After Facebook and Groupon Stumble, a Cautious IPO for Twitter

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A surprise tweet announcing that Twitter has made a confidential filing to go public has sparked a frenzy of speculation about what the company may be hiding. “Twitter’s IPO Filing: What’s the Big Secret?” asked Forbes. “140 Reasons to Worry about Twitter IPO,” read a headline in USA Today. And on Reuters: “Twitter’s ‘Secret’ IPO Puts Investors in the Dark, for Now.”

While observers have been waiting for Twitter to go public for a while, the company’s September 12 announcement about its choice to make a confidential securities filing was unexpected, and it fueled rumors that all was not well with the company.

But Lawrence G. Hrebiniak, an emeritus professor of management at Wharton, says the move was likely more due to a desire for caution following controversial IPOs by Facebook and Groupon. “Twitter is testing the waters. It’s playing it safe,” Hrebiniak notes. “It is also trying to avoid all of the publicity, hoopla and rumor generation that marked the Facebook debacle. It simply wishes to take things slowly and deliberately, get SEC feedback and then decide what to do.” Meanwhile, the micro-blogging site is also laying the groundwork for generating a steady revenue stream from the 140-character updates and short videos posted by its users.

The company is taking advantage of a provision in the 2012 Jumpstart Our Business Startups (JOBS) Act, which allows small firms with less than $1 billion in revenue to keep their draft filing for an IPO confidential. “[Twitter] must release its data at least 21 days before marketing the IPO, which, in today’s high-speed cyber world, is more than sufficient for investors and others to examine and evaluate the company,” Hrebiniak says.

The goal of the JOBS Act, which President Obama signed into law in April 2012, is to make it easier for smaller companies to get access to capital, with the idea being that as the firms expand, they would hire more people. The JOBS Act created a new category of firms called “Emerging Growth Companies” with a revenue cap of $1 billion. Such companies have up to five years after going public to comply with certain Sarbanes-Oxley auditing rules, compared with two years for traditional IPOs. Another perk is that the legislation allows those firms to make confidential S-1 filings with the SEC.

The JOBS Act is popular among businesses that qualify for its so-called “secret IPO,” including MGM Holdings, the parent of movie studio Metro-Goldwyn-Mayer. From January to mid-September, two-thirds of the 131 IPOs that have been priced were filed confidentially, according to Renaissance Capital, an IPO research firm in Greenwich, Conn. Based on historical trends, Renaissance said, Twitter could file a public S-1 this year and price its IPO to go public in early 2014.

“Twitter is testing the waters. It’s playing it safe. It is also trying to avoid all of the publicity, hoopla and rumor generation that marked the Facebook debacle.” — Lawrence G. Hrebiniak

A confidential IPO is different from a traditional IPO in that, among other things, the latter requires a company to make an IPO filing public even if it does not have all the necessary information yet. As data is added or amended, the company makes additional public filings leading up to the IPO itself. “The typical IPO sees many amendments,” notes Luke Taylor, a Wharton finance professor. “My forecast is that we’ll see fewer amendments for Twitter because [the company] has have been going back and forth with the SEC.”

By keeping the S-1 private until three weeks before marketing the stock to investors in a road show, which precedes the IPO, a company can delay public scrutiny on any dealings with the SEC that might damage the public’s trust in the business. Investors will eventually see any changes the SEC has required, but as attachments to a cleaner filing that has been vetted by regulators.

Airing disagreements with the SEC in public can hurt a company’s reputation. Groupon’s standing among investors was damaged when the SEC questioned an accounting metric the company used called the adjusted consolidated segment operating income (ACSOI). The metric excluded Groupon’s substantial costs for marketing and acquiring new customers. Under ACSOI, Groupon posted operating income of $60.6 million for 2010. Using standard accounting rules, it posted an operating loss of more than $400 million the same year. The firm went public in 2011.

Fuzzy Metrics

Twitter might be trying to avoid a similar public battle with the SEC. As a social networking company, some of its internal metrics fall into an accounting gray area. For instance, assessing the value of a Twitter follower will be harder to establish than traditional measurements. Such fuzzy metrics could lead to trouble with the SEC.

“Evaluating the soft metrics of companies in the social media space isn’t always straightforward or easy, so Twitter is looking for the SEC’s feedback and implicit reaction to its data,” Hrebiniak points out. “I’m sure it’s not hiding anything; the process will uncover all of the relevant data eventually, so hiding stuff and playing games are silly, and I’m certain this isn’t the company’s logic behind the confidential filing.”

Another benefit of filing secretly is that the company delays divulging information that could benefit rivals, such as trade secrets and level of profitability. “Twitter is not giving competitors an early chance to see its financial and strategic data,” Hrebiniak says. Even a delay of a few months could make a difference in a market with few or no barriers to entry, Taylor adds.

Moreover, in a confidential filing, a company can opt to cancel its IPO in secret and avoid any conjecture that something went awry. This way, Twitter avoids any second-guessing. But then, filing a secret S-1 has its own downside. “There will be a public perception in the market that you’re not being optimally transparent,” says Andrea Matwyshyn, a Wharton professor of legal studies and business ethics. When the filing becomes public, “your documents will likely be subject to greater scrutiny.”

