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Summary:

Raising $100 million is newsworthy for any company, but when it happened to Twitter this week, it also seemed to raise a hundred million eyebrows. Most notable was the company’s $1 billion valuation, which was labeled “exospheric” and “a new manifestation of the dot-com bubble” and […]

goodies_birdRaising $100 million is newsworthy for any company, but when it happened to Twitter this week, it also seemed to raise a hundred million eyebrows. Most notable was the company’s $1 billion valuation, which was labeled “exospheric” and “a new manifestation of the dot-com bubble” and invoked numerous comparisons to 1999 — aka, the Year of Investing Dangerously. But are Twitter’s new investors really crazy? Not at all.

The skeptics have a point: From the perspective of fundamental analysis, there’s no rationale here whatsoever. The private investment valued Twitter at the same $1 billion as the public markets have accorded companies like TiVo, which saw revenue of $250 million in its last fiscal year, and Ariba, which made $330 million. Google is trading around seven times its revenue — using that ratio, Twitter should be raking in about $140 million annually.

As is often pointed out, Twitter has yet to make a dollar, and may not do so by the time we reach the end of 2009. Meanwhile, the company is facing a series of tech glitches, slowing traffic and a reluctance among mainstream users to embrace it as they have Facebook. With $100 million, Twitter, which employs 60 people, can hire another 500 and pay them $75,000 each for the next two-and-a-half years. By then, surely one of them will have figured out a way to make a buck.

But Twitters’ new investors have at least two options. The first, of course, is getting Twitter to make money, which isn’t beyond the pale. There is evidence that Twitterers are for some reason more likely to click on an ad, and if that doesn’t work Twitter can just buy one of the companies that makes money through its service. The harder part is making a profit and keeping it growing.

That may or may not happen in the next few years, which brings us to the investors’ second option. A cynical one, in my view, since it relies on the greater fool theory, which says that you can ignore fundamental analysis as long as you sell out at a higher price to someone even more reckless with their money than you are. The last decade has seen many tech and media giants all too happy to play the greater fool: Time-Warner with AOL, eBay with Skype, Google with YouTube, News Corp with MySpace. Even when the acquired company started churning out a profit, it was often too puny to justify the sale price.

The buzz around Twitter is so loud, and media companies are so awkward about using social media that they’ll jump at the chance to buy the startup and make it their own. But if past is prologue, here is what’s likely to happen: A rival (Facebook, Google) will find a way to steal market share from Twitter. Twitter will poke around for potential buyers, likely a media giant that has more cash than it does instinct for social media. Twitter’s new owner will plaster the service with ads, alienating longtime users and shrinking its market share even more. By then, Twitter’s early investors will have cashed out.

In the meantime, the Twitter investment does not herald another tech bubble. The IPO market is shifting into a higher gear this week, but valuations of tech IPOs like Vitacost.com — an online retailer trading at two times revenue — are nowhere near the insane levels of 1999. Similarly, as PricewaterhouseCoopers and the NVCA noted recently, venture investments in 2009 will be on par with those of 1996, well before the dot-com bubble. Twitter may be a one-company bubble, but that doesn’t mean it’s a regrettable investment.

At least not right now.

Image courtesy of Twitter.

  1. Here’s the real issue that I find distasteful having been in this industry for 15 years and having two exits under my belt: Twitter is being sold as “real-time search” AND a “social network”. It’s neither. It’s just a micro-blogging system and a communications platform. That’s it. I am not saying that it is without value, quite the contrary. Anything with millions of users has some value.

    The billion dollar valuation is all about a VC in NY with a sub-par reputation trying to regain some mojo. Twitter just happens to be the vehicle. None of the top tier firms would have led the round which is why we ended up with a firm that no one on the east coast *ever* thinks about.

    1. It’s a platform which gets many eyeballs which advertisment can be sold against. If I start a website that is called “The Nothing Website” which is nothing but white background and absolutely does nothing but extracts 100 million eyeballs, that site is worth a lot of money. Here’s the real world. Valuation is based on the value it brings in no matter what it is. It’s all about creating a platform.

      1. twitter backgrounds jojo Sunday, September 27, 2009

        Agreed. It’s all based on how many eyeballs you get and what you do with it. You have to get creative to sell the space to make more money out of it.

      2. “But are Twitter’s new investors really crazy? Not at all.”

        Kevin, you will be eating your words next year same time..It’s not prophecy, it’s common sense… ;-)

    2. “It’s just a micro-blogging system and a communications platform.”

