Many investors are still captivated by Twitter (NYSE:TWTR), even three months after its IPO. Shares doubled on its IPO debut, with much of the media rushing to call the stock overvalued.
But that's the thing about high-tech IPOs, especially those that are momentum plays. Shares told Mr. Market to "get lost" and continued their trek to nearly $75. Now we're back down to $47. After the first quarter earnings report, the stock tumbled. Investors scurried for the exits after hearing that growth came in below expectations, and might actually be slowing. And in the world of high-tech, users are the holy grail.
Although Twitter is still the youngest of the Big 3 social networks, founded in 2006, while LinkedIn (NYSE:LNKD) was founded in 2003 and Facebook (NASDAQ:FB) in 2004, early adoption in the U.S. might be plateauing. There's no secret there.
Here's where many investors get Twitter wrong. Twitter's value isn't in its user base alone. It's all about engagement -- the number of users engaging with ads.
Twitter's competitive advantage in less than 140 characters:
Twitter has an average user base that's, by age, older than Facebook. This older userbase is much more inclined to engage with ads.
Facebook's core audience, percentage wise, is 18 to 24-year-olds, while Twitter's is 25 to 34. By 2018, the 35 to 44-year-old demographic will match the number of teens using Twitter. For Facebook, the percentage of teens using the site outpaces 35 to 44-years-olds by some fifteen percentage points. Marketers will flock to the platform getting engagement results. Older people deliver results.
That kind of reach is very appealing to marketers.
How do we drive engagement though?
Great question. Keeping the platform "fresh" is the first step. Twitter's complete redesign earlier this year is a welcomed re-fresh, even for yours truly. And on the other side, it's not just about making the platform more user friendly, but also more effective for marketers.
The notion of the "second screen" is a powerful concept. Twitter is quickly becoming a platform for commenting and interacting about TV in real-time. There's tremendous value here for advertisers here. Advertisers can directly target TV conversations happening on Twitter, tailor their ads to specific audiences, and insert commercial messages in the middle of a Twitter user's timeline.
And whenever someone says, "but the valuation..." I always remember that in the near term the market is a voting machine. The near-term can be a five- or even ten-year window, however.
Once Mr. Market can digest the fact that a slowing user base isn't necessarily a bad thing, and that a maturing user base is a positive for revenues, I'd look for more consistency and clarity in analyst estimates. For now, the fact that the highest 2015 analyst revenue estimate is 50% above the average, and the lowest is 20% below, gives me little reassurance that Wall Street can do a better job at predicting the numbers than my local Starbucks' barista.
As analysts wrap their heads around Twitter, it'll be a race to the voting machines. And just like the days of sustained periods of trading at over 300 times earnings for Netflix (NASDAQ:NFLX) and Amazon (NASDAQ:AMZN), Twitter's valuation will become even less relevant.
Twitter might still be the bargain of the class of 2013 IPOs.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.