Twitter (NYSE:TWTR) IPO Infested with Risk

Brian Hicks

Written By Brian Hicks

Posted October 18, 2013

Twitter’s impending IPO is expected to catapult the microblogging company forward into a new era of expansion – but with huge net losses and a minefield of risks, is Twitter heading for trouble?

Twitter birds on a wire

In September, Twitter announced (in a tweet, of course) its intention to go public. Not long after, a minor frenzy occurred when people began erroneously sucking up shares of Tweeter Home Entertainment (OTCPK: TWTRQ) thinking it was Twitter’s new listing.

Though excitement is still high, Twitter’s S-1 filing with the Securities and Exchange commission revealed the company had doubled its annual revenue to $168 million, but also tripled its net losses to -$64.6 million. The filing also exposed a lot of the problems Twitter will face as it moves forward.

Huge Operating Costs

A major component of Twitter’s net loss is attributable to a significant increase in operating costs. Research and development and sales and marketing both enjoyed wide increases in investment, and the total cost of operations was $126.2 million in the nine months ending on September 2013.

Infrastructure, better known as the stuff that prevents users from seeing Twitter’s famous “failwhale” error page, also comprises a major part of Twitter’s ongoing costs. It takes a lot of muscle on the back end to handle billions of tweets per second, and the company promised to invest in infrastructure in all of its markets, regardless of their cash flow.

The S-1 Filing is worded as follows: “We expect to continue to invest in our infrastructure in order to enable us to provide our products and services rapidly and reliably to users around the world, including in countries where we do not expect significant near-term monetization.”

In other words, it costs a lot to run Twitter with little guarantee of income.

On Monetization

Twitter didn’t even begin to generate revenue until 2009, three years after it launched. What’s more, it only started to sell advertisements in 2010. Its history of monetization is short, to say the least.

Because Twitter is consumed mostly on smartphones and tablets, the company has to continually find ways to effectively monetize on different screen sizes and dimensions. If promoted products are not represented effectively, their performance drops.

Twitter’s S-1 filing revealed that its pay-for-performance “Promoted Accounts” and “Promoted Trends” are driving significantly less money on mobile than they are on desktop platforms.

“This has in the past reduced, and may in the future continue to reduce, the amount of revenue we are able to generate from these products and services as users increasingly access our products and services through mobile and alternative devices,” according to the company’s filing.

Facebook had it much worse than Twitter, with very little mobile revenue when it went public.  After a full year below its IPO price of $38 per share, Facebook is finally gaining steam as its mobile monetization kicks in.  The company’s fourth quarter report will reveal the degree to which its mobile ads are working.  If its system is effective, its shares will continue to grow.

Twitter, by comparison, already has its cards on the table.  Its promoted content model has underperformed. 

All the other risks

Money issues are just part of the overall Twitter landscape. The site can be adversely affected by a number of factors:

  • Competition: Improvements on other social media sites can draw power-users and celebrities away from Twitter and diminish its relevance.  While there has yet to be a service to upset Twitter as a public opinion ticker, tastes change rapidly when new mobile apps gain traction.
  • Failure to Iterate: If Twitter does not introduce new features as the demand for them appears, it can also experience an erosion in its user base.
  • Technical Difficulties: When connectivity, electricity, or the Twitter service goes down, so does its revenue stream. Likewise, if there is a security breach or compromise of the site’s integrity, it could bring the site down, or alienate users.
  • Overuse of Advertising: This is the problem faced by all ad-driven services. At what point does advertising become pollution and send users packing?
  • Spam/Abuse: Twitter certainly has a culture of its own, and a “spambot” account known as @Horse_ebooks became quite popular. The strange, fragmented tweets appeared to be scraped at random from other texts, and the result was often hilarious. It was later revealed that the account was an art project, and not a bot at all. The point, however, is that Twitter is capable of becoming a graveyard of low-quality junk tweets if there isn’t assiduous content curation.

Many of these risks boil down to the simple fact that Twitter’s value is identical to the value of all social networks. It is not in the service it provides, but in the people who use that service.  

With all these risk factors, and no clear answer to an effective monetization strategy, when the IPO debuts, I’m staying far away. 

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