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Twitter's IPO an Investment in Constant Change

NEW YORK ( TheStreet) -- Amazon (AMZN - Get Report), Google (GOOG - Get Report) and even Facebook (FB - Get Report) have far different business models from when they each went public, and those considering the shares of Twitter should expect the same as the micro-blogging site looks to sell $1 billion in stock to public investors.

Twitter's IPO documents, released late on Thursday, paint the picture of a fast-growing media powerhouse that sits at the confluence of news and advertising. While the San Francisco-based company now boasts annual revenue that is likely to exceed $500 million this year, cash flow and profits on a measure of adjusted earnings before interest, taxes, depreciation and amortization (EBITDA), Twitter's business model nevertheless faces tremendous uncertainty as a stock listing looms.

The company generates 87% of its revenue from advertising on its network and, in particular, three sources: Promoted Tweets, Promoted Accounts and Promoted Trends. Advertisers are clearly interested in the platform. Twitter said in its IPO filing that its advertising sales have grown to $221 million in the first six months of this year from just over $7 million for all of 2010.

Such advertising sales may grow significantly in coming years, helping Twitter to scale to a point of profitability as Google, Facebook and LinkedIn (LNKD) have all done since their respective IPO's.

Still, potential Twitter investors shouldn't just vet the company's IPO documents for growth rates and a picture of its current financial state. They should also think about how and where Twitter will evolve in coming years.

Tech Precedents

Google, Amazon and Facebook all are proof that IPO filings only say so much; it is what comes after the share sale that matters most for investors. After all, IPOs are intended to raise equity capital that firms use to scale their businesses and expand into new products.

In that sense, Twitter may be in a far better position than its current finances and disclosures indicate.

Google went public in 2004 proclaiming that it was a superior Web search and advertising product to Yahoo! (YHOO) and a swath of little-remembered competitors such as Lycos, AskJeeves and NetScape. The company raised $1.67 billion in new capital in a listing that valued Google at over $27 billion dollars. Nearly 10 years later Google has a $291 billion stock market capitalization and dozens of new products to compliment its still-dominant Web-search business.

Just a few years after Google's IPO, the company bought Web-video sharing site YouTube in a deal that was panned as expensive at the time, but that may go down as one of the great merger and acquisition values of the 21st century. The company also bought Android, a fledgling mobile operating system for $50 million in 2005 and it is now in the process of acquiring mobile sensor start-up Waze Communications.

Google has used its equity capital and cash flow to make acquisitions and invest in smartphone, tablet and PC-products that now have a significant global market share. Some Wall Street analysts and investors consider the company in the vein of Berkshire Hathaway (BRK.A), with a set of distinct businesses that each hold significant value on their own. The company is also pushing its investment into smart cars, cable infrastructure and virtual accessories like Glass and Wallets.

The Web search business that Google investors scrutinized during its IPO remains, but a bigger part of the company's success has come from innovations such as Chrome, Android and the like.

The same can be said about Amazon, which has been characterized in multiple eras as a Blue Chip firm and as a dot-com bust. The online retailer went public in 1997 with a valuation just north of $300 million. It could only boast revenue of $16 million and no profits to show to investors.

With its equity capital, Amazon also was able to expand into businesses that were ancillary to its initial online retail business, especially in follow-on offerings in the wake of the dot-com bust. The company launched its Kindle e-reader in 2007 and is now a maker of a suite of tablet products that are expected to complement its retail business. Amazon has invested in steaming media and it boasts an AWS cloud business that powers competitors such as Netflix (NFLX).

Amazon still generates the bulk of its sales from online retail, however, it also is increasingly viewed as a conglomeration of distinct businesses, each with bright prospects.

More recently, Facebook's IPO signals just how much can change for a company in the wake of its share listing. When Facebook filed its IPO documents in early 2012, the company generated most of its revenue and user engagement from desktop PCs and presented a shift in consumer Web consumption on mobile devices as a risk.

About 18 months after Facebook's IPO, the company is generating its strongest revenue growth from its mobile advertising business and the promoted advertising that increasingly touches the news feeds of users on the billion member social network. Mobile now accounts for 41% of Facebook's total ad revenue as of its most recent quarterly earnings.

In fact, after a weak post-IPO performance, CEO Mark Zuckerberg made it a point to impress on investors that the company had barely started investing in its mobile advertising business. Facebook's recent earnings and stock performance reflect that fact.


The key in Google, Amazon and Facebook's ability to adapt to new business models and earnings streams hinged on the power of their core product.

Google would have no success in its sprawl of new products if people didn't rely on its search business. Amazon's Kindle roll-out wouldn't be working if users had moved their online shopping to competitors like Groupon (GRPN) and Faceook wouldn't be able to boast fast mobile ad revenue if users weren't willing to shift their usage from desktops and onto smartphones.

With that in mind, Twitter's Thursday IPO documents portray a company with an unstable set of current earning streams, but the ability to quickly adapt to changes in the marketplace. Consider the risks that Twitter faces.

The company has virtually no no recurring revenue. Corporations re-up their spending campaigns on the network at the whim of their budgets and advice from wholesale ad buyers. A new competitive threat, economic change or shift in consumer habits could pose a profound threat to Twitter.

The company also only launched its advertising products three years ago, and that rollout has only picked up pace in the past year as advertising makes it onto Twitter streams on Apple iPhone and Google Android devices.

Twitter may also still have to prove the value of its advertising product to firms, as corporations decide where to target their marketing spending. For instance, the company may need to prove a dollar spent on its platform is worth more than a dollar spent on Facebook, Pandora and LinkedIn, or in Google search tabs. As a news product, Twitter also appears to compete against traditional online media, which all rely heavily on advertising revenue.

There is nothing in Twitter's IPO filing that can tell a prospective investor whether Promoted Tweets will eventually allow the company to grow upon its reported $10 billion to $12 billion valuation.

But the company also shows the efficiency in its operations and the scale in its user base to quickly adapt.

Twitter is looking to raise $1 billion in equity capital through a share sale, the company's accumulated losses only total $418.5 million in its seven-year history and its shareholder deficit is just $164.4 million. Taken another way, it has cost less than half a billion dollars for Twitter to achieve its current scale.

It is no surprise then that as the company scales its revenue to what appears to be a 2013 run-rate in excess of $500 million it is already reporting positive cash flow and adjusted EBITDA.

The scale is what is important.

Twitter now boasts over 218 million average monthly users (MAUs) and 500 million daily tweets on its network. That equates to hundreds of billions of tweets in a given year, a figure that is only likely to grow in coming years. Even if changes to the ad market play against the viability of Promoted Tweets, Twitter will have the ability to implement new revenue streams and likely at a low incremental cost.

Vine a micro-video sharing application may prove to be Twitter's best source of revenue given the visual appeal and quick engagement that the platform can boast to prospective corporate advertisers. Twitter doesn't disclose what it cost to roll Vine out to users and advertisers, however, the video sharing network already has blue chip corporate and music industry relationships.

The Bottom Line: Investors should scrutinize Twitter's IPO documents for a business model and valuation they are comfortable about investing in. They should also believe in Twitter's ability to evolve into new businesses that aren't a part of the company's IPO.

-- Written by Antoine Gara in New York.

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