Twitter IPO: Risk factors and growth

In the third of our series covering risk factors in Twitter's S-1 filing we look at the potential growth implications for Twitter and how it sees itself progressing post IPO.
Written by Eileen Brown, Contributor
Image: Albert Bridge/Wikimedia Commons

Twitter has submitted its filing to the U.S. Securities and Exchange Commission (SEC) listing potential risks to the business across several different areas. In this series, we look at each of these risks in turn and what this means for anyone planning to invest in the company.

From the filing (in bold):

"If we fail to grow our user base, or if user engagement or ad engagement on our platform decline, our revenue, business and operating results may be harmed."

Twitter’s growth has been very healthy so far in terms of users. Whilst growth in the U.S. is slowing, international growth shows a different trend.

Twitter's monthly active users, worldwide growth
Image: SEC/Twitter

During the first six months of 2013 there were 80.2 billion Twitter timeline views in the U.S. This is 57 percent more than during the first six months of 2012.

In the rest of the world there were 207.1 billion timeline views during the first six months of 2013, which is an 89 percent increase over the same time period up to June 2012.

Twitter must focus on growing its international business to take advantage of the continued opportunity for advertising in these new markets.

"Our operating results may fluctuate from quarter to quarter, which makes them difficult to predict."

Believe it or not, Twitter is seasonal. Advertisers spend more with Twitter during the fourth quarter of the year than they do during the first three months of each year. This short-term revenue hike will affect Twitter’s figures during this time.

Unplanned disasters such as the tsunami in Japan and the planned advertising for the Super Bowl also had an impact on revenue. Twitter warns that this variance makes it impossible to predict whether its next quarter business results will be good or not so good.

"If we fail to expand effectively in international markets, our revenue and our business will be harmed."

As the figures above show it is vital that Twitter focuses much of its energy in attracting new users and advertisers from outside of the U.S

Currently, a higher proportion of Internet users in the U.S. use Twitter than Internet users in other countries. There is less opportunity for Twitter to grow in the U.S. 

In the future, Twitter expects its user growth rate in certain countries, such as Argentina, France, Japan, Russia, Saudi Arabia, and South Africa, to be higher than user growth rate in the U.S.

The challenge is turning the growth of users into revenue. In the U.S., three months to June 2013 advertising revenue was $2.17 per timeline view. Across the rest of the world, three months to June 2013 each timeline view generated revenue of $0.30.

Although international timeline views are growing, revenue is not keeping pace with U.S. revenue per timeline view. This will cause Twitter’s growth to slow unless it brings new innovations into its international platform.

"We have a limited operating history in a new and unproven market for our platform, which makes it difficult to evaluate our future prospects and may increase the risk that we will not be successful."

People who do not use Twitter cannot understand its value. Twitter has said that new users might find its product confusing. Unlike Facebook you do not need to follow someone who follows you on Twitter — this can baffle people unused to this type of social networking.

Twitter only began to generate revenue in 2009, and began its promoted products in 2010. This gives it little financial history for it to be able to predict its future results. It also has competitive challenges internationally.

Mobile messaging product Kakao in South Korea offers similar features to Twitter. It has a 24 million strong user base, which could prevent Twitter from growing in the region as much it would like to. 

"If we fail to effectively manage our growth, our business and operating results could be harmed."

Twitter is enjoying growth — both in its user base — and its headcount, which has grown by 10 percent to 2,000 staff over the last two years. It is paying its staff well and runs the risk of overpaying its staff and over expanding its infrastructure.

Twitter is also concerned about becoming a large organisation and not being as agile as a smaller company in terms of innovation and flexibility.

Larger organisations also have significantly larger operating costs — and have to invest in parts of the world that do not yet return a profit to the business. This could pose a significant risk. 

"We may expend substantial funds in connection with the tax liabilities that arise upon the initial settlement of RSUs in connection with this offering, and the manner in which we fund that expenditure may have an adverse effect on our financial condition."

Restricted stock units (RSUs) are grants valued in terms of company stock granted to a member of staff. The recipient can't immediately cash in their stock until a period of vesting has passed.

Sometimes stock is granted with 20 percent of the total amount vesting each year over a five-year period. This vesting is subject to the recipient still working at the company at the time.

The tax laws may have changed over this five-year period. This means tax implications both for the recipient and Twitter. Twitter might find that its tax liability reduces its profit.

"We may require additional capital to support our operations or the growth of our business, and we cannot be certain that this capital will be available on reasonable terms when required, or at all."

Will banks think Twitter is a good risk after IPO and lend it money on good terms? Or will it only be able to raise capital at high interest rates? If Twitter cannot get the cash it needs on the terms it wants then it will not be able to grow in the way it predicts.

"Future acquisitions and investments could disrupt our business and harm our financial condition and operating results."

Often acquisitions depend on retention of key staff. If the acquisition means that all of these key people leave to work at another company, then a successful acquisition is much more difficult. Yammer’s top execs joined Fuzebox one year after Microsoft acquired the company.

Sometimes employees that work at start-ups really like working at start-ups. Working in a large organisation really does not appeal to them.

As Twitter grows and acquires start-ups to expand its services portfolio it might find that the very people it acquired with the business want to stay in the start-up world.

"If we fail to maintain an effective system of disclosure controls and internal control over financial reporting, our ability to produce timely and accurate financial statements or comply with applicable regulations could be impaired."

Public companies have to comply with a lot of regulations to demonstrate transparency to their investors. Accounting and legal practices have to be compliant with legal frameworks and reporting requirements. This is time consuming and expensive.

If there are any weaknesses in its disclosure then Twitter will be fined by the authorities. This will change perception about Twitter and affect its stock price.

Based on the above risk factors would I buy Twitter shares? 

Twitter is moving quickly from a small start-up to a publically traded organisation with strict frameworks, governance and accountability to its users, shareholders, advertisers and investors.

Growth in U.S.-based users is slowing, however Twitter generates most of its revenue here. It needs to focus on its international users and encourage key local influencers such as politicians and celebrities to use the service.

It also needs to generate higher revenue whilst finding more advertisers for its pipeline. This needs to be achieved in countries outside of the U.S. It is a big risk for a company where an opportunity to grow its user base by 1.3 billion in one country is blocked by the Chinese authorities. 

Access to Twitter could be blocked in other countries too should the political landscape change.

Based on these risks, I would not buy Twitter stock.

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