Aug 01, 2014

    Twitter is still no match for Facebook

    TWITTER is now profitable, practically speaking. To justify its inflated valuation, however, it must overcome a problem inherent in all advertising-driven businesses: inertia.

    Officially, Twitter lost US$144.6 million (S$180 million) in the second quarter of this year.

    Normally, it wouldn't do to trust gimmicky measures like adjusted Ebitda (earnings before interest, taxes, depreciation and amortisation) or "adjusted net income" for a large public company. But Twitter is justified in touting these. The adjustments are not a gloss on the company's operational performance. They mainly concern Twitter's expenses for stock-based compensation, which reflects the care it is taking to attract and retain top talent.

    Had it not been for US$158 million in stock-based compensation expenses in the last quarter, it would have earned about US$14 million, its biggest profit (although based on generally accepted accounting principles, it has never had a profitable quarter).

    For a company that started monetising its user base only in 2009, and has had to hire rapidly, that's not bad.

    It proves that the platform can subsist on advertising and data licensing revenue even now.

    Twitter's revenue is growing much faster than expenses. In the second quarter, revenue was up 124 per cent year-on-year, while expenses increased 94 per cent (mostly because of hiring).

    It is no longer burning money: The adjusted net income has been positive for the past three quarters. It is also rapidly correcting its geographical imbalances.

    Twitter has only 22 per cent of its audience in the United States, but makes 64 per cent of its revenue there. However, international revenue increased 168 per cent year-on-year in the second quarter, much faster than revenue for the company as a whole.

    The business model is viable and globally scalable. The service many of us have come to rely on for news will not wither on the vine.

    For investors, the story is more complicated. Twitter's earnings to sales are a fraction of Facebook's.

    And according to data compiled by Bloomberg, Twitter had the highest predicted 2015 price-to-earnings ratio of its Internet industry peers even before its share price rocketed an inexplicable 29 per cent after the second-quarter results announcement. There's a lot of long-term faith priced into the company's valuation.

    It's not clear what Twitter can do to justify this kind of faith.

    Facebook, with its 1.37 billion monthly active users, would need to make a lot of mistakes for Twitter, with 271 million, to catch it. That's not likely to happen, if only because scale now favours Facebook: In the last quarter, it spent US$0.95 per user, compared with Twitter's US$1.09.

    It's tough to be so far behind a powerful rival.

    A report in April by marketing company Resolution showed that ads on Twitter were more effective than on Facebook, generating more clicks, but big advertisers such as Pepsi, McDonald's, Hertz and FedEx still spent 127 per cent more money with Facebook because ads there reached more users.

    Twitter still has a comparative advantage over Facebook in mobile ads: They make up 81 per cent of its ad revenue, compared with 62 per cent for Facebook.

    Advertisers, however, will not be impressed: Facebook started selling mobile ads only two years ago. Now, only Google can rival it in mobile.

    Being a perpetual runner-up, however, is a structural reason, and Twitter is not doing anything to close the gap with Facebook.

    In absolute terms, Facebook added 41 million users in the last quarter; Twitter signed up 16 million, its highest tally in five quarters.

    There is no reason, then, for investors to give Twitter higher valuation ratios than they grant Facebook. The company is no dud, but it makes sense to modify expectations about its place in the industry.