deserves a 70, it will fall hard,” he says.

Olson still thinks it could be a good buy at some point. It’s smaller than Facebook, so its growth should be faster. It’s also in a powerful niche market—“it’s on the pulse of the news world,” he says—which any competitor would have trouble entering.

Ainsworth also thinks it could be a good buy, but he too recommends waiting at least a few months. Investors may miss an initial bump in the stock price, but if you think it can find new sources of revenue and grow its user base, then the price will continue to appreciate over the long term. “We’re hardly rushing to buy. But we do think Twitter will survive and have a dominant brand-name position,” he says. “So we can wait.”

The CB Hotlist

While you wait for Twitter’s debut, consider these (upwardly) mobile tech stocks:

eBay Inc. (NASDAQ: EBAY)
P/E: 27.2 | 1-yr rev inc: 21% 1-yr total return (C$): 14.8%
The online marketplace has a fast-growing mobile platform, says Olson.

Google Inc. (NASDAQ: GOOG)
P/E: 26.5 |1-yr rev inc: 32% 1-yr total return (C$): 31.4%
Google is moving into mobile via apps, YouTube and Android.

Facebook Inc. (NASDAQ: FB)
P/E: 197 | 1-yr rev inc: 37% 1-yr total return (C$): 105.4%
The social network is now increasing its mobile revenues every quarter.

Baidu Inc. (NASDAQ: BIDU)
P/E: 29.8 | 1-yr rev inc: 54% 1-yr total return (C$): 35%
China’s Google. Baidu operates the country’s top online search engine.

Akamai Technologies (NASDAQ: AKAM)
P/E: 37.8 | 1-yr rev inc: 19% 1-yr total return (C$): 42.2%
Akamai helps firms interact with customers better on mobile.