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Success of Twitter’s Business Model Questioned Ahead of IPO

Kevin Chupka
Executive Producer/Writer

As the frenzy builds into Twitter’s (TWTR) IPO later this week there’s going to be a ton of talk about valuation. The company announced today that the pricing range has risen from $17-$20 to between $25 and $25 a share. The truth is no one really knows if the company is worth $3 or $30 billion in the next five years. Twitter’s ultimate value depends on a several variables, only a few of which are in the company’s control.

In the attached video Bob Peck of SunTrust makes the case that Twitter is a steal at anywhere near its IPO price. Citing ad revenues growing at 120% last quarter and his conversations with product marketing directors, Peck says Twitter is perfectly positioned to take advantage of huge surge of money into social media.

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Over the next few quarters Twitter would be hard-pressed not to rake in revenue almost regardless of what it does. According to Nielsen, ad spending on-line grew nearly 27% world wide in the first half of 2013.

It’s easy to extrapolate great things from that growth, but based on a report from Forrester released last week, not every advertiser is so thrilled. Forrester’s survey of 395 marketing executives found that they rate Twitter among the least effective ways to advertise. Worse still, the execs rated Twitter dead last in a ranking of “marketing partner satisfaction.”

Getting back to the sticky question of what Twitter is actually “worth,” Peck freely concedes Twitter isn’t going to get a free ride on industry ad growth forever. “Ultimately it will come down to effectiveness (of the ads),” Peck says. “If the effectiveness of the ads isn’t there you’ll see ad growth slow down.”

Figuring out how much effect ads have on buying patterns is as much art as it is science. What ad agencies do best is sell the value of advertising itself. Twitter needs to prove its ad space is valuable by objective measurements (click through purchases etc.) and become a better marketing partner in the eyes of product managers.

Related: Why Twitter's Valuation Will Soar Leading Up to IPO

If it can pull off those two feats and do so while continuing to grow its user base Twitter’s stock will prove to a be a steal. If it fails on any of those fronts Twitter’s stock will share the same dark fate as Zynga (ZNGA) or Group-On (GRPN).

The reality is Twitter is almost certainly mispriced. It’ll take about a year before we know whether that means the stock is cheap or wildly overvalued.

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