The definitive Twitter value play

By Felix Salmon
November 7, 2013

Twitter is about to raise more than $2 billion, on a valuation of more than $18 billion, in its IPO. At some point on Thursday morning, an opening price for the stock will be set — a price which will almost certainly be north of the official IPO price of $26 per share — and after that, it’s off to the races. Will Twitter stock go up? Will it go down? Is it a buy? Is it a sell? Is the company worth what the market says it’s worth? It’s a pretty silly game to play, at heart, since no one has a clue what the answers are, not even Twitter’s underwriters, who had to raise the valuation of the company twice.

Still, silly games are often the most fun, so, go knock yourself out with the official Breakingviews Twitter valuation calculator! Or, you can use Lex’s version, which is a relatively pure discounted cash flow model, not dissimilar to the back-of-the-envelope calculations by which the Economist managed to come to a “reasonable” valuation of $18 per share. Anything north of that level, intones the venerable weekly, constitutes “a poor long-term investment”.

But the fact is that when it comes to valuing a technology stock, it’s stupidly easy to get any number you want. Here’s one extreme: the valuation of any company should be equal to the net present value of its future dividends. Twitter is going to pay no dividends for the foreseeable future, therefore, its value is zero. Or, here’s another extreme: Twitter should easily be able to generate $5 billion a year in revenue pretty soon, and grow to that level very quickly, which would justify a multiple of, I dunno, 12X revenues. Which would mean a capitalization of $60 billion, or about $110 per share.

The point is that any valuation for Twitter is a result of guess upon guess upon guess. Take Henry Blodget’s attempt, for instance. We know with reasonable certainty that Twitter is going to generate about $625 million in revenue this year, so why not treble that number, and declare that its revenues are going to grow to $2 billion in 2015. Then, multiply that number by 10, since that’s more or less where Facebook and LinkedIn are trading — and you get a valuation of $20 billion, or about $35 per share.

If you wanted to get a bit more sophisticated, you could try using probability distributions instead of hard numbers — but we have no more insight into the probability distribution for Twitter’s 2015 revenues than we do into a single forecast for those revenues. And there are certain valuation metrics, like “the amount of money Twitter might get bought for”, which are even more tenuous — yet clearly important.

So if anybody has any real conviction, one way or another, with regard to whether Twitter’s stock is overvalued or undervalued, you can be pretty sure that they don’t really know what they’re talking about. It’s going to be a trading vehicle for the first few days, with investors jockeying to get in or out at the best possible price. All of which is going to make the price-discovery process even more drawn-out and unreliable than it normally is. We are living, after all, in a world where a single bitcoin is worth more than $250, even though it has no cashflows at all.

So how is the individual investor supposed to navigate these treacherous waters? It’s actually incredibly easy. And it works like this. Twitter’s profits, if and when they ever appear, are going to be some fraction of its revenues. Its revenues, in turn, are going to be some fraction of the value it provides to its users. I have personally already extracted many thousands of dollars in value out of Twitter, over the past five years, and it hasn’t cost me a penny. On an ROI basis, I’m doing unbelievably well — and my returns are only going to keep on growing into the future.

Here’s my advice, then: take the amount of money you were thinking of investing in Twitter, and divide it by the rate at which you value your own time. So, if you were going to invest $5,000 and you value your time at $50 per hour, then you’d end up with a figure of 100 hours. Then, instead of spending the $5,000 on Twitter stock, spend 100 hours on Twitter: the cost is the same. The value you get from being on Twitter — from interacting with people you admire, from learning new things, from being able to express yourself so easily and concisely — will be much greater than the value you’d ever get from buying $5,000 of Twitter stock. And you’ll still have $5,000 left over to do whatever you want with, whether it’s putting it into some other investment or spending it on something awesome — a holiday, perhaps, or a gift to a friend, or even some fine wine.

Twitter is an amazing platform, where nearly all of the value ultimately accrues to the people who use it. If you don’t use it, you’re missing out. And maybe you think that it’s a silly distraction, and that you don’t have the time for such things. If you do think that way, then go ahead and buy yourself that time, with the money you were thinking of investing in Twitter stock. Leave the noise trading to others: you’ll be on to a much more certain thing.

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