Little Birds

10.04.13

Gaming the Twitter IPO

The company has grown massively in a short time, to 215 million users. But can it turn a profit? Daniel Gross isn’t so sure.

Twitter is going public. After filing a stealthy filing a few weeks ago, on Thursday afternoon, the company filed a formal S-1. This granted investors, gawkers, and the generally curious a look under the hood of the company for the first time.

What they found shouldn’t be surprising to veteran internet-related companies: it’s a firm with insane growth in eyeballs, rapidly growing revenues, no profits (yet), and a quasi-messianic do-good mission. (“we have democratized content creation and distribution, enabling any voice to echo around the world instantly and unfiltered.”) After a quick read through the prospectus, there’s one significant question: can Twitter grow rich and profitable before it grows mature?

There are several noteworthy items in the document, which runs well over 200 pages.

First, Twitter, compared to other social media sites, tends to exert less control over its users and the environment it has created for them.  A similar impulse fuels its corporate governance structure. At both Facebook and Google, the founders, Mark Zuckerberg, and, Sergey Brin and Larry Page, have a special class of shares that allow them to exert voting control far beyond their actual financial ownership of the company. That’s not very democratic. But Twitter’s founders have chosen not to go that route. The founders and bosses will have Class A shares – one share, one vote – just like any schmo who buys in at the IPO. (They’ll just have a lot more of them.)

Second, the company neatly encapsulates a certain type of 21st century business. You can create a lot of value and wealth without creating many jobs, or using much in the way of raw materials and space. Twitter, the prospectus informs us, has about 2,000 employees, leases about 300,000 square feet of office space (about the size of three Wal-mart supercenters), plus data centers.

To do so, however, you have to convince lots of people to create stuff – content, much of it compelling – for free, and then let you sell advertisements against it. The business rests not so much on violating users’ privacy, but by tracking user behavior on the medium and then divining your interests, desires, needs, and fears – and then packaging that information to advertisers. Advertisers, Twitter says, can target “interests and genders of users, which we predict form the accounts a user follows and the history of interaction.”

And the company plans to ramp up its efforts to monitor what you’re doing and monetize it. “We believe a user’s Interest Graph produces a clear and real-time signal of a user’s interests, greatly enhancing our targeting capability.” If you live your life out loud – which is what a lot of people do on Twitter -- don’t be surprised that somebody is recording everything and then figuring out how to package it to advertisers.

Third, the company is a phenomenal growth story – but one that may be already tapering and will find it difficult to match the reach of Facebook or Linkedin. Consider. Twitter has 215 million monthly active users, 100 million of which use the medium daily. Together, they create about 500 million tweets per day. That’s quite good. Twitter says it has plenty of headroom. “Industry sources estimate that as of 2012 there were 2.4 billion Internet users and 1.2 billion smartphone users, of which only 215 million are MAUs of Twitter,” the company noted.

But the growth in users is slowing. Between March and June 2012, the number of users rose from 138 million to 151 million, an increase of 13 million, or 9.4 percent. For the next few quarters, the quarter-to-quarter growth rate stood at above 10 percent. But from March 2013 to June 2013 (the most recent quarter Twitter reported), monthly active users rose from 204 million to over 215 million – a quarterly increase of just 5.3 percent. Most companies would kill to recruit 11 million new users in three months. But the trend line seems to be pointing downward.

As for finances, revenues are growing much more rapidly than users. Revenues rose fourfold from $28.2 million in 2010 to $106.3 million in 2011, then rose three-fold to $316.9 million in 2012. While the numbers are getting larger, the growth rate is falling. Between the first half of 2012 and the first half of 2013, revenues rose from $122.3 million to $253 million, an increase of 107 percent. Again, that’s an extremely impressive growth rate. But the pace of growth is slowing sharply, as typically happens when companies grow in size.

Most companies would kill to recruit 11 million new users in three months.

The company has lost money for the last several years, though it is getting closer to profitability. It racked up a $67 million loss in 2010, a $128 million loss in 2011, a $79 million loss in 2012, and a $69 million loss in the first half of 2013. The good news is that losses as a percentage of revenue are declining very rapidly – from 140 percent of revenue in 2010 to 27 percent in the first half of 2013. The good news for Twitter investors is that costs are growing at a slower clip than revenues – between the first half of 2012 and 2013, revenues rose 107 percent, while expenses rose 86 percent.

Another interesting nugget. Most social media stocks penetrated the U.S. first and then took their act quickly overseas. Twitter, from its origins, has been much more global. Already, the company notes, “users outside the United States constituted 77% of our average MAUs in the three months ended June 30, 2013.” But since internet businesses aren’t as well-developed in the generally poorer nations outside the U.S., international revenue only accounted for 25 percent of total revenues. That means a huge opportunity for Twitter to cash in on the growth of digital media, e-commerce and advertising outside America’s borders.

So can it grow rich and profitable before it grows old? That may seem an absurd question to ask about a company that didn’t exist seven years ago. But it’s not outside the pale. There may be 7 billion people in the world. But realistically, only a fraction of them are eligible and able to participate in social media. And with 215 million users, Twitter already has a very solid fraction of them already signed up. Plus, social media users are also notoriously trendy and fickle. There’s no cost to join Twitter, and no cost to quit. Twitter has gained tremendous scale. But for it to double its user base from the current level will be quite a chore, and may take several years. In the meantime, once it goes public, it will face larger pressures to monetize all those tweets and ramp up advertising. That may work spectacularly well, or it may alienate some users.

The beauty of social media companies like Tumblr, Instagram, and Twitter – especially ones that didn’t face early pressures to turn profits – is that they are frictionless. They can scale very rapidly. Barriers to entry are low. The users become evangelizers. But if Twitter wants to maintain its revenue growth, it is going to have to push harder on advertising, spend more money on marketing, and generally be more overt about its efforts to profit from the contributions of its millions of users. Twitter may well succeed in doing so. Since going public, Facebook has successfully ramped up its ad business across multiple platforms. And Twitter’s management is very smart.

But I still wonder whether, given the limitations of the medium, and the success that Twitter has already had, the company will be able to continue to notch its impressive recent history of user, revenue, and margin growth.