Twitter is finally going public, and its shares are expected to trade between US$23 and $25 on the first day of trading. That means the company could be valued as high as US$14 billion on day one. Investors may be wary of such a high valuation considering all the uncertainty surrounding the company’s business model and future prospects. I’m actually quite comfortable with Twitter at these prices, however. I think there’s a good chance the company will be worth US$50 billion in five years. Here are five reasons why: 1. It’s already at scale. Twitter has become very big, very…
Twitter is finally going public, and its shares are expected to trade between US$23 and $25 on the first day of trading. That means the company could be valued as high as US$14 billion on day one.
Investors may be wary of such a high valuation considering all the uncertainty surrounding the company’s business model and future prospects. I’m actually quite comfortable with Twitter at these prices, however. I think there’s a good chance the company will be worth US$50 billion in five years. Here are five reasons why:
1. It’s already at scale.
Twitter has become very big, very fast. The platform has delivered more than 350 billion tweets since inception. What’s more, its more than 230 million monthly active users (MAUs) tweet a billion more every two days. And the platform continues to grow, MAUs increased 39% in the third quarter.
We shouldn’t be surprised by how quickly Twitter usage has grown since hitting a critical mass of users. The platform is easy to use. And once you pick up a couple of key pieces of the Twitter vocabulary, anyone can join the billions of conversations happening all over the world.
Speaking of the world, Twitter is a global company. Nearly 200 million of its MAUs are outside the United States and grew 41% last quarter. As more people flock to Twitter, I expect the company to one day report the platform generates one billion tweets per day.
2. Twitter’s writing the next chapter of the online advertising playbook.
Google (NASDAQ: GOOG) established a new paradigm in advertising: the keyword ad. As more and more people gravitated to Google’s search engine, marketers followed, bidding for placements in the results. Last quarter, 84% of its US$14.9 billion in sales came from advertising, a staggering figure indeed.
The keyword ad is going to stay relevant for a long time. But Twitter, Facebook (NASDAQ:FB), and LinkedIn (NYSE: LNKD) are writing the next chapter of the online-advertising playbook using the social ad. The social ad is a form of content marketing that is growing as a result of all the conversations happening on Twitter, Facebook, LinkedIn, and in many other places.
It’s a very simple. Marketers create and distribute “relevant and valuable content to attract, acquire, and engage a clearly defined and understood target audience.” The end game is to drive “a profitable customer action,” but the social realm can do so much more. On Twitter, its Promoted Products can build awareness, association, preference, and even direct actions. They are going to be a huge force in online advertising.
3. Twitter has an established place in the marketplace.
If you’re a little nervous about Twitter going up against Google, Facebook, and LinkedIn, don’t be. First, marketers spend more than US$500 billion annually on advertising. So there’s plenty of room for everyone, especially if you’re differentiated from the competition.
Fortunately, Twitter has established its territory in the marketplace. Facebook may know what you “like,” but Twitter knows what you’re interested in — in real time. In fact, Twitter generates an ever-shifting Interest Graph for its users depending on what they’re talking about and who they’re connected with.
Remember the definition of content marketing I gave you above? The Interest Graph is exactly what marketers need to bring valuable and relevant content to a target audience. That’s why marketers have ramped up their spending at Twitter.
In 2012, the company generated US$317 million of revenue. In the first nine months of 2013, revenues have grown to US$422 million, up 106% from the previous nine-month period. Just like with Google’s keyword ads, marketers know a good deal when they find one. And they’ve found one at Twitter.
4. Monetisation is just beginning.
Twitter has staked its claim as a real-time communication leader and a content-marketing specialist. Now the company has focused its attention on monetising its assets. And as I showed above, its opportunity is huge.
We are still in the early stages of the social-advertising trend, giving Twitter, Facebook, and LinkedIn plenty of room to grow going forward, especially on mobile devices. Facebook COO Sheryl Sandberg recently said that, “Today mobile represents 12% of consumer media time, but it’s still only 3% of ad budgets.”
What we will see is that, over time, ad budgets will follow the eyeballs. With 76% of its engagement and 71% of its revenue coming from mobile, Twitter is well positioned to grow as more marketers allocate more dollars to social ads on mobile devices.
The company only started generating revenue in 2010, waiting for the platform to attract users and get to scale before thinking about generating revenue. That may seem daunting to some investors, but to me it was a great strategy. It allowed the company to build its first-mover advantage and strengthen its network effects.
