Here's How Twitter Becomes a Multibagger in 5 Years

Twitter is finally going public, and its shares are expected to trade between $23 and $25 on the first day of trading. That means the company could be valued as high as $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 $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: GOOGL  ) 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 $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 $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 $317 million of revenue. In the first nine months of 2013, revenues have grown to $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. Monetization 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 monetizing 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: $0.97/1000 timeline views.

Putting all of that together, Twitter generated about $154 million of ad revenue per quarter. It also generated $15 million of revenue from data licensing, for a total of $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: $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 $0.17 to $0.36. By comparison, prices ended at $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 $4.1 billion in revenue. I think that could be low, as the numbers above show Twitter could generate over $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.

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Read/Post Comments (15) | Recommend This Article (76)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 05, 2013, at 5:59 PM, saucerboy wrote:

    Companies advertise on Google because companies make money off of traffic driven by Google search ads. Companies advertise on Facebook because companies make money off of traffic driven by Facebook re-targeting ads.

    Companies DON'T advertise on Twitter because Twitter ad products DON'T generate a positive return on ad spend. Furthermore, advertisers can't pinpoint which ads work and which ads don't work, because Twitter doesn't provide conversion tracking. What a joke.

    Twitter's greatest value comes from celebrity/thought-leader endorsements via Twitter. And don't get me wrong--authentic celebrity endorsements can drive tremendous value for a company. But whatever it takes to get that endorsement--money, PR, etc--Twitter won't see a penny of that investment. Twitter has no way of capitalizing on its own true value proposition. And for this reason, it will fail.

  • Report this Comment On November 05, 2013, at 6:31 PM, cmalek wrote:

    Twitter may have revenues but how much profit has it shown?

    Pray tell, what happened to MySpace??? Any chance Twitter may go down the same road? (along with Facebook) The cool, hip people are already moving on to Tumblr and other social networks. When Grandma and Grandpa have Twitter accounts and your grocer is on Facebook, those sites are no longer hip. It's analogous to when your barber starts giving you stock tips, it's time to get out of the market.

  • Report this Comment On November 05, 2013, at 9:52 PM, ayaghsizian wrote:

    As David Meier states, Twitter stock may be a good addition to your portfolio if you only buy a relatively small piece (and you have a high risk tolerance).

    I tend to think of investments from a risk reward perspective. Twitter is a great and growing company. I think we can all agree on that. But as an investment, it comes with very high risk and hopes of very high reward. At $25 per share, I understand the Market Cap will be around $14 billion. The type of people that invest this week are the type that would hope to get a 3- or 4-bagger eventually, which would mean a market cap of 42 to 56 billion dollars. That's big. And hard to achieve. Most companies never get that big. I hope that whoever invests in Twitter this week does well but I will not be one of them.

    I believe there are easier ways to get multi-bagger returns. Invest in small companies that are growing. It is much easier for a company worth $140 million to become a $560 million dollar company. Less risk and more reward. I'm not promoting penny stocks - I'm promoting investing in great small companies. Real companies with real products and real growth and small market caps. Look at CALM and HCI for a couple of good examples. I own both. CALM sells eggs and grows revenues and pays dividends and HCI sells insurance and grows revenues and pays dividends. Boring but profitable. Low risk/high reward. Or subscribe to the Motley Fool service hidden gems for some great ideas. A wonderful service because they research many great small companies that have huge multi-bagger potential. They recommended Under Armour when it was like $20.

    Twitter is a great company with wonderful revenue growth and anyone that invests in it needs to understand that it is priced very high to begin with. Anyone that bought FB shares last year around the IPO price of $38 went through a scary rollercoaster ride to get to $48 now. Not bad. People that invested in dividend and revenue growing small caps made closer to 50% and collected dividends. More reward with less risk.

    I hope everyone here does well on their investments.

    Ara

  • Report this Comment On November 06, 2013, at 10:04 AM, migolfmaster wrote:

    I missed out on Amazon and Google but bought FB at $20 and it now sells at $48. Twitter is worth a look but I will not be buying on day 1.

  • Report this Comment On November 06, 2013, at 3:18 PM, mdk0611 wrote:

    It may be a multibagger in 5 years, but at $25-28 per share you could be taking a 30% hair cut over the next 3 months.

  • Report this Comment On November 07, 2013, at 4:47 AM, Stonewashed wrote:

    Twitter “will be able to take an estimated $154 million tax deduction for a stock option compensation expense which its own books show cost Twitter only $7 million.” That is 20 times larger than its actual expense.

    .... “Enormous options-fueled executive pay packages, reaching hundreds of millions of dollars, became a source of scandal with the (tech) bubble’s collapse and the ensuing bankruptcies of Enron and other large corporations due to accounting malfeasance.”

    http://blog.chron.com/txpotomac/2013/11/senators-say-twitter...

  • Report this Comment On November 07, 2013, at 8:20 AM, ravenesque wrote:

    But can Twitter make me $100+ million in 102 minutes?

    http://ghostinthemachines.wordpress.com/2013/04/30/pulverize...

  • Report this Comment On November 07, 2013, at 10:47 AM, EquityBull wrote:

    Too late. Indications are for 46/share on the open. that is 30B valuation. No upside priced in for the next few years. they took it all off the table on day one. 50 times revenues right now is the multiple. Insane. No profit

  • Report this Comment On November 07, 2013, at 11:10 AM, djtetsu wrote:

    Facebook -> pumped up ads -> teens flee

    New social medias come to replace ones that tries to monitize: pinterest, tumblr, instagram are all the rage right now because they are in their growing phases (read:'no ads')

  • Report this Comment On November 07, 2013, at 11:13 AM, djtetsu wrote:

    all of them will eventually become 'uncool' and will collapse eventually.

    As a web developer, I can say, they don't have irreplaceable technology such as Google.

    For the long term, I'd say nay.

  • Report this Comment On November 07, 2013, at 11:39 AM, KombatKarl wrote:

    5 years? It nearly became a multi-bagger one in one hour. Hit 92%.

  • Report this Comment On November 10, 2013, at 9:01 AM, gianca wrote:

    Sorry, but how's that possible?

    If it's so hard to price such businesses, they shouldn't go public at this stage. Is it an artificial or forged way to gather salaries for twitter employees and managers?

  • Report this Comment On November 11, 2013, at 7:35 PM, ujvar wrote:

    FB - experience more ore less we will see again.

    Dont be too greedy says Warren B. Jump out that rocket as Long as you can ...

  • Report this Comment On January 12, 2014, at 12:18 PM, this wrote:

    that's the worst advice ive ever heard take this from a person who know very lirrle about stock and twitter will be bought out there stock will go way down if almost not to 0 after first of year I cant believe motley fool would put this out put your money where your mouth is bet me any amount on this worst advice foloow it tour a fool now if you just bought it to go in and wham bam get in and get out it will go up so go in at first then get out after first yeare after you see the first sign of a drop its around 701 m 71 right now after first of year first 5 or 6 dollar drop sale you can always get back in when it hits bottom take your profits buy a little more more but that takes away all the gamble just watch

  • Report this Comment On January 12, 2014, at 12:19 PM, this wrote:

    facebook will be a great longterm gain

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