Recently, we learned that Twitter had begun its initial public offering (NYSEARCA:IPO) process using the streamlined regulatory framework introduced by the 2012 Jumpstart Our Business Startups (JOBS) Act. And as analysts and investors search for clues on Twitter's valuation, many again are raising questions about how the JOBS Act impacts financial reporting transparency. In questioning the Company's recent JOBS Act filing, Holman Jenkins of the Wall Street Journal asked:
"Why does a super-prominent company like Twitter need to avail itself of these arrangements?"
Great question! As many of you know already, this grumpy old accountant has never been a fan of the JOBS Act (see "Garbage In, Garbage Out - Are Accountants Really to Blame?" and "Is Model N A Transparency Violation?"). Any legislation that reduces the ability of market participants to make informed investing decisions, gets a "no" vote from me. But in this case, what WILL Twitter's financials really tell us? Nothing that we don't already know! Let me explain…
We should not be surprised by Twitter's JOBS Act filing. There are already hints that the 2010 and 2011 numbers were not good, so why not postpone public disclosure as long as possible. As for current numbers, not much is publicly available, but market-research firm eMarketer reported advertising revenues for the Company of $288.3 million in 2012, and expects $582.8 million in 2013 and $950 million in 2014. All of this makes valuation a bit problematic, forcing reliance on recent private transactions which some believe may justify a $9 to $10 billion value. From this one might incorrectly conclude that the Twitter IPO could be a "poster child" for what it is wrong with JOBS Act disclosure. But we don't really need current financial statements from Twitter! We already have everything we need to form a pretty good idea what the post-IPO balance sheet, income statement, and statement of cash flows will look like.
All we have to do is apply the basics of market multiples analysis to create a set of financial statements for Twitter. If we agree that similar companies have similar assets and capital structures, then we should be able to "back in" to Twitter's post-IPO balance sheet. But first we must find a set of "comparable" (comp) companies. This comp group should share commonalities in industry, technology, customers, size, capital structure, and growth prospects, to the greatest extent possible.
I used the Global X Social Media Index ETF (NASDAQ:SOCL) as a starting point in finding my Twitter comps. This yielded 27 companies which I narrowed down to 19, as 8 were listed on foreign exchanges which precluded easy data access. Next, I eliminated companies that did not appear to have a business strategy or model similar to that of Twitter. For example, I retained all companies with Standard Industrial Classification (SIC) codes 7320 (i.e., computer programming, data processing, etc.) but deleted those with SIC codes 7371 and 7372 (i.e., computer programming services and prepackaged software). Companies like Changyou.com (NASDAQ:CYOU), Zynga (NASDAQ:ZNGA), and Jive Software (NASDAQ:JIVE) fell out as comps. Finally, I deleted companies whose primary revenue source was NOT advertising. This eliminated Nutrisystem (NASDAQ:NTRI), Pandora (NYSE:P), Groupon (NASDAQ:GRPN), United Online (NASDAQ:UNTD), Youku (NYSE:YOKU), Google), Netease Inc. (NASDAQ:NTES), Yandex (NASDAQ:YNDX), Angie's ListI), LinkedIn (NYSE:LNKD), Demand Media (NYSE:DMD), and Renren (NYSE:RENN). This yielded a final comp group consisting of Facebook (NASDAQ:FB), Sina Corp (NASDAQ:SINA), Yelp Inc. (NYSE:YELP), and Meetme Inc (NASDAQ:MEET).
After selecting comps, I used fiscal year-end 2012 balance sheet data from Wharton Research Data Services to create common-sized balance sheets for each company. Then, I averaged each balance sheet line item for each asset category. With this data I then forecasted a post-IPO balance sheet for Twitter. This yielded a balance sheet comprised of the following major asset categories (and percentage amounts): cash and short term investments (41.84 percent), other current assets (11.83 percent), Net PPE (8.36 percent), and goodwill and other intangibles (28.36 percent). Given the relative recency of these comp company IPOs, Twitter's hypothetical capital structure is dominated by a stockholders' equity of 81.16 percent, with current and long-term liabilities totaling only 10.93 percent and 7.92 percent, respectively.
Next, I estimated Twitter's total assets relying on recent annual revenue amounts reported in the popular press ($600 million), and the average revenue to assets percentage (46.84%) of my four company comp group. This generated a total Twitter post-IPO asset base of almost $1.3 billion. Finally, to get amounts for each balance sheet line item, I simply multiplied the $1.3 billion in total assets by the above balance sheet category percentages for my comp group. And voila, a post-IPO balance sheet for Twitter!
