Latepost Twitters Bar Mitzvah! Is Social Media Coming Of Age?

Life's transitions, from single to married, from renter to homeowner, as well as from employed to retired, simply to holler a few, are never easy, since the rules change, every bit exercise the measures of success as well as failure as well as that is maybe the argue that they are accompanied past times ceremonies (weddings, housewarming, retirement parties). The life of a draw organisation is also total of transitions, as well as non alone are they simply every bit hard for investors, traders as well as managers, but they oftentimes occur without ceremony, as well as tin move unnoticed. In the final iii years, social media companies remove hold claimed centre position inwards marketplace conversations, outset when they went populace at prices that old-time value investors found inconceivable, as well as hence every bit their ups as well as downs became part of marketplace lore. In the final few weeks, nosotros remove hold seen this fascination amongst social media companies play out again, outset inwards the marketplace reaction to Mark Zuckerberg's post service earnings statements close Facebook's hereafter investment needs as well as hence inwards Twitter’s struggles to reclaim its narrative at its analyst coming together final week. I teach a feel that nosotros are on the cusp of a transition, where the fourth dimension for pure storey telling (and its metrics) is ending as well as to a greater extent than traditional metrics (revenues, profitability) volition come upwardly to the fore. That does non presage, every bit some are suggesting, the terminate of the social media party as well as a collapse of social media marketplace capitalizations, but it does hateful that investors, traders as well as managers remove hold to recalibrate to a unlike game, where they volition survive judged non on pure sector momentum but on their capacity to cull winners from losers as well as respect the correct metrics for making those judgments.

The Business Life Cycle: Investing as well as Valuation Dynamics

In an earlier post, I made the argument that the centre of gravity inwards both valuing as well as pricing shifts every bit a draw organisation evolves from an stance to a production to a profit-generating business. The figure below summarizes those shifts as well as expands on the implications.

When a draw organisation is at the stance stage, both value as well as cost are driven past times marketplace potential as well as by narrative, rather than numbers. As the draw organisation transitions to a production phase, the questions move to a greater extent than specific, amongst both investors as well as traders looking at how good the product/service attracts customers, amongst usage statistics driving pricing. Further along the life cycle, the show becomes whether usage tin survive converted to revenues as well as revenues to profits, amongst numbers driving narrative. The tabular array also highlights what I view every bit the biggest dangers at each stage of the life cycle. In the early on phases, the dependence on the macro storey (the macro delusion) can atomic number 82 investors to value companies inwards a promising marketplace every bit good highly, inwards the aggregate. The perils move to a greater extent than company-specific every bit you lot displace through the life cycle.

The Social Media Reality Checklist

The social media sector is a immature one, amongst fifty-fifty its most established companies are soundless alone a few years old, fifty-fifty if you lot throw Google into the mix. In the final iii years, the outset moving ridge of social media companies remove hold been listed inwards populace markets as well as investors remove hold had to cost them. Using the life bicycle framework developed inwards the final section, these companies were priced using “macro” stories close marketplace potential (online advertising) generally, amongst revenue drivers (number of users, subscribers or downloads) to a greater extent than specifically determining marketplace standing. That is neither surprising nor irrational, as well as reflects what investors remove hold typically done inwards other immature sectors (dot com inwards the 1990s, for instance) inwards the past.

As the social media sector ages (and technology scientific discipline companies should remove hold their lives measurement inwards dog-years, aging much faster than the ease of the market), the enquiry becomes whether nosotros are approaching a transition point, where investors start bespeak to a greater extent than pointed questions close revenue growth (and what it is costing) as well as profitability. I may survive jumping the gun but the market’s shocked reaction to when I valued Twitter for its IPO, a companionship that was promoted for its online advertising potential, I examined this enquiry past times looking at both the size of the overall advertising marketplace as well as what pct of it was inwards online (digital) advertising. Recapping as well as updating, global advertising revenues remove hold grown close 4% a yr for the final v years, as well as online advertising has surged from less than 5% of total advertising revenues, inwards 2008, to 25.76% of revenues, inwards 2014, amongst an increasing portion attributable to mobile advertising. Allowing for growth inwards the total advertising marketplace as well as an growth inwards the online advertising percentage of it yields an estimated marketplace of betwixt $209 billion as well as $323 billion for the entire online advertising marketplace inwards 2023. It is this marketplace that social media companies are competing for as well as the revenues for each of them has to survive measured against this whole.

The Online Ad marketplace is getting to a greater extent than competitive: The growth potential of the online advertising marketplace is attracting novel entrants, some of whom are soundless private (like Snapchat) as well as some inwards the procedure of beingness created. While much of the initial growth inwards social media companies has come upwardly at the expense of other types of advertising (print media, inwards particular), growth volition move harder to respect every bit online advertising becomes a larger piece of the pie. It is a given that at some point, sooner rather than later, the revenue growth at 1 online advertising companionship volition remove hold to come upwardly at the expense of some other online advertising company. Thus, if you lot assume that Twitter volition remove hold revenues of $35 billion inwards a decade, you lot volition hence also remove hold to position the losers inwards the marketplace (Facebook? Google?). This additional contest volition also atomic number 82 to pull per unit of measurement area on operating margins, amongst companies cutting prices to teach revenue growth, making the merchandise off betwixt revenue growth as well as profitability forepart as well as center.

