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3 Ways to Value Twitter’s IPO: From $20 Billion to Bust

Aaron Pressman
The Exchange

Twitter has finally announced plans to go public, though its formal filing was confidential, kicking off a frenzy of analysis, debating and, of course, tweeting over just how much the social-networking service is worth.

Twitter IPO tweet

No one wants to see another Facebook (FB) debacle. Amid trading glitches and secret, negative analyst views, Facebook shares dropped below their initial price of $38 on the very first day and dropped below $19 in late 2012. The shares only regained the $38 level last month, 14 months after the IPO, and are now trading at around $44.

But the biggest problem with Facebook’s IPO may simply have been the overvalued stock price given the company’s financial future as it could be forecast at the time. A company surrounded by unanswered questions on its mobile-advertising strategy probably should not have been priced at an overall $100 billion valuation.

So how much is Twitter worth? According to a recent leak, hedge funds were offering to pay $28 per privately traded shares recently, setting a $14 billion valuation for the entire company. Even without full financials, there are a few back-of-the-envelope methods to give the numbers a reality check.

The simple way

Without detailed financial statements, many analysts are groping with rudimentary valuation estimates based simply on revenue, the easiest financial metric to estimate.

Twitter will have revenue of about $600 million this year and a projected $1 billion next year, according to outside estimates.

A similar stock such as Facebook trades at about 18 times its estimated 2013 sales, according to FactSet. LinkedIn (LNKD) trades at 22 times sales and Yelp (YELP) at 23 times.

So using a simple measure of 20 times sales, Twitter could be worth $12 billion to $20 billion. SunTrust analyst Robert Peck used the revenue multiple method in a brief note on the Twitter IPO today, saying he expected the deal would value the company at about $20 billion.

Twitter's peers trade at less lofty valuations relative to their projected 2014 revenue -- 11 times for Facebook, 14 times for LinkedIn and about 13 times for Yelp. Topeka Capital Markets analyst Victor Anthony says on that basis, Twitter is worth closer to $14 billion.

The complex way

A lack of data from real life has never stopped Wall Street from trying to fill in the blanks and come up with more-complicated models.

Analyst Michael Pachter at Wedbush Securities tried to estimate Twitter’s revenue, expenses, and research and development costs to get at its profitability and future growth prospects earlier this year.

On the bottom line in Pachter’s model, Twitter could generate $230 million in profit on $1 billion in revenue. But because the service can grow without increasing its costs at nearly the same rate, almost half of additional revenue should flow to the bottom line. At $2 billion of revenue, profits would be $700 million.

That allows for the use of somewhat less-crude valuation ratios, such as a company’s total value after including debt and subtracting cash, known as enterprise value, compared to its earnings before interest, taxes, depreciation and amortization, or EBITDA.

Facebook trades at a ratio of 36, LinkedIn 159 and Yelp, still losing money, is off the chart, according to FactSet. Somewhere in the middle, at 100 times $230 million, Twitter could be worth $23 billion. At 50 times $700 million, it’s up to $35 billion.

Another way to assess the market value of twitter is to look at a publicly traded proxy. The GSV Capital fund (GSVC), which owns private shares of Twitter and other non-public tech companies, shot up 15% on Friday after news of the filing.

About 15% of the fund’s $250 million of assets were invested in private Twitter shares at the end of June. The fund valued the investment at $38 million, or about $20 per common share, implying a $10 billion value for Twitter.

To account for the jump in GSV’s stock price, the value of the Twitter stake would have to be about double the June 30 level, valuing Twitter at about $20 billion.

The hard way

Before investors get too carried away, remember that, for every super-sucessful LinkedIn IPO, there’s also a Groupon (GRPN) or Zynga (ZNGA) deal gone bad. Those social-networking duds tanked despite high-profile, high-hype IPO debuts.

Groupon, purveyor of the ubiquitous online discount coupons, went public in November 2011 at $20 a share and suffered through accounting investigations, slowing growth and a CEO firing. Its shares trade at around $11.50 today.

Online game maker Zynga, which went public at $10 a share around the same time, has suffered to adjust as more users go mobile. It trades around $3 today.

Twitter's confidential filing obscures any debates the company may be having with regulators at the Securities and Exchange Commission — the kind of debates that might have been a warning sign on the Groupon deal, for example. But there are a few other signs that Twitter may not be the next big thing for investors.

For one, Twitter’s growth in total active users has slowed this year, according to the AllThingsD blog. After hitting 200 million monthly active users at the end of last year, the company set a goal of doubling to 400 million this year. But the service only has about 240 million users currently.

Also, publishers using Twitter to build audiences for marketing new books have seen a dramatic slowing in the rate of growth of their followers. Twitter follower counts for 16 large and small publishers grew 31% in 2013, after more than doubling in each of the three previous years, according to a survey by Publishers Weekly.

Twitter has also sometimes struggled to break out of the nerdy niche. Everyone and their grandmother may be on Facebook but Twitter attracts a more limited crowd. Sure, the most followed rock stars such as Justin Bieber and Katy Perry have over 40 million followers and have issued multiple thousands of tweets. But the average user has just 126 followers and tweeted a total of only about 300 times.

Don't forget that GSV Capital held pre-IPO shares of FaceBook, too. The fund’s share price crashed along with Facebook when the IPO went south, though it later recovered.

Investors in Twitter would like to see a smoother climb.

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