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(KACPER PEMPEL/REUTERS)
(KACPER PEMPEL/REUTERS)

STRATEGY LAB

Invest in Twitter? Why 140 characters may be worth $15-billion Add to ...

Chris Umiastowski is the growth investor for Globe Investor’s Strategy Lab. Follow his contributions here and view his model portfolio here.

Should you buy Twitter stock when its long-awaited IPO finally happens? If it ends up being priced around $30 (U.S.) a share, I personally would be quite interested.

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This is not – repeat, not – a recommendation for others to follow suit. In particular, if you can’t stomach volatility, steer clear.

Twitter could drop like a stone, and there is no assurance the share price will ever climb above its IPO level. That’s what social media stocks are like.

So why am I interested? One reason is that Twitter is not a fad. It’s genuinely useful. And useful innovations generally find a way to make money.

An example of its usefulness came on Thursday night, when Twitter finally released the preliminary prospectus for its stock offering. A few years ago, if I had been looking for opinion pieces on a hot IPO, I would have headed to Google to search for them.

Not this time. It was far easier for me to find stories and comments about the Twitter IPO on Twitter itself. Searching Google was frustrating in comparison.

Like me, lots of other people now find Twitter to be invaluable. And that’s why I think the company stands a very good chance of building a powerful advertising business on top of its social media service.

For now, much remains unclear. The prospectus doesn’t tell us how much money Twitter plans to raise, or at what share price. Observers are guessing that Twitter will aim to raise about $1-billion (U.S.) at a share price that would value the entire company at around $15-billion. By my reckoning, that would involve pricing the shares at about $30 each.

To get a handle on what that means, let’s look at the numbers we do have.

Twitter was launched in 2006, and has grown to 215 million monthly active users. According to the prospectus, it took in $253.6-million in revenue in the first half of this year.

The growth rate of that revenue has been impressive. Sales tripled in 2012 compared with 2011, and in the first six months of 2013 they doubled again versus the comparable period in 2012. This gives me confidence that Wall Street is being realistic when it estimates 2014 revenue in excess of $1-billion.

Now, there are obvious challenges ahead. The biggest is that Twitter is losing money – nearly $70-million in the first half of this year alone.

I’m not that worried, though. To me, Twitter’s losses reflect a well-reasoned decision to put growth ahead of profitability for now. So it has expanded its work force tenfold since January, 2010, to help fuel that growth. (It now has about 2,000 people on staff.) If Twitter surpasses $1-billion in revenue next year, I believe the company will be materially profitable.

Of course, hitting $1-billion in revenue means the company has to continue its pell-mell expansion. Many observers worry that the growth rate of Twitter’s user base is slowing. It expanded 44 per cent in the past year, a big drop from 78 per cent the year before that.

But people who are obsessing over this seem to forget that it’s a natural result of getting very large. By any standard, 44-per-cent growth is still remarkable.

Considering how easy it is to set up a Twitter account, and how important the platform has become as a source of breaking news, growth should continue at a double-digit rate for quite a while.

Twitter has less than 10 per cent penetration among the world’s 2.4 billion Internet users, so there is plenty of room for expansion.

There is also plenty of room for increased profitability. Twitter is early in the process of turning its millions of users into money, and I’m sure it’s working on rolling out advertising features and new ways to sell data about its users. For now, it’s focused on testing ad products in the United States before bringing them to other countries, so international ad markets remain nearly untapped. But all of that is likely to change over the coming years.

Let’s look forward. Even assuming that the growth rates of the past couple of years taper a bit, I think Twitter could reach $2-billion in revenue in 2015. If so, that could result in a $500-million annual profit.

Suddenly a $15-billion market capitalization doesn’t seem insane. It would value the company at about 30 times 2015 earnings. That’s high, but Google also looked expensive when it went public in August, 2004, with an initial market capitalization of about $23-billion. Nine years later it has been one of the top performing S&P 500 stocks.

 
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