Growth volition move to a greater extent than expensive as well as the accounting volition rest opaque: As social media companies compete for a slower-growing online advertising market, they volition remove hold to reinvest to a greater extent than to generate growth. That reinvestment, though, volition oftentimes select forms that accountants soundless exercise non categorize every bit working capital missive of the alphabet expenditures as well as volition non present upwardly inwards residual sheets (as assets) or on cash current statements (as working capital missive of the alphabet expenditures). It volition select the cast of R&D, client acquisition costs, production evolution costs or acquisitions of other companies inwards the infinite (often amongst stock, rather than cash) as well as none of these are dealt amongst good or consistently past times accountants. Customer acquisition costs, R&D as well as production evolution costs are treated every bit operating expenses (when they should survive considered to survive working capital missive of the alphabet expenditures) as well as stock-based acquisitions oftentimes disappear into sparse air (or the footnotes to fiscal statements). The termination of this confusion is that fiscal statements for social media companies don’t mensurate what they claim to: income statements exercise non mensurate earnings, residual sheets exercise non reverberate the assets owned as well as the working capital missive of the alphabet invested to teach them as well as cash current statements are skewed past times the usage of equity (to compensate employees as well as pay for novel investments).

While all of these remove hold been truthful for the entire existence of social media companies, they tin survive glossed over inwards the early on phases but cannot (and should not) survive overlooked every bit companies age.

Market Consequences

If you lot purchase into the notion that a transition is coming, at that spot are predictable consequences for investors as well as markets:

Unexplainable volatility: During transition periods, at that spot volition survive struggles that play out inwards markets betwixt investors on either side of the transition, some belongings on to the old metrics as well as measures as well as others moving on to novel metrics. With social media companies, the old volition include investors who soundless focus on users as well as user intensity measures to cost companies, whereas the latter volition facial expression at revenues, investment as well as earnings. The marketplace volition reverberate this schizophrenia on the part of investors, amongst wild as well as completely unpredictable swings inwards prices, every bit 1 grouping or the other tries to assert its dominance.
Market milkshake out: As the focus shifts to revenues as well as earnings, the marketplace volition start culling the herd, knocking downward the prices of the losers as well as sustaining the pricing of the winners. The game volition alter for both traders as well as investors; traders volition no longer survive able to ride sector momentum (as they tin inwards the early on phases of a life cycle) as well as investors volition respect a bigger payoff to focusing on fundamentals.
Macro to micro focus: When a sector is young, the game belongs to the storey tellers as well as specially those who tell macro stories (about shifts inwards the draw organisation as well as disruption). As the sector matures, it shifts to those who convey the to a greater extent than prosaic skills of assessing private companies to the forefront.

If this is a transition, at that spot is stormy conditions ahead but that tin move to your advantage, as well as if you lot tin maintain your wits as well as teach inwards through, you lot volition survive rewarded.

Advice (unsolicited as well as maybe unwelcome) for social media companies

If life bicycle transitions are hard for traders as well as investors, they tin survive fifty-fifty to a greater extent than shocking for managers as well as specially hence for those who were successful playing the old game. With social media companies, for instance, where increasing the break of users as well as user intensity has created positive payoffs for the final few years, managers volition remove hold to alter how they deal companies, what they emphasize inwards earnings reports as well as how they frame their narratives. This is non going to come upwardly easily or without pain, fifty-fifty for the most successful as well as adaptable managers . I know that the they volition teach lots of advice (and volition pay for it) from consultants as well as bankers, but hither is mine, if they care:

Manage for investors, non analysts: Don't operate nether the presumption that the equity enquiry analysts that tout your stock are marketplace leaders as well as tendency setters. Equity enquiry analysts are to a greater extent than followers than leaders, creatures of momentum rather than arbiters of value as well as catering to their fickle demands volition non protect your stock from getting battered, if the marketplace mood turns.
Be opened upwardly close investment needs as well as marketplace challenges: Growth is never gratuitous as well as patch at that spot are some investors who are willing to survive deluded, most sensible investors would prefer honesty from you, where you lot lay out the costs that you lot recollect you lot volition ship inwards your pursuit of growth. It is this context that I recollect Mark Zuckerberg was correct to acknowledge what should remove hold been obvious from past times history. Facebook is spending large amounts of coin to maintain its pathway to potency of online advertising. (After all, they simply spent $22 billion consummating the Whatsapp acquisition.)
Be transparent inwards your accounting: Dispense amongst the games that you lot may remove hold played inwards the past. Stop adding dorsum stock-based compensation to come upwardly up amongst adjusted EBITDA as well as acting similar acquisitions made amongst stock actually cost you lot nothing. It is truthful that accounting rules are neither logical nor consistent as well as that you lot may survive bound past times them inwards preparing your fiscal statements, but your pro-forma statements tin survive used to reveal to a greater extent than close your draw organisation (rather than to obscure it).

