Is Twitter overvalued?

Techcrunch reported this weekend on rumours that everyone’s favourite micromessaging service Twitter is raising VC$ again – at a $250M valuation. That sure sounds high for a company with no revenue!

My fav social media analyst Jeremiah Owyang crunched the numbers to suggest that each active user on Twitter is worth $ 74. I’d like to take it even further to look at whether Twitter is overvalued at $250M.

The case for ‘Yes’

With 6M reported members, and 3.4M active members, Twitter is a phenomenon. But how do you monetize this base?

Premium: Under a freemium model, conventional wisdom says that 3 – 5% of users will upgrade to a paid service. So, let’s take the high end and assume a $50/ year paid service (doubt they’d get more than that).

Under this illustration, 300K (6M * 5%) users would upgrade. This would generate $ 15M in revenues for Twitter. Now, let’s look at this rumoured valuation. These numbers suggest a value of 16.67X forward revenue (250/ 15) or $ 833.33 for every paid user (250M/ 300K). This is very high. Only mobile operators who lock you into multi-year contracts can come to close to these per user values.

Advertising: Given the amount of time we spend tweeting and following each day, there is an advertising play here. But I see two issues: rates and control.

Rates: Don Dodge suggests that the average CPM rate for social networks is $0.36. To generate that same $15M in revenue from ads, Twitter would need to serve up 42B pages!

Control: How do they do that when most of Twitter’s activity does not take place on their web site but on 3rd party clients?

Not sure this valuation makes sense based on the advertising potential either.

The case for ‘no’

There are some arguments to suggest that $250M would not be overvaluing Twitter:

Growth:
The 6M reported user figure is pretty old now. The actual figure today may be much higher as this graph (courtesy of Techcrunch) suggests:

A growing user stream is worth way more than a stagnant one. The per user value numbers may be much lower when we factor in current and projected growth.

Ego:

As I said at the outset, Twitter is a phenomenon. Somebody will want to own this and will pay handsomely for it. Even before raising additional $, Twitter is in a league where only the biggest companies could or would buy it (Google, Cisco, Facebook, Microsoft, etc). These companies can pay big ticket prices. Just look at the $ 1.65B Google paid for Youtube back in 2005.

If Twitter raises another $20M, that will bring its funding to date to $ 40M. Let’s assume the VCs will collectively own 75%. Under these numbers, for the VCs to get 10x cash on cash back (i.e. to get $400M back), the company would need to exit for $533M ($400 / 75%). That’s not such a big number given Twitter’s market presence.

Conclusion?

So is Twitter overvalued? That question will never be answered till it exits. Till then, its just conversation. I do know that if I was on the VC side, I’d have a tough time justifying a $250M pre-money. But on the other hand, I’d also be very eager to get a piece of the company. Investments like that don’t come around every day.

What do you think? Is Twitter overvalued?

  • Mark MacLeod

    Hey Matt, that's tough to say. The only publicly available benchmark for a freemium business is Xing (” target=”_blank”>http://www.xing.com) which trades on the German Stock Exchange. They trade at about 12x trailing revenue (i.e. 12 times last year's revenue). Given growth rates that's a much lower multiple of the following year's (or 'forward') revenue. The bet with twitter, and why it commands a high valuation, is that the growth potential is so much that it almost doesn't matter what you pay to buy a part of it today.

  • Mark MacLeod

    Hey Matt, that's tough to say. The only publicly available benchmark for a freemium business is Xing (” target=”_blank”>http://www.xing.com) which trades on the German Stock Exchange. They trade at about 12x trailing revenue (i.e. 12 times last year's revenue). Given growth rates that's a much lower multiple of the following year's (or 'forward') revenue. The bet with twitter, and why it commands a high valuation, is that the growth potential is so much that it almost doesn't matter what you pay to buy a part of it today.

  • Matt_B

    Great post Mark. If 16.67X forward revenue is too high for a company like Twitter, what do you feel is the right multiple or range? Thanks.

  • Mark MacLeod

    Hey Shayna, You raise some good points. I wasn't on myspace in the early days, but I agree the current experience is pretty sucky. There's no question that if twitter goes mainstream the experience will change. many of its early adopters will move on. That may not be a bad thing for the company or its investors (though it would be bad for all of us using it). It's a big risk to invest in it, but I think they are leading the way in a form of communication that is only just beginning. It could be as big as SMS or IM.

  • Lady VoIP

    Its hard for me to say what the value of twitter would be if it went "mainstream" because of the changes that would surely follow. Myspace, for example, used to be fun. But between advertisements and constantly increasing usership (spam from local bands anyone?)… I hardly log in anymore. And with the number of tweeters that are already just using the site to promote something, I shudder to think what paid advertising might do to our little microblog. It would be quite tricky for someone to turn a profit on twitter without taking away from the appeal that give it this suggested high value. I do not mean to say it can't be done though. (I certainly have faith in Google for example) Which leaves the question: how do you get the value out of twitter without lowering its value?

  • Mark MacLeod

    You're absolutely right Julien. The slope of the growth curve is key to assessing this valuation. If they hit the mainstream, it will be cheap

  • Wallen's

    YouTube was sold at $ ~40 per unique visitors so $73 seems high at first sight. However, without going through the maths, it does not seem overly crazy to me IF (and it's the big if) you believe that it will really go mainstream. The tipping point could be reach soon … or never.

  • Wallen's

    YouTube was sold at $ ~40 per unique visitors so $73 seems high at first sight. However, without going through the maths, it does not seem overly crazy to me IF (and it's the big if) you believe that it will really go mainstream. The tipping point could be reach soon … or never.

  • Mark MacLeod

    Hey Joshua, the art of valuing privately held companies is just that – an art. The only number that matters when it comes to valuation is what someone is willing to pay. All good…

  • JoshK

    "So is Twitter overvalued? That question will never be answered till it exits." At which point we will ask it again. Isn't finance fun?!

  • Mark MacLeod

    I have to agree with you. People think the game is over and that Twitter has won, but it is only just beginning to enter the mainstream. This creates opportunity for them to build a huge user base. It also creates the potential for more competition as big companies like Cisco or IBM make build vs buy decisions. Bottom line for me – if I could invest in twitter, I would.

  • Qlubb-Andy

    Great post. I think it is misleading to use the number of active users today as a static measurement. If they indeed have 3.4M active users, it pales into comparison to the potential # of users who will be using Twitter in the coming years. I don't think Twitter does any marketing (as far as I can tell) and they've been able to grow through word-of-mouth quite nicely which means their cost of user acquisition is very small. Given the wide variety of usage models and the ecosystem of partners that are building applications on top of their API, they clearly have momentum to continue to grow at an incredibly fast clip. I wouldn't be surprised if they had 10x the number of users within a few years (if they play everything right).