With Facebook's tumultuous I.P.O. in mind, Twitter tries to value its shares

It has more than 200 million active users. It played a central role in the protests against governments in the Middle East a couple of years ago. And it appeals to a generation of Internet users who relish publicly expressing themselves in short bursts of 140 characters or less.

But how much is Twitter really worth?

That is the question investors will have to grapple with as Twitter's bankers begin the task of selling shares in the company in the coming weeks. With enthusiasm for Internet companies — and in particular, social media firms — heating up again, Twitter may have little trouble persuading buyers to pay up. But Facebook's botched I.P.O. last year, and the drubbing its shares suffered in the ensuing months, show that even the most highly anticipated technology offerings can swoon badly.

One aspect of Twitter's I.P.O. could hamper investors' ability to determine the right price for the company. The company is taking advantage of a law approved last year that allows it to keep its financial data confidential until three weeks before its shares are marketed. Facebook released financial statements three and a half months before its stock offering in May 2012. That gave investors ample time to weigh Facebook's prospects before deciding whether to participate.

"I see no reason why Twitter should not open its books to public scrutiny," said Anup Srivastava, an assistant professor at the Kellogg School of Management at Northwestern University. "Why wait until the last minute?" Until the official Wall Street sales pitches begin, outsiders only have minimal information to go on. One piece of data is an estimate of revenue, which Twitter records when it charges for the advertisements that are inserted into users' streams of messages. It also licenses user activity data to outside firms.

Twitter's revenue is expected to reach nearly $600 million this year, according to internal projections and the research firm eMarketer. Investors are using that figure as a starting point for arriving at an overall value for the company. Today, for instance, the total value of Facebook's shares on the stock market is about 15 times the revenue that analysts expect the company to post this year. Applying that multiple to Twitter's forecast revenue of $600 million this year values the company at $9 billion.

This is an imperfect approach, since it ignores costs. Also, 15 times is more than double the sales multiple for Google, which has long been the Big Daddy in Web advertising.

Mr. Srivastava is skeptical of the high valuations placed on relatively young companies. "It looks like the Internet bubble all over again," he said.

But the doubters are likely to be drowned out. Bullish market participants find it easy to make their case when companies like Twitter appear capable of posting high growth rates into the foreseeable future.

Kevin Landis, chief investment officer at Firsthand Funds, which bought Twitter shares on the private market, is an optimist about the company. He said there were reasons Twitter should have an even higher valuation than Facebook. For instance, Twitter, he said, already has a strategy for mobile devices. Facebook was still working out its approach to mobile devices when it went public. And since it is a younger company, Twitter may also be able to increase its earnings more quickly than its established rivals.

"What people are doing when they buy a growth stock is asking where the company might end up," Mr. Landis said.

Advertising dollars pour into Facebook and Google because people spend so much time on those companies' Web pages. Twitter has substantially fewer users, but it must nevertheless try to convince advertisers that its users are as valuable.

One reason companies say they use Twitter is that it offers them a chance to interact quickly with trends and "conversations" that take place on the service. Such campaigns can also be timed to coincide with prominent events on television.

Honda advertises on Twitter and used it as part of a broad summer campaign that helped generate 20 percent more in auto sales this July than in July 2012. "Twitter certainly contributed to that," Alicia Jones, a social marketing manager at Honda, said.

Still, Twitter may yet hit choppy waters. Its short-message format does not appeal to everyone. If it fails to add large numbers of new users, it may be perceived as a niche player. To branch out, Twitter will mostly likely have to spend a lot of money on new technology. Facebook had to spend substantial sums to support its mobile initiatives. Those appear to be paying off now, but they are a reminder that expansion into new areas can be costly. Anyone sizing up Twitter as an investment needs to estimate how much the company may have to spend to stay relevant on the Internet.

The credibility of Twitter's top officers, including its chief executive, Dick Costolo, will be tested during the I.P.O. process. Michael Pachter, an analyst with Wedbush Securities, said Twitter could learn from some of Facebook's missteps. Facebook executives, he said, had not been sufficiently open about the company's activities, and had not given enough detail on the company's expenses. "Let's hope Twitter understands that it has to court investors," he said.

As the conversation about Twitter intensifies, investors may be wise to keep Facebook's turbulent past in mind. Buying shares at the I.P.O. led to losses, though shares in Facebook are now higher than the offering price. But being bearish as the company recovered also was a bad bet.

The dilemma boils down to this: What should investors pay for a seemingly well-run and popular company? Or as one Twitter user, @EpicureanDeal, posted on the service on Friday: "Re Twitter's IPO: you need to understand that a good firm, a profitable firm, and an attractive stock investment can be 3 unrelated things."

(Published by NYT - September 13, 2013)