Investors placed a $US6 billion ($6.4 billion) bet on shares in Twitter on Tuesday as the sharemarket punters responded to a better than expected quarterly result and pushed the share price up by 30 per cent. This is no ordinary analytical response to projected returns. The company did not make a profit – it actually increased the size of its loss to $US145 million, compared with a $US42 million loss a year ago.
Nonetheless, the market was pleasantly surprised.
Twitter did, however, increase revenue by $US173 million, which is what investors got excited about. But this is a company capitalised at more than $US22 billion – large enough to be in the top 20 Australian companies. Its quarterly revenue of $US312 million is still very skinny.
Thus it is a giant leap of faith for investors to assume that its earnings will catch up to the value of the company any time soon.
By way of illustration, the company’s price earnings multiple sits at a staggering 1159 times. In other words, the value of a share represents 1159 times that of projected earnings per share in calendar 2014.
This is not to say earnings won’t catch up eventually, but it is fair to question whether there is sufficient information to assume they will.
Put in perspective, listed companies trade at price earnings ratios of about 10 to 15 times. Those considered to have growth potential typically trade on a multiple of 20 to 30 times. Twitter is well outside this ball park. Put another way, Twitter would need to earn about $US2.20 per share to achieve a multiple of 25 times. Based on the most generous analysts’ current expectations, it will post a profit of about US4.5¢ per share this year. Others believe it will post a loss.
Those analysts now predicting Twitter will turn this profit by the end of this calendar year do so on the basis that its advertising revenues are beginning to improve and that it experienced heavier than expected use of the service in the quarter.
The revenue gains are certainly encouraging but the bubble in usage appears to have as much to do with a World Cup-induced Twitter frenzy than a genuine or sustainable new rate of growth in users.
Investors will need to see a longer-term trend – indeed, several more quarters – to make any meaningful conclusions about this.
Another measure the company likes to use is how much the service was being used – how many times the feeds were being refreshed – and this measure was flat.
So the excitement appears to be all about Twitter's ability to ‘'monetise'’ or attract advertising – to follow in the steps of another social media giant, Facebook.
Just a glimpse of this potential got the market excited despite the fact that Twitter's share price requires some fairly heroic assumptions about revenue and profit growth.
Against this backdrop, Twitter’s acquisition of monthly active users has been slowing. The company argues that people are not measuring usage properly – missing out on the tweets that are embedded on other websites, which could more than double its reach.
In the early days of these companies they are justified in focusing on increasing their subscriber base – it's a valuable asset. The trick is to increase revenue as the company matures but at a much faster rate than costs.
(Having said that, in the quarter just reported, Twitter’s costs appear to be significantly higher than the previous corresponding period.)
The bottom line is that neither investors or the company’s management really knows how fast Twitter can grow profits and how long (if ever) it will take before the earnings justify a share price that sits in nosebleed territory.
While from a user perspective Twitter is a well-established operator, having colonised the world with its infectious short message service media, the fact remains that in a corporate sense it is still in its infancy.
Its performance during the World Cup demonstrates its appeal during big events, which the management will undoubtedly capitalise on. But it is a clear reminder that usage can be a bit lumpy.
As such, it can’t be lumped in the same basket as some of the more established digital disruption players, such as Google – which incidentally trades on a multiple of 22 times.
At these prices Twitter is best left to those investors that like to take a punt. It is an option trader's dream because the share price is so volatile that there is plenty of opportunity to take profits from roller-coaster moves.
It starting trading on the US stock exchange last year, having been issued at $US26 a share, and rose immediately to $US70 a share. After releasing its results on Tuesday, it rose from $US38 to more than $US52.
