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Analysis: How to play TWTR without being a twit – USA TODAY


Tim Mullaney, USA TODAY
9:20 p.m. EDT October 3, 2013

The quality of Twitter’s newly released financial information is such a mishmash that even grizzled financial writers are willing to borrow a trick from Sex and the City, where each episode was built around a question that anchored the weekly column of its heroine Carrie Bradshaw.

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In this case, the query of the day: How do I play Twitter’s initial public offering without looking like a twit?

The answer is found in the four great fundamentals of any savvy IPO investor:

1. How fast are the company’s sales growing in an already large and promising market?

2. Is this timing right for this company to do an IPO? The best time for an Internet company to go public historically has been right around the time it turns profitable — give or take. The biggest part of the risk is behind the company and there’s enough upside potential to make things interesting.

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3. The so-called “does it scale” question: Is the company growing its profits faster than it’s growing its sales (including any needed dialing back on research and development, marketing and overhead)?

4. Is the valuation reasonable?

Look, the twit would be the investor who doesn’t realize that Twitter will be a hot deal, regardless. Even if the company commands less than the $14 billion valuation it reportedly seeks, Twitter is quite likely to raise $1 billion or more at what would be a nosebleed-inducing price-to-earnings multiple for nearly any other company.

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But to keep from getting burned after the IPO hoopla subsides, investors need to do their homework. So here are some answers:

1. No doubt Twitter is growing fast — though, it must be said, not quite as fast as it once did. Revenue rose 107% to $253.6 million in the first half of this year. But in 2012, sales nearly tripled and almost quadrupled in 2011. Analysts predict the company can grow revenue about 70% in 2014.

The social-media ad market where Twitter can make money is vast but not infinite. My colleague Scott Martin cites experts who forecast 25%-a-year growth through 2015. Attention-getting but also worth acknowledging that the days of slowing growth for Twitter are on the horizon.

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2. Few will argue that Twitter’s timing is off. Though many research reports will focus on Twitter’s net income losses, savvy investors know to look at the social media giant’s cash flow because it doesn’t include expenses like depreciation, which matter more to the accountants than to hot-IPO investors.

Twitter’s operating cash flow turned positive in the first half of this year and on that basis, the company turned a $9.66 million profit vs. a $23 million loss in the same period a year ago.

It means the company is at a tipping point where fixed expenses are at last covered by revenue and prospective users will drive improving profit margins. That margin expansion is what allows investors to invest in IPOs with very high P-Es and get a good night’s sleep.

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3. Whether Twitter “scales” is not a given. Revenue gains year to date are outstripped by a 141% jump in R&D spending, which accounts for 44% of revenue. Its marketing budget is also growing 20% faster than its revenue though other overhead costs appear to be in check.

If Twitter can justify the what and the why of growth in R&D and marketing and more importantly show the increases are temporary, concerns can be allayed. However, it’s not certain that it is temporary, especially if ad spending growth in this space decelerates as forecast.

4. That begs the most important question — valuation. If Twitter hits $1 billion in revenue in 2014, the company may be asking investors to pay a forward P-E of 14. For comparison sake, Amazon.com’s forward P-E is about 1.5. Salesforce.com is at 6 and Facebook is getting 12 but is far more profitable than Twitter. And the stock price of all of these companies wouldn’t be considered cheap.

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The bottom line: You can say you owned Twitter early but nearly all Internet IPOs that become the success stories to which Twitter aspires have endured painful post-IPO woes that have hammered the stock for a while.

Investors who paid up at the outset become unforgiving if a company’s quarterly earnings miss the mark or it fails to capitalize on some market opportunity quickly enough. At a $14 billion valuation, Twitter’s stock price will be just as vulnerable as Facebook’s was for many months after its May 2012 IPO.

If you’re a long-term investor, Twitter is on pace to earn $1 billion dollars in revenue as expected and questions about how fast profits grow and for how long are normal.

Twitter’s a hitter, with a business that –well, almost– matches its unique cultural sway and its over-the-top hype. Yes, dear Carrie, baby can definitely afford that pricey new pair of shoes.