Its revenue model is very straightforward: It’s based on the number of monthly active users, how often those users view their timelines, and how much Twitter can charge advertisers per 1000 timeline views. In the third quarter, Twitter averaged 232 million MAUs, up 39%. Timeline views per MAU increased 8% to 685, and ad revenue per 100 timeline views increased 49% to $0.97. Those are all moving higher, foretelling more revenue going forward.
5. Twitter can expand in many directions.
Today, Twitter generates its revenue from two sources: Promoted Products and data licensing. Promoted Products include Promoted Tweets, Promoted Accounts, and Promoted Trends: Promoted Tweets are ways advertisers can interact with users directly. Promoted Accounts help advertisers build their following. And Promoted Trends make users aware of things that are happening which may be relevant to them.
As we saw above, these products are attracting incredible attention of marketers. Although I don’t expect Twitter’s sales to grow more than 100% for much longer, there’s good reason to believe the company’s sales will grow at a fast rate for quite some time. The proliferation of mobile devices is the first catalyst. Analysts expect 1.1 billion smartphones and tablets to be sold in 2013. They expect that number to jump to 1.9 billion in 2017. That means more users coming to Twitter to create and digest information on their mobile devices.
As more people become comfortable using Twitter, timeline views should continue to rise. The company will be able to use the data collected to fill out more Interest Graphs, which will enable marketers to create more relevant and targeted advertising. That should lead to higher returns of investment for those advertising dollars, causing more marketers to come to Twitter — thus bidding up the prices required to place ad.
I will end this section with a simple question highlighting growth options to consider in the future: What if the platform could facilitate commerce?
Putting it all together equals multibagger.
Here’s where Twitter stands at the end of the third quarter of 2013.
– Users: 232 million monthly active users.
– Engagement: 685 timeline views/MAU.
– Ad spending: US$0.97/1000 timeline views.
Putting all of that together, Twitter generated about US$154 million of ad revenue per quarter. It also generated US$15 million of revenue from data licensing, for a total of US$169 million, up 105%.
But the question is, “Where can Twitter go from here?” Over the next five years, it’s very possible that Twitter could have:
– Users: 575 million monthly active users, up 20% per year
– Engagement: 875 timeline views/MAU, up 5% per year
– Ad spending: US$2.50/1000 timeline views, up 21% per year
Let’s put those figures and growth rates in perspective. In five years, Twitter would have less than half the numbers of users that Facebook has today (1.19 billion). Remember, the number of users grew 39% last quarter. Twitter’s ad revenue per 1,000 timeline views rose 49% last quarter, with the international contingent rising 112% from US$0.17 to $0.36. By comparison, prices ended at US$2.58 in the United States, up 50%. What we’re seeing at Twitter, and many other companies, is that marketers are becoming more comfortable with online and mobile advertising in social media. Prices will continue to rise, as long as those ads remain effective.
According to S&P’s Capital IQ, analysts estimate that Twitter will generate US$4.1 billion in revenue. I think that could be low, as the numbers above show Twitter could generate over US$5 billion in annual ad revenue. As revenue increases, margins should increase quickly. Twitter is spending a great deal of money today to build its infrastructure and develop new products for users and customers. Those costs should fall as a percentage of revenue, making the company very profitable in the future.
Twitter will remain one of the most important global communication platforms. And as its network grows and becomes more profitable over time, the market is very likely to give the company a high EV/Sales multiple. We can look at the early years of a strong, profitable network like eBay for a comparison. So I wouldn’t be surprised to see an EV/Sales multiple of 10. Yes, that’s high. But it does not include the data licensing revenue segment, nor does it account for the commerce potential I mentioned above. Hence, the multiple could be lower.
Don’t get me wrong. An investment in Twitter comes with risks. But I think it is a company that investors should own, even if it’s only a tiny piece of their portfolios. Yes, that’s right. I will be an early buyer. Twitter is changing the way we communicate. It has an incredible tailwind behind it and a management team that wants to strengthen and grow the platform over time. I look forward to holding my shares for many, many years.
Discover The Motley Fool's favourite income idea for 2013-2014 in our brand-new, FREE research report, including a full investment analysis! Simply click here for your FREE copy of "The Motley Fool's Top Dividend Stock for 2013-2014."
A version of this article, written by David Meier, originally appeared on fool.com.