Quick Thoughts: TWTR – Questions for the Roadshow

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–        Preliminary pricing for TWTR at $17-20/share values it at $12.5B, fully diluted at the upper end of the range. I believe that it is worth $30B+ and that pricing may rise ahead of issue

–        TWTR management has begun its roadshow – the S-1 is straightforward, but lacks detail in many areas, leaving many questions for management to answer for investors.

–        On revenues, TWTR’s ad sales relative to user visits have sharply accelerated over the past 3 quarters with no detail as to the drivers of the acceleration and its sustainability.

–        On costs, TWTR’s target model, released Thursday night, projects 49-53% OPEX to sales – ~1000bp ABOVE FB today. Why do they need to spend so much more?

Twitter announced a preliminary price range of $17-20 per share for its IPO on Thursday night, with final pricing anticipated for November 6. This pricing values the company at $10.6-$12.5 billion, well below the more than $30 billion valuation implied by my model. While the roundly criticized Facebook IPO, with its upward re-pricings and subsequent weak trading, undoubtedly gnaw at both Twitter management and its bankers, I wouldn’t be surprised to see the deal price at least a bit above the current range. Investors were showing considerable enthusiasm for the IPO before the surprisingly conservative pricing estimates were released, and there is probably plenty of room before the Facebook scenario becomes a realistic concern.

At the same time, Twitter management released the presentation materials for its upcoming roadshow. Most of it is a reiteration of the business case presented in the S-1, with the exception of the last page, where Twitter laid out a target cost model. Earlier in the week, I laid out my expectations for the company’s long term cost structure, projecting that its operating margins as a mature company ought to be in the 37-40% range, a few percentage points ahead of Facebook, which is well on its way to delivering that level of profitability. Twitter’s target cost model echoed my expectations on gross margins, where its less storage intensive business model should leave it with lower infrastructure costs, but it also suggested operating expenses at 49-53% of sales. This range is FAR higher than Facebook today, which has spent 40% of sales on OPEX YTD, including 12.4% of sales on employee stock compensation, a level that should decline as the effects of the 2012 IPO fade This looks like sandbagging of the highest order.

Question 1: Why should target R&D spending be so much higher than Facebook or Google? Google invests in “moonshots” like self-driving cars, and famously encourages its engineers to spend a day a week on “passion projects”, yet its R&D spending has never exceeded 12% of sales. Twitter’s business opportunities and use case would not seem any more R&D intensive than Facebook’s, yet Twitter proposes spending a third more than that company as a percentage of sales.

Question 2: Why should G&A spending be 10%, when the large majority of tech companies spend less than 8%? Given an admirably focused product strategy, without obvious legal and regulatory challenges, why should Twitter’s sustainable G&A spending be amongst the highest of all tech companies in the S&P 500?

Question 3: What level of employee stock compensation vs. sales will Twitter target? Based on the stock compensation estimates provided in the S-1, it is safe to assume that the costs will be more than 25% of sales in both 2013 and 2014. Once this IPO related activity is absorbed, how much employee stock compensation is fair? Most tech companies have reined their employee stock programs in to well less than 10% of sales. What should we expect of Twitter?

Question 4: How much more advertising can be inserted into timelines before users feel that the experience has been degraded? Like Facebook, Twitter has been very successful in increasing the density of ad insertions into the user experience. While signs suggest that users have been accepting of that change, there is obviously a threshold of tolerance. Does Twitter have any idea of where that is and how far away from it they are?

Question 5: How much room is there for Twitter ad pricing to rise with time? History suggests that new ad forms see rising prices as agencies and advertisers grow more comfortable with the efficacy of a new medium. With media partners, Nielsen on board, and growing acceptance of mobile advertising in general, is Twitter experiencing improving pricing and is it likely to see growth in the future?

Question 6: How do the Amplify partnerships work vis a vis advertising on Twitter? Twitter has signed an impressive array of media partners who will use their platforms to promote Twitter and use Twitter to promote their own platforms. Many of these tweets will carry advertising, often, coordinated with ads on the media partner’s properties. How much of the ad revenue from spots appended to a media partner’s Tweet go to Twitter and how much goes to the partner?

Question 7: What are Twitter’s goals for integration into device platforms? Twitter has signed agreements with Microsoft and Apple for a certain level of integration into their operating systems, and many of Google’s Android licensees include Twitter as a default app. Can Twitter take the integration further and what are the costs and benefits of doing so? Does NOT having its own platform hurt Twitter in any way?

Question 8: How can Twitter counter the threat of messaging apps and is there an opportunity to expand Twitter’s own messaging capabilities? In many regions – Asia, Latin America, Africa – messaging apps, like Kakao, Weibo, What’sApp, and Line, are so popular that they are threatening app and media distribution. How will Twitter compete? What are the advantages of Twitter vs. these messaging centered apps? Does Twitter see adding a more robust messaging platform as an opportunity?

Question 9: What are the challenges in monetizing Twitter in international markets? Ad sales per 1,000 timeline views are MUCH lower outside of the US. To what extent is this an intrinsic gap that may never be closed vs. a lag in the development of the market? As a mature company, how close do you think monetization rates in various regions of the world can come to the US?

Question 10: What type of acquisitions will make the most sense for Twitter? Most of Twitter’s deals have been acqui-hire acquisitions to gain talent. Recently, Vine added a new consumer app to complement the main Twitter service, while MoPub adds a missing element to Twitter’s advertising strategy. Which of the three types – talent acquisition, new services/applications, expanding capabilities – should we expect to be more prevalent in the future? Does Twitter expect to expand the in-house services tied to its platform, as Facebook has done with Instagram?

For our full research notes, please visit our published research site.

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