The big value of Twitter's little bird

Twitter's IPO valuation will come down to the intangible premium investors are willing to pay to avoid missing the next big thing. But close analysis indicates a tight target range for the float.

Twitter has started the process of an initial public offering, but there is a lot we don’t know about the financials behind the company and its present position.

Is Twitter profitable? If so, how profitable? If not, how far from profitability? How much cash does it have on hand presently? How much will it be looking to raise? And the biggest question of all: what amount will the IPO value the company at?

Initial reports suggested that Twitter would be seeking a valuation in the vicinity of $15 billion. However, the valuation of well hyped, large-scale digital companies is something that is generally far from standard or scientific. It’s generally illogical and confusing.

This is made more complex if the company is experiencing rapid growth or lacks a historical precedent of profit over an extended period. Twitter fulfills both of these conditions. What metrics are there for those wanting a bit more insight into the likely IPO valuation to look closely at? And what can be determined from the past IPOs and current valuations of similar companies, like Google, LinkedIn, Facebook, Zynga and Yahoo?

Looking primarily at revenue, earnings before interest, taxes, depreciation and amortisation, users and ARPU (average revenue per user) can provide some pretty good insight into what Twitter may deem the market is willing to pay. Of course, institutional investors with access to confidential S-1 information will have deeper insight into forward projections, strategic plans and more granular information around revenue and costs.

However, past IPOs in this sector have taught the market that they are much less about the tangible value of these companies and much more about the intangible premium investors are prepared to front up to avoid the financial fear of missing out around the next big tech thing.

While Twitter revenue numbers are presently unknown, the most widely used estimate of the company's likely 2013 revenue comes from eMarketer. They have estimated Twitter will bring in $582 million this year. In the absence of profit or EBITDA, many technology investors will look at top-line revenue as a way of working out a valuation through valuing a company at a multiple of its present revenues.

Based on revenue over a 12-month period ending June 30, comparable companies are trading at the below:

Google - 5x (Revenue = $US55.79 billion, Market cap = $US296 billion)

Zynga - 2x (Revenue = $US1.093 billion, Market cap = $US2.48 billion)

Yahoo - 6x (Revenue = $US4.82 billion, Market cap = $US29.85 billion)

Facebook - 18x (Revenue = $US6.11 billion, Market cap = $US107.9 billion)

Linkedin - 26x (Revenue = $US1.24 billion, Market cap = $US32.56 billion)

Source: Capital IQ

As you can see, revenue multiples vary wildly, from 2x for Zynga to 26x for LinkedIn. If Twitter was to be valued at a comparable revenue multiple to Yahoo or Google, it would fetch a valuation on IPO around the $3-3.5 billion mark. This is highly unlikely, Twitter was valued on the private market at around $10.5 billion less than 12 months ago. If Twitter commanded the same revenue multiple of LinkedIn it would IPO at around $15.1 billion. On Facebook’s 18x multiple a $10.5 billion valuation results.

Revenue is one way of looking at potential value, but EBITDA is generally more preferred by technology investors. It is unknown whether Twitter is generating positive EBITDA. Based on the $582 million forecast for eMarketer it is unlikely this would be anything meaningful (ie. north of $100 million). Even assuming Twitter was generating $100 million in EBITDA would most likely result in a valuation below the company’s present valuation, based on the below EBITDA multiples:

Google - 17x

Zynga - 15x

Yahoo - 23x

Facebook - 39x

Linkedin - 205x

Source: Capital IQ

Using Facebook’s 39x EBITDA multiple as a guide, Twitter on EBITDA of $100 million (hypothetically) would be worth $3.9 billion. The only way it could generate a higher valuation using this method would be to mirror LinkedIn’s astronomical 205x multiple, which would value the company around $20.5 billion.

Admittedly, looking at a present revenue and EBITDA numbers is unlikely to present a clear case on the likely IPO valuation of Twitter. We might be better off looking at things a bit differently.

ARPU is a favoured acronym of many digital publishers — average revenue per user — and is a metric that is used by the market to get an indication of whether a company is growing users as well as growing yield. For most digital businesses, ARPU is extremely low when compared to TV and offline media.

For instance, a TV network like Channel Seven will generate annual ARPU of approximately $A80 per viewer, whereas a business like Facebook will generate ARPU for the same period of $US5.30. For Seven, the figure refers to Australia only while for Facebook it’s a global figure (and will be weighed down by less developed markets such as Asia and Africa). However, the $US5.30 for Facebook is relatively in line with similar numbers for Yahoo! ($6.03), LinkedIn ($5.53) and Zynga ($4.71). Google is in another league, with estimated ARPU at $US42.92 annually.

On Twitter’s 2013 eMarketer estimate, and its own claims of 240 million users, Twitter is generating an annual ARPU of $US2.43, less than 50 per cent of Facebook and less than 90 per cent of Google. One could see this as a shortfall of Twitter’s revenue potential, or a sign that Twitter hasn’t really focused too much on ad sales or ad products and as a result has significant upside. The market will determine that the latter is most likely the reason and, as a result, investors have a reason to be bullish about Twitter’s growth prospects.

Forecasts for 2014 and beyond will shape the Twitter valuation. If Twitter can grow at its 2013 level of around 20 per cent in 2014 to 290 million users, and increase ARPU from $US2.43 to $4, it will most likely eclipse $US1.1 billion in revenue for 2014. $1.1 billion is an almost 100 per cent increase from 2013, however it should be noted that this number implies that Twitter will still generate ARPU significantly lower than its peers and also involves a very conservative growth estimate of 20 per cent.

With $1.1 billion in revenue, if Twitter followed Facebook’s current revenue multiple of 18x it could seek to IPO at a value of $US19.6 billion. It is reasonable to assume that Wall Street will view Twitter and Facebook as similar businesses with similar upside - both are social networks, both rely presently heavily on advertising revenue, both have strong data troves on their users and both have ambitions to use this data to power advertising on sites external to their own platform. On top of this, both are trying to play nice with established media - in particular TV - which both view as integral to maintaining engagement and value with users and advertisers.

Investors valuing Twitter based on a reasonable estimate of its 2014 revenues using Facebook’s current revenue multiple is a likely scenario. For one, valuing Twitter on any reasonable EBITDA or price to cash flow multiple will not present a valuation above its present private market value and will not appease present investors, who fear it is undervaluing the company and its prospects. Twitter has seen 100 per cent revenue growth over the past three years and is likely to experience the same outcome in 2014, which puts it in very exclusive company.

Google's annual growth is around 20 per cent, Facebook's growth is closer to 40 per cent and LinkedIn around 32 per cent, which means Twitter represents one of the few digital media players offering stratospheric growth, albeit off a relatively low base. That is highly appealing. It is also important to point out that the past three-month period has been very good to Twitter’s social peers: Facebook's stock has risen 88 per cent over that period, LinkedIn 49 per cent.

Between $US17.5 and $US19.6 billion is my prediction for Twitter’s desired IPO valuation and the figure it will be shopping around to institutional investors. When it comes to technology company valuation it is less about a fair and reasonable price and more about testing the limits of what a hungry market is willing to bet on riding the next big thing.