Now, does the balance sheet make sense? Sure and here's why. The significant cash balances reflect the recapitalization proceeds from the IPO. The large amounts of goodwill and other intangibles are the result of numerous company acquisitions made during the past two years according to Victor Luckerson: Vine (October 2012), We Are Hunted (Fall 2012), Bluefin Labs (February 2013), Ubalo (May 2013), Marakana and Trendrr (August 2013), and MoPub (September 2013). There is no surprise here and some of you may recall the grumpies ranting about intangibles and cost capitalization issues last year in "The Beauty of Internet Company Accounting." In that same post, we also explored valuation concerns about deferred tax assets. As noted above, Twitter's balance sheet undoubtedly will include these intangibles as well, probably a function of the sizeable tax net operating losses that the Company is now compiling.
And what about the income statement you ask? Well, since advertising seems to be the major revenue source in this version of the Company's business model, it is unlikely that we will see any of the unusual sales treatments found in the recent IPO's for Groupon (i.e., gross vs. net), LinkedIn (i.e., multiple deliverables), or Zynga (i.e., virtual goods).
There is generally nothing very complicated or interesting about advertising revenue recognition. However, three of the four comps (Facebook being the exception) reported operating losses after depreciation and amortization for fiscal year 2012, which is understandable given the start-up nature of these ventures. Twitter no doubt will report operating losses as well, and can be expected to make liberal use of non-GAAP metrics to "explain away" poor performance as not reflective of "reality." It will be interesting to see what expenses the Company deems "special" or "non-operating" in nature: depreciation, amortization, stock-based compensation, acquisition costs? All of the above?
Then, there are the operating cash flows (OCF). The same three comps (Sina, Yelp, and Meetme) reported either negative or transitory OCFs for 2012, clearly reflective of their stage in their company life cycle. We should expect more of the same from Twitter. For those of you that think I am being overly harsh toward social media IPOs, remember that Facebook earned an "A" in financial reporting from the grumpies.
So, see…we really don't need those financial statements after all, do we? But in "Please Twitter, Just Stay Weird," Fahad Manjoo raises a number of strategic concerns which this grumpy Twitter user wants answered, and soon! For example, once a public company, Twitter will be forced to run more ads. We already see this coming as the Company "Strikes Deal with the NFL" and "Pitches Itself to TV Networks." How will monetization ultimately affect the user experience? And then there is the continuing social media company dilemma…who is the customer? The media user who pays little or nothing, or the advertiser who is so key in revenue creation?
Taking care of the advertiser might actually chase off users. As the Wall Street Journal's Yoree Koh and Keach Hagey indicate:
"Getting companies to pay for Twitter publicity is a crucial distinction for the seven-year-old company as it tries to convert its online influence into a business model—especially when rival Facebook Inc. also wants to become a hub for real-time conversations."
If Twitter simply "devolves" into another Facebook News Feed, one could argue that the Company may be sacrificing the very identity that made it special in the first place.
And the concerns / questions don't stop there. Why all the sudden pre-IPO buzz on NFL contracts, new ad products, and new acquisitions? How do all these tie into the Company's strategy, or do they? Why the sudden pre-IPO need for working capital? Is there some sense of urgency to look like a real company? Or could this just be another Grouponesque scenario designed to enrich a select few by bringing to market a neat idea and platform with no real proven way to make money with it. Few would disagree that Groupon's initial premise was exciting…using technology to bring merchants and customers together. However, initially the company had no real strategy, model, or sense of market competition, all of which has contributed to its recent operating struggles. And it doesn't help that Twitter turned to a former Zynga player to lead it to market, or that it just now is looking for a financial reporting manager. Just some of the concerns running through this Twitter loving grumpy old accountant's head.
I vehemently disagree with Wharton Professor Lawrence G. Hrebiniak who indicated that:
"[Twitter] must release its data at least 21 days before marketing the IPO, which, in today's highspeed cyber world, is more than sufficient for investors and others to examine and evaluate the company."
Twenty-one days may be enough to push some numbers around in a spreadsheet, but it is clearly inadequate to promote a meaningful dialogue with management to address the unanswered questions about strategy and business model and leadership. Yet, people are still going to buy into the Twitter IPO, just like they did for Groupon and Zynga. Hopefully, the outcome will be more positive. If not, Twitter's 140 character limit should be sufficient for the eulogy…
This essay reflects the opinion of the author and not necessarily that of The American College, or Villanova University.