Facebook’s IPO in May 2012 was the poster child of what could go wrong in a high-profile IPO. Lead underwriter Morgan Stanley was criticized for over-pricing the offering, while in the midst of the road show the firm’s Internet analyst cut his Facebook growth projections. Nasdaq botched the early hours of the first day’s trade, resulting in lawsuits and an SEC fine. Then, investors expressed concern about Facebook’s slowing growth and monetization strategies, which fueled a sell-off in ensuing months.

It took more than a year for Facebook shares to rebound, and the company is now worth around $116 billion. Twitter, once it goes public, is expected to be worth $10 billion or more. Twitter investor Prince Alwaleed bin Talal of Saudi Arabia has said he heard the company is worth $14 billion to $15 billion, but its value might even be higher, according to a September 15 story by Reuters. At one-eighth of Facebook’s market cap, Twitter has far fewer users as well. In February, Twitter disclosed that it has more than 200 million active users. Facebook has 1.15 billion worldwide.

In the secondary market, where insiders of private companies can sell their shares, Twitter recently received offers from hedge funds to buy shares from its employees and investors at $26 to $28 per share, which would value the company at $14 billion, tech blog GigaOM reported on September 12, citing anonymous sources. Previously, Twitter had been trading at $18 to $22 per share.

What to Look for in Twitter’s IPO

“The Twitter IPO will be interesting to watch,” Matwyshyn notes. As one of a handful of high-profile social networks, the company will be scrutinized over how it plans to generate more revenue. One metric to watch is the value Twitter places on consumer-generated content, she says.

Matwyshyn will look at Twitter’s growth pace as well; Facebook’s slowing growth was a worry to investors. “Some of the similar concerns exist,” she notes. Finally, she wants to know whether Twitter will continue to commit to user privacy protections. “It has been more aggressively protective of users’ privacy than other companies.”

But Wharton operations and information management professor Eric K. Clemons prefers to consider the long-term investment potential of Twitter instead of the immediate bump from the typical IPO. Overall, he’s not optimistic about the company’s future. “Does the world really need a broadcast short message service?” asks Clemons, who once predicted AOL’s decline. “What is the business model?”

“Not everything is monetizable through ads.” — Eric K. Clemons

He adds that others could replicate Twitter’s service. “What can [Twitter] do that LinkedIn and Facebook can’t do? What are their differentiators? What are their barriers? What will it take for LinkedIn or Facebook to [add] a broadcast facility that allows you to tweet in much richer messages?”

Then there is the issue of consumer behavior. Companies like Facebook and Twitter are known for social interaction, but socializing is not the same as selling. Clemons notes that when people socialize, they behave differently than when they are marketing a product or service. People usually do not mix the two. “[For example,] have you ever given a speech as a best man or maid of honor? Did you try to sell anything during your speech?” he asks. The folly of social networks is that they are trying to combine two disparate behaviors, Clemons argues.

Twitter currently makes money from ad revenue that it raises in three ways: promoted tweets, promoted trends and promoted accounts. Advertisers pay to have promoted tweets inserted into the message flow seen by users who are targeted by keywords, interests, gender, geography and other factors. With promoted trends, advertisers pay to be at the top of Twitter’s trending topics list for a whole day. The tweet is clearly labeled “promoted.” Twitter also makes money through promoted accounts. Advertisers seeking more eyeballs can pay to be at the top of the site-generated recommendation list of accounts to follow.

Glued to the Set

Twitter also wants to build more business around television. According to social TV analytics firm Bluefin Labs, which Twitter owns, 95% of live social media conversations related to TV programming take place on Twitter. Twitter partners with broadcasters and advertisers in its Amplify program to co-sponsor tweets. For example, ESPN and Ford collaborated on tweets featuring instant replay clips of college football bowl games.

Shawndra Hill, a Wharton professor of operations and information management, suggests that Twitter faces competition in this arena from Facebook, which recently announced that it would make posted comments about TV public. Facebook’s initial partners are select news organizations such as CNN and NBC’s Today show, which will integrate social media conversations into their broadcasts in real time.

What makes Facebook even more formidable is that it can also see the demographic make-up of people discussing a certain topic. Twitter does not have the kind of detailed user information that Facebook possesses, Hill says. One can infer details about Twitter users based on what they tweet, but more personal information is not known. Twitter is working to remedy this shortfall, but it has a ways to go. Meanwhile, Facebook senses an opportunity. “Facebook is going after the space pretty aggressively now,” Hill notes. “It will be interesting to see how the competition yields new solutions.”

In addition, Twitter is entering the mobile ad serving and ad exchange business with the recent acquisition of MoPub, a start-up that produces mobile banner advertising and interstitials, or ads that show up as users wait for a web page to load. MoPub’s ad exchange business lets advertisers bid and place their mobile ads in real time.

Twitter is expected to post global ad revenue of $582.8 million this year and nearly $1 billion in 2014, according to eMarketer. Fifty-three percent of ad revenue will come from mobile; revenue from that source was nearly non-existent two years ago. By 2015, eMarketer expects Twitter to post $1.33 billion in global ad revenue, of which 60% will come from mobile, the research firm said.

But Clemons remains skeptical: “Not everything is monetizable through ads.”

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