When Twitter's (NYSE:TWTR) IPO leapt on initial trading, common consensus was the stock had gotten ahead of the financials and current holders were in for a couple of quarters of pain. This was ubiquitous; many analysts -- myself included -- opined about Twitter's valuation. But, what if we all were wrong? Could the fact we are bereft of imagination have caused us to miss a great opportunity in this undefined social-media platform?
Research and development, Twitter's secret weapon
Perhaps our foresight is lacking, but it does not appear that Twitter's is. The company is investing in research and development (R&D) like no other social media company. In the company's S-1 filing, it reported spending an amazing 47% of revenue on R&D. Upon first glance, that appears shockingly high: Facebook (NASDAQ:FB), for instance, reported spending 10% on R&D pre-IPO. Social-media job recruiter LinkedIn (NYSE:LNKD) reported 27% of sales on product development.
But, let us remember, young companies that invest wisely in their businesses usually develop sustainable competitive advantages. Twitter may be on to something that will allow them to diversify their revenue stream. If so, this sets Twitter apart from the standard social media advertising model and points to the fact that Twitter may be undervalued.
What did Twitter discover?
Twitter discovered it is more than just an advertiser. The real-time nature of Twitter makes it a data mining giant. Matter of fact, the company reported data licensing fees of $47 million during the nine months ended Sept. 30, equal to around 11% of total revenue during that period. Data licensing fees are fees Twitter receives from data partners to access, search, and analyze historical and real-time data on Twitter's platform. Right now, Twitter has five data partners that account for roughly 73% of its data licensing revenue and 8% of Twitter's overall revenue. However, the data appears to be valuable to these partners; licensing revenue was up 36% compared to 2012 with a 30% increase from existing partners.
In addition, the data mining nature and its data licensing business will allow Twitter to grow revenues directly and indirectly through more effective ads. Even the largest company in the world, Apple, has gotten in on this bandwagon by buying Topsy, a Twitter data miner, for millions. Quite simply, this data is inherently valuable.
Where I was wrong
We analyzed Twitter as if it were another Facebook, a mere ad-driven business with the majority of revenues from these ads -- that's currently the case, but that could also change. In fact, it has the potential to be a multi-revenue stream company more akin to LinkedIn than Facebook. If Twitter can grow its data licensing business like big data is growing (58% annualized growth between now and 2017, according to Wikibon), that business could eventually overtake its ad-driven revenue.
Overly optimistic? Perhaps...
Before we crown this Twitter's amazing opportunity, it is important to listen to management. According to Twitter's own S-1, "data licensing fees are expected to decrease as a percentage of our total revenue over time." In the short run, even if Twitter is able to match Wikibon's 58% big data growth rate, it would still fall short of its ad-based year-over-year revenue growth from nine months ended Sept. 30 2012 to the nine months ended Sept. 30 2013 -- 121%.
However, that eye-popping growth from an advertiser will be hard to maintain for a long period of time. In the end, opportunities are just that -- opportunities. If Twitter can execute in this space then perhaps it deserves its high-valuation, but that's a large if. However, investors would be wise to pay careful attention to Twitter's data licensing business going forward.
Jamal Carnette doesn't own shares in any of these companies. The Motley Fool recommends Facebook and LinkedIn. The Motley Fool owns shares of Facebook and LinkedIn. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.