Why Investing $100M in Twitter Isn't Crazy

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. [digg=http://digg.com/tech_news/Why_Investing_100M_in_Twitter_Isn_t_Crazy]

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 (s tivo), which saw revenue of $250 million in its last fiscal year, and Ariba (s arba), which made $330 million. Google (s goog) 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 (s twx) with AOL, eBay (s ebay) with Skype, Google with YouTube, News Corp (s nws) 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 (s vitc) — 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.