It was through these lens that I looked at Twitter's presentation to analysts during Twitter Analyst Day inwards San Francisco. While Anthony Noto, Twitter's CFO, may remove hold impressed investors (to movement the cost to jump 7.5%), old habits drib dead hard as well as the presentation violates all iii of my suggestions: the utter was tailored to analysts (violating dominion #1), at that spot was no lift inwards the presentation of how much Twitter volition remove hold to pass to grow (violating dominion #2) as well as the study culminated amongst the obligatory adjusted EBITDA (completing the violation trifecta). There were, however, moments of substance, specially on what the companionship sees every bit its revenue path for the long term. In add-on to presenting tweaks to the production (improved fourth dimension line, boosting video as well as improving interaction), Mr. Noto announced that the companionship intended to survive "one of the top revenue-generating Internet companies inwards the world", pushing implicitly to survive set inwards the companionship of Google as well as Facebook as well as provided analysts amongst his projection for Twitter's revenues over the side past times side decade:

Source: Twitter's presentation at Analyst Day

I must confess that I was underwhelmed past times the terminate number, as well as hither is why. In a post service inwards August 2014, I valued Twitter at $22.53/share, amongst a projected revenue of almost $15.2 billion inwards 2024. If the projection inwards Twitter's ain graph for revenues is credible, I may remove hold been a trivial every bit good optimistic inwards my valuation; using a $14 billion revenue approximate inwards 2024 yields a value per percentage of $20.81. Put to a greater extent than bluntly, for Twitter to survive valued at to a greater extent than than $41.85/share (the cost on Nov 14, 2014), you lot would demand a lot to a greater extent than revenues than Mr. Noto is projecting inwards this graph for 2024. The tabular array below lists breakeven points to justify today's price:

Valuation spreadsheet: TwitterAug2014.xls

Twitter has its move cutting out for it. It has to either respect ways to grow much faster than it is projecting or it has to move at bringing investor expectations down, amongst the caveat that at that spot are no soft landings for high-flying companies. If online advertising remains Twitter's primary business, getting the break-even revenues ($30-$40 billion) volition survive problematic, partly because of external factors (more contest as well as express advertising budgets) as well as partly due to internal constraints (limits on the sponsored tweets users volition select inwards their fourth dimension lines). There remains the possibility, maybe fifty-fifty a probability, that Twitter volition survive able to respect other ways to monetize their user base of operations (retailing, for instance) but that is a move inwards progress, as well as the operating margins inwards these novel businesses volition non come upwardly closed to the 25% operating margin that I am assuming for the online advertising business.

Transition Breaks
As I watched as well as read close the Twitter extravaganza, I was reminded of the ancient Jewish tradition (mirrored inwards other religions) of "bar mitzvah". In that ceremony, a Jewish adolescent "come of age", studying the Torah as well as amongst the guidance of a rabbi. The ceremony is designed to set the basis on notice that the shaver has move an adult, amongst the associated responsibilities as well as accountability. Realistically, no 1 expects overnight changes, since a teenager volition soundless survive a teenager after the ceremony, but it soundless serves every bit an of import reminder that the rules are changing. As an aside, the seeking out of venture working capital missive of the alphabet past times a start-up tin survive analogized to a much before as well as to a greater extent than painful ceremony that all Jewish babe boys remove hold to move through, amongst the hurting of giving upwardly a piece of your draw organisation going amongst the relief when it is done.

Though the notion of a ceremonial coming-of-age for companies may strike you lot every bit outlandish, that is the usage that getting listed inwards a public marketplace played inwards the decades before the 1990s. Thus, companies similar Apple as well as Microsoft both had established draw organisation models before they went populace inwards the 1970s as well as 1980s. The rules changed inwards the 1990s, when dot-com companies leapfrogged the procedure to move populace much before inwards the life cycle, as well as every bit that tendency has continued inwards the social media space, investors as well as managers remove hold invented novel (and sometimes bizarre) metrics to cope. It may non survive a bad stance to remove hold the equivalent of corporate bar mitzvahs, where investors, traders, as well as managers are reminded that a companionship has come upwardly of age. My 1 reservation amongst Twitter's bar mitzvah was that Anthony Noto, Twitter's CFO, seemed to survive playing the usage of the rabbi (because of his street cred amongst analysts) inwards the ceremony, amongst equity enquiry reports operating every bit scripture. I recollect it is wisdom, non street credentials, that you lot facial expression for inwards a rabbi as well as timeless truths, non passing glory, inwards your holy books. The Twitter ceremony would remove hold been a lot to a greater extent than persuasive, if Warren Buffett had been officiating, reading out of Ben Graham's Security Analysis. Perhaps, side past times side time!