      Yep, that’s it allright. AOL bought ICQ. What became of that $280,000,000 cash purchase? Nuttin Honey.

      IMO there WILL be many winners as a result of what the brilliant people at Twitter have created. The rub maybe that the real winners may not be the Twitter folks. I’m cool with that.

      But I suspect they will demonstrate the same kind of vision they did when they decided not to focus on monetization earlier than coventional wisdom dictated. They will witness new opportunities as they become available, or they may even create them. But when that happens I think they will take advantage with a success rate that will surprise many.

      It will be interesting.

      Pass the popcorn..

  2. ” From the perspective of fundamental analysis, there’s no rationale here whatsoever”

    On the other hand investing $100m in Spinvox was completely rational… o.O

  3. I wrote a piece yesterday entitled “Why Would Any Rational Person Invest In Twitter At A $1 Billion Dollar Valuation?” that I think adds some additional perspective on the Twitter funding. You can read it here: http://www.uniquevisitor.net.

    In a nutshell, if you didn’t participate in this round you’ll probably never get a chance to invest unless and until they go public. And btw, can we please move beyond the “but Twitter isn’t making any money yet” nonsense? It’s boring and tiresome.

    1. >In a nutshell, if you didn’t participate in this round you’ll probably never get a chance to invest unless and until they go public.

      Yep. For most people, that pretty much sums up all venture investments.

  4. The valuation from my point of view is irrelevant – it’s just what those investors agreed to pay – might be a good or bad bet for them. What *is* important is twitter raising $100million – which is an awesome some and gives the company a great shot at staying independent (possibly even for good and innovating) – something that wouldn’t happen if they had sell out.

    And if someone is offering to buy in a $1 billion – take their money!

  5. Agree with Steven …

    I hate perfectly good companies loosing their sanity, direction and purpose in this mad mad game of valuations. Skype IS fundamentally a great product and company. Who cares how much its worth. Its for a stock market to decide. When they sold out based on some crazy game of who is a bigger fool they lost strategic direction. I think they finally have a little direction but its in a way too late,

    Even facebook has been subjected to this unending search for their true worth. But I do like Facebooks IPO focussed strategy. In the end they are in for the long haul.

    Twitter too is fundamentally a great product and company. I am sure It will find a way to make money and be profitable. However I hope that this mad game of fools valuation does not catch up with them. By delaying the search for A revenue stream they are letting people put mad figures on their head and thus the ridicule…

  6. Om,

    I think the question of valuation is irrelevant (although plenty are happy to debate it). The market decides, and as real estate goes, it’s about location, location, location. Twitter is prime real estate.

    The larger question is why raise $100M (besides, that you can), when it sets extreme expectations as companies feel pressure to live up the dollars invested, can pollute the clear heads of founders who risk starting to believe their own PR, and can adversely impact company culture.

    The only rationale that I could come up with is that this financing makes sense if one assumes that Twitter’s plan is to roll up the choicest portions of the third-party twitter ecosystem into their core (through M&A); refine their API approach to this newly aggregated/federated platform; and then cultivate a deeper, richer ecosystem around same.

    Then, when the tree needs a good “pruning” again, they can start the M&A process anew.

    If interested, I blogged on this one in a post called:

    Twitter Financing: Pruning the Garden with $100M Shears
    http://bit.ly/1902st

    Check it out and let me know if the thesis resonates or not.

    Mark

  7. Oops, sorry, Kevin. I saw a tweet from Om on this, and then neglected to read who actually wrote the article.

  8. @Kevin All due respect – I couldn’t disagree with more regarding your prognostication about Twitter’s likely future. Where’s the analogous example for your “past is prologue…” reference? I think you’ve missed the point completely.

  9. Jeff,

    By past, I meant the big buyouts in the previous paragraph. Those big deals have a pattern, where either the parent tries to boost revenue (MySpace) and chases away users, or preserves a business model that doesn’t make enough money to justify the purchase price (Skype). You are certainly free to disagree, I am just presenting my view.

  10. Kevin,

    I was referring to the “Twitter’s new owner will plaster the service with ads…” portion of your piece. The 3 companies that you cite other than Skype are at their cores destination sites. They are places whereas Twitter is a pipe.

    Besides that, I think Evan’s experience with Google after he sold Blogger to them will prevent the scenario you suggest.

    But thanks for checking in – much appreciated.

    1. I think it depends less on the founders of these companies than on the acquirer. Google/Blogger is a positive example, but look at Yahoo and Flickr – the founders have moved on and this week we saw Yahoo make some moves that angered longtime users.

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