Chris Umiastowski is the growth investor for Globe Investor's Strategy Lab. Follow his contributions here and view his model portfolio here.
Twitter Inc.'s roadshow must be going well.
The social media company announced Monday it was hiking the proposed price of its initial public offering, expected later this week. That speaks to the enthusiasm the company is encountering as it talks to prospective institutional investors.
So should you be a buyer at the new, higher price?
Last week, when the deal looked as if it would happen at $17 (U.S.) to $20 a share, I was set to write an article explaining why I would be happy to line up for the stock. Now that Twitter's bankers have raised the price range to $23 to $25 a share, let me state the obvious: The company is less of a bargain than it was at the old price.
But, yes, even at the new, higher valuation, I'm interested.
To be sure, I can understand other people's reluctance. If we use the high end of the new price range and look at the fully diluted share count of about 695 million shares, Twitter could have a market value of $17.3-billion on its first day of trading. For a company that generated revenue of only $534-million in the past 12 months while losing money, that is a hefty valuation.
Ultimately, though, investors pay for the future, not the past. Anyone who uses Twitter knows it has barely started to sell ads, which mostly come in the form of "promoted tweets" – short, paid messages (often with pictures) that appear in the Twitter timeline of a company's target audience.
Twitter has yet to unleash its full power to advertisers. As it rolls out new advertising features and launches these features in new markets, revenue will explode higher.
This isn't just wishful thinking. About 75 per cent of Twitter's revenue now comes from the U.S. market, where it is focusing its ad efforts – yet only 23 per cent of Twitter's users are in the United States. Simply by rolling out its existing ad programs to international markets, the company should be able to multiply its existing revenue.
And that's just the start. I calculate that Twitter is generating about $7 per user, annually, in the U.S. market. Facebook, which has a longer track record of selling advertising, brings in more than double this amount of revenue per user in the same market. To my mind, there's nothing to suggest that Twitter won't eventually be equally successful at turning eyeballs into money.
The real question is how big the market for mobile advertising on smartphones and tablets will grow. Considering there are billions of people worldwide who don't yet use a smartphone, I believe there is ample room for expansion and that the market will be dominated by three players: Google, Facebook and Twitter.
Check out this statistic: In the U.S., only 3 per cent of all advertising dollars go to mobile devices. Given the pace at which smartphones and tablets are being adopted, advertisers will radically shift how they allocate spending over the next decade. Mobile devices are bound to be a much bigger target. Twitter is perfectly positioned to capitalize on this trend.
So let's talk about money. Aswath Damodaran, a professor at New York University, is an authority at investment valuation and recently attracted attention with his estimate that Twitter is worth just over $17 a share.
Given that, how can I possibly feel the IPO is worth buying at $23 to $25 a share? I think Prof. Damodaran is being far too conservative in his assumption that the total online ad market will grow only 5 per cent a year. I think it will expand much more quickly.
Sure, if you buy shares of Twitter, you have to prepare yourself for volatility and the very real possibility of a financial loss. But think long term. If I buy shares, I'll be doing so because I think Twitter will be the No. 3 mobile advertising company in the world, behind Facebook and Google.
By my calculations, Twitter could easily exceed $10-billion in revenue one decade from now, which should mean at least a tripling in value, or about a 12-per-cent annual return. And things could turn out even better if I'm underestimating just how important mobile advertising will become.
Chris Umiastowski