Challenges abound for Twitter ahead of and beyond initial public offering

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SAN FRANCISCO — Twitter has built a digital town square that’s teeming with activity but riddled with financial potholes. Seven years after co-founder Jack Dorsey sent the first tweet, more than 500 million posts are shared each day.

Advertisements have quickly turned into Twitter's main source of revenue, which has soared from just $28 million in 2010 to a projected $650 million this year.  JEFF CHIU/ASSOCIATED PRESS
JEFF CHIU/ASSOCIATED PRESS
Advertisements have quickly turned into Twitter's main source of revenue, which has soared from just $28 million in 2010 to a projected $650 million this year.

But all the chirping hasn’t translated to profits, nor is it expected to any time soon.

As Twitter prepares to complete its initial public offering of stock this week, the San Francisco company’s history of losses totaling nearly $500 million is raising questions about its ability to turn a cultural phenomenon into a sustainable business.

The company’s stock market debut shares parallels with the IPOs of online social networking leader Facebook Inc., which went public nearly 18 months ago, and search engine leader Google Inc., which made the leap to Wall Street in 2004.

But Facebook and Google were already profitable by the time they went public.

“An exciting business with lots of users doesn’t necessarily generate returns,” says James Gellert, the CEO of Rapid Ratings, a subscription service that examines the financial health of companies.

Rapid Ratings gives Twitter’s financial fitness a 19 on a scale of 100. Gellert says that between 1991 and 2011, 90 percent of companies that defaulted on their debt received a rating of 40 or below. The firm rated Facebook at 73 just before its IPO and Google at 80 before its 2004 offering.

With 232 million users and an IPO poised to reach as much as $2 billion, Twitter is unlikely to go bust. So many investors are optimistic that Twitter on Monday raised the projected price range of its IPO to $23 to $25 per share, up from $17 to $20.

Despite that enthusiasm, Twitter faces a slew of hurdles that range from an outsize proportion of international users – who generate less revenue than U.S. counterparts – to concerns about a slowing rate of growth.

Twitter is set up so users can “follow” anyone – a celebrity, politician, sports star or pithy teenager – who also has an account. This flexibility makes Twitter like an open book.
In its IPO paperwork, Twitter highlights the simplicity and spontaneity of its service and depicts it as one big conversation.

Twitter will have to get more users to be more active – and more attractive targets for advertisers. According to an Associated Press-CNBC poll, 29 percent of people with Twitter accounts never tweet.

Twitter’s user growth is already slowing. It took Facebook eight months, from August 2008 to April 2009, to go from 100 million to 200 million users. For Twitter, it was 15 months, from September 2011 to December 2012.

Beyond Facebook and LinkedIn, Twitter also faces competition from up-and-coming startups such as Instagram, the wildly popular photo-sharing app owned by Facebook, Pinterest Inc. and even the likes of Snapchat, a service that lets users send photos and videos that disappear in less than 10 seconds. There’s also a host of emerging social networks for niche audiences.

“Users’ attention and time is becoming more fragmented, and so is the advertising revenue,” says Larry Chiagouris, a Pace University marketing professor who studies social media.

Last week, Facebook surprised investors by acknowledging that fewer young teenagers are logging in to its site daily, a trend that threatens to undermine the social network’s vitality. This hasn’t emerged as a major problem for Twitter, but it probably will have to keep spending heavily to develop features to keep the younger part of its audience hooked.

One of the company’s biggest problems may present its greatest opportunity. Most of Twitter’s user growth is outside the U.S. at the same time that the company has gradually introducing more advertisements on its service. The ads have quickly turned into Twitter’s main source of revenue, which has soared from just $28 million in 2010 to a projected $650 million this year.

Even so, there’s unevenness in the way Twitter generates its ad revenue. Just 26 percent of its revenue comes from abroad, even though more than three-quarters of its users – about 179 million people – live outside the U.S. Put another way, Twitter generated $2.36 per U.S. user in the July-September quarter compared with just 24 cents per user in the rest of the world. Facebook, by comparison, generated 52 percent of its revenue outside the U.S. in the same period, fetching an average of $4.83 per U.S. user and $1.07 per international user.

The dramatic imbalance between Twitter’s international revenue and its audience size abroad means the company isn’t getting enough of a return on its investment into making sure the service works smoothly for users outside the U.S.

In its IPO documents and video presentation to prospective investors, Twitter says it plans to bring in more international revenue by hiring more sales representatives in Australia, Brazil, Ireland and the Netherlands. The company also says it will introduce technology that will make it easier for marketers in other countries to buy ads.

Ramping up advertising growth will be difficult in many countries that lack the affluence and marketing-driven culture of the U.S., predicts Andrew Sheehy, an analyst at Generator Research.

In its IPO documents, Twitter listed Saudi Arabia, Russia and South Africa among the countries where it expects to gain a significant number of users in the next few years.

“Unfortunately, the international side of Twitter’s business is less of a monetize-able beast than the U.S. is,” Sheehy says. “This dynamic is not going to go away overnight.”


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