Challenges abound for Twitter heading into IPO

SAN FRANCISCO (AP) — 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 through the online messaging service, more than 500 million posts are shared each day by everyone from the Dalai Lama to Justin Bieber.

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.

Twitter’s IPO promises to be another touchstone in the Internet’s evolution from a geeky backwater to a wellspring of world-changing innovation and jaw-dropping wealth. In that sense, the company’s stock market debut shares parallels with the IPOs of two rivals: 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. By contrast, Twitter’s coming out is a throwback to the late 1990s, a more perilous time in Internet investing — when hundreds of dot-com companies completed IPOs without ever having earned a profit.

“They have a nice and interesting base to build upon, but an exciting business with lots of users doesn’t necessarily generate returns,” says James Gellert, CEO of Rapid Ratings, a subscription service that examines the financial health of companies.

Rapid Ratings gives Twitter’s financial fitness a rating of 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. By comparison, the firm rated Facebook at 73 just before its May 2012 IPO and Google at 80 ahead of its August 2004 offering.

With 232 million users and an IPO poised to raise as much as $2 billion, Twitter is unlikely to go bust like so many of the companies that disappeared after the dot-com bubble burst in 2000.

So many investors are optimistic about the company’s future that Twitter on Monday seized on the demand for its stock and raised the projected price range of its IPO to $23 to $25 per share, up from an earlier target of $17 to $20. The stock is expected to begin trading on the New York Stock Exchange on Thursday morning after setting a final price sometime Wednesday evening.

Despite that enthusiasm, Twitter faces a slew of hurdles that range from an outsize proportion of international users —who generate less revenue than their U.S. counterparts— to concerns about a slowing rate of growth at a time when its user base is less than a quarter of Facebook’s.

Although they both compete for people’s attention and posts, Twitter and Facebook work differently.

Facebook gives its users control over who’s in their social circle and which of their online friends can see specific posts. Twitter is set up so users can “follow” anyone — whether it’s a celebrity, politician, sports star or a pithy teenager — who also has an account on the service. This flexibility makes Twitter like an open book that can be read by anyone. Unlike Facebook, Twitter restricts each post on its service to no more than 140 characters.

Twitter’s openness has left the service with a bit of an identity problem. While Facebook is known as a to connect with friends and family and LinkedIn is the go-to place for exploring career opportunities, Twitter’s purpose is more difficult to define, says Scott Kessler, an analyst with S&P Capital IQ.

In its IPO paperwork, Twitter highlights the simplicity, accessibility and spontaneity of its service and depicts it as one big conversation. Gartner analyst Brian Blau believes many people see it as a “giant party line.”

Blau’s analogy is apt. Long before Twitter, a party line was a telephone line shared by multiple subscribers. Think of it as a line for you, your neighbor and maybe Mrs. Smith around the corner. In rural areas, an entire town might share a single party line. If the line was in use, other subscribers could pick up their telephone and either eavesdrop or join the conversation.

Jumping into the discussion is alluring to the chatty and vivacious, but intimidating for those who are still unsure of their voice. Twitter will have to find ways to get more users to overcome their timidity so they become more active — and more attractive targets for advertisers. According to a recent Associated Press-CNBC poll, 29 percent of people with Twitter accounts never tweet at all.

Twitter’s user growth is already slowing, triggering alarms among some analysts. 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 the following December. Facebook, only two years older than Twitter, now has 1.2 billion users.

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 such as members of the military, the visually impaired, doctors and people who want to connect with their neighbors.

“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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