All that twitters isn’t gold

On March 10, 1876, Alexander Graham Bell made the first telephone call — to his assistant in the adjoining room — uttering the immortal words, “Mr. Watson, come here, I want to see you.” On May 13, 1897, Guglielmo Marconi sent the first radio transmission across six kilometers of open sea, transmitting the equally stirring words, “Are you ready?” On March 21, 2006, at 9:50 p.m. Pacific Standard Time, Jack Dorsey sent the very first tweet containing the even more memorable phrase, “just setting up my twttr.” (The more observant reader might notice that the English language has evolved in the last 125 years to dispense with such frivolous items as capital letters, punctuation marks, and superfluous vowels — and is limited to thoughts profound enough to be expressed in 140 characters).

Twitter had an initial public offering of its stock in November, and the great reverence accorded to it by financial press would encourage one to believe that is an innovation as great as the telephone, the radio, and perhaps even sliced bread. It is hard to argue that Twitter has not made a significant impact on large sections of our society. By June 2013, there were over 200 million Twitter users active each month, of which almost 170 million were outside the United States

When U.S. forces raided Osama bin Laden’s compound in Pakistan, the first report to reach the West did not come from CNN, the BBC, or the Associated Press. It came via Twitter from a resident of Abbottabad. President Obama used Twitter to declare victory in the 2012 presidential election. Some have suggested that he should have used Twitter as a platform for people to sign up for the Affordable Health Care Act.

There were critics of the Twitter IPO process who said that the stock offering was not to the public but to a very select group of people and companies — unlike the Google IPO, which used a Dutch auction method, resulting in a broader distribution of shares. The initial share price of $45.10 gave Twitter a company valuation of over $25 billion. Sales revenue for 2012 was nearly $317 million, almost double the previous year. The only fly in this ointment is that Twitter has yet to make a profit. The company reported losses of $164 million in 2011, $79 million in 2012 and $69 million in the first six months of 2013.

Shortly prior to the IPO, The Wall Street Journal interviewed Anant Sundaram, a professor at the Tuck School of Business at Dartmouth. He stated that even with a valuation as modest as $8 billion (about one third of the actual first day valuation), Twitter would need to grow revenues at a compound growth rate of 30 percent per year for the next 10 years. Even at that growth rate, he estimated that 70 percent of the initial offering price would be attributable to cash flows extending way beyond the year 2024. Positive cash flow is what you get when you actually make a profit, so Professor Sandaram expects that Twitter will eventually find a way to have revenue exceed expenses.

If we assume that Professor Sandaram is correct, it would appear that Twitter must find many more customers and/or find a way of generating much more revenue from the existing customers. The discussions in the SEC filings about sources of revenue are a little vague. If the company is only able to generate the existing revenue per customer, then the professor’s prediction would require Twitter to have about 2.75 billion customers by the end of 2023. Now the United States Census Bureau predicts the world population in 2023 to be about 7.75 billion, so Twitter will have to capture as customers about one third of the entire population of the earth — including remote places with high birth rates and no cell phone service (perhaps that is why the birth rate is so high — with no cell phones, what else is there to do?)

Professor Sundaram talked of growth rates and future cash flows but offered little guidance about profits or from where those profits might arise. In fact, the official offering document filed with the SEC also offers a lot of hope but not much substance in this regard. The key measure of potential revenue and profit is described by Twitter as “the total number of timeline views per monthly active user (MAU).” I will attempt to translate that into English for those readers who went to school when English was still being taught. A timeline view is the long stream of tweets showing all those you have chosen to follow when you log on to Twitter. The company believes that “timeline views per MAU” is a measure of “user engagement,” which is defined in the SEC offering document as the “measure of our ability to monetize our platform,” That is IPO-speak for eventually making a profit. In the three months ending June 2013, this advertising revenue per timeline view was $2.17 in the United States and 30 cents in the rest of the world. With 85 percent of the active users outside the United States, that yields a weighted average of only 80 cents.

So why am I going on about this? The point is that the initial price of the stock does not represent the intrinsic value of the underlying business of the company, but merely the value of being an early owner of the stock of the company. The company itself stated “We do not anticipate declaring any dividends in the foreseeable future. Consequently, investors may need to rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investment.”

In a letter to Berkshire Hathaway shareholders in 2000, Warren Buffett said “The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute. They all plan to leave just seconds before midnight. There’s a problem though — they are dancing in a room in which the clocks have no hands.”

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