Seeking Alpha
Long/short equity, contrarian, deep value, event-driven
Profile| Send Message|
( followers)  

Twitter (TWTR) has had a rocket ship ride since its Initial Public Offering, soaring over 100% and making those lucky enough to get in on the deal (probably relatives and close friends of the underwriters and favorite clients of the brokers) a lot of money.

(click to enlarge)

The excitement over the stock reflects the enormous growth of Twitter users since it was founded not that long ago.

(click to enlarge)

Hollywood celebrities have turned to Twitter as a key vehicle to keep their fan base up to date on their news with Justin Bieber, Katy Perry and Lady Gaga beating out President Barack Obama for the win, place and show positions.

(click to enlarge)

The euphoria has taken the market capitalization of Twitter to more than $30 billion. Not bad for a company that has yet to show a profit and from whom no profit is expected any time soon.

Future profits from Twitter are expected nonetheless, and like Google (GOOG) and Facebook (FB) the revenue source is advertising. All three of these internet powerhouses look to advertising dollars as their source of monetizing the traffic they create. But while Google is already making billions from advertising and Facebook is joining the $1 billion club, Twitter is expected to generate a measly few hundred million in advertising revenue in 2014.

(click to enlarge)

Google, of course, uses its industry leading search engine as the vehicle to target advertisements allowing advertisers to buy "words" to promote their products in an auction process that lets the high bidders enjoy high ranking among search results, a technique that has been very effective for both advertisers and internet users alike.

Facebook's advertising model is a bit different. With one of the best databases in existence on almost 1 billion people, Facebook can let advertisers reach very specific subsets of the Facebook user population ideally matched to the characteristics of the target market for their products. Not surprisingly, advertisers are giving Facebook the old college try to see how much success the platform can generate and at what cost.

Twitter is a whole different story. On the plus side vendors can "Tweet" about product news to a wide audience of visitors to Twitter in real time. Finding a balance between filling the airwaves with random spam and providing visitors with information they want is going to be more of a trick in Twitter space but there are a lot of clever people working on the issue, and it is too early to conclude whether it will be a blowout success or a dismal failure.

It is not too early to conclude that Twitter is over valued however. Facebook has revenue per user north of $2.00 and a market value per user of about $98. Twitter has revenue per user of less than a dollar and a market value per user of about $110.

Last year, the Wall Street Journal published some Comscore data on user engagement for popular sites and reported that Facebook engagement was 405 minutes per user in the month while Twitter was 21 minutes. I would think the vastly higher engagement metric for Facebook would imply a greater effectiveness of advertising using its platform than on Twitter. Presumably, the value of a user on Facebook should be a multiple of the value of a Twitter user.

(click to enlarge)

Whether user engagement is the right metric is debatable but when companies have no profit and no prospect of profit, analysts look to any metric they can to find and assess value and revenue per user and time spent on site per user are near the top of the list.

I come at the problem a different way. Twitter has about 232 million users. If they all generated $5 in revenue for Twitter annually (or about five times the current estimates for 2014) Twitter would be have revenues of just over $1.2 billion. Presumably it has some costs and if profitable would pay some taxes. I know some companies (salesforce.com (CRM)) add back management compensation in determining the "adjusted profit" they suggest investors use to value their shares, but I am old fashioned so I am going to assume Twitter investors will eventually look for net profit after taxes and value the company at an appropriate multiple in light of its growth. In the 6 months ended June 30, 2013 Twitter reported costs of $316 million so I will assume total year costs of $632 million. With my theoretical revenue of $1.2 billion (a few years off but assume it was now) Twitter would have about $570 million of pre-tax income and at a 25% tax rate would earn net income of about $425 million.

Now let's assume that Twitter grows to 1 billion users over 5 years and the ratios hold. Five years from now Twitter might be a $6 billion company earning $2.1 billion net income. Put a 15 multiple on that and the 5 year out Twitter might be worth $30 billion. A lot would have to go right. Revenue per user would have to quintuple. The number of users would have to grow five fold. And investors who bought the company's shares at close to $60 today would have broken even.

Cracks are already appearing in the Twitter growth story. The number of unique visitors to Twitter has fallen from its mid-summer high of over 45 million to about 40 million today.

(click to enlarge)

The point is pretty simple. It is not enough to be a believer to own Twitter shares today. Rather, you have to be borderline insane.

For bullish investors, I suggest you take a bit of money off the Twitter table. I understand the price of tulip bulbs has fallen to affordable levels since their peak in 1637.

I have no position in Twitter but will very likely short the stock in the near future if I see any sign this modern day example of the Dutch tulip bubble of the early 1600's has run its course.

Source: It May Be Time To Short The Twitter Bubble