In Twitter’s IPO Filing, Reasons for Concern

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Twitter’s planned initial public offering is among the most anticipated in recent years. Millions of people worldwide use the service to vent about politics, check news headlines and follow Miley Cyrus.

But in a regulatory filing Thursday, Twitter confirmed a more modest financial reality: It’s a perennial money loser. The company hemorrhaged $69 million in the first half of this year, an increase of 40% from the same period in 2012.

That is just one of the many revelations in IPO filing highlighting Twitter’s challenges. Although Twitter, the service, is wildly popular, its business is still evolving.

The filing is intended to help investors decide whether to bet on Twitter, a company with 215 million monthly users who post nearly 500 million messages daily. The company had initially filed the paperwork in July, but it kept the details secret until now under a recent federal law. Twitter said it’s hoping to raise $1 billion in the offering, although that amount is only an estimate and could change later on. The actual IPO could come by the end of the month based on a requirement that companies wait three weeks after making their filing public before pricing the offering.

A big reason for Twitter’s financial shortcomings is that, for most of its brief history, the company made no effort to make money. After introducing the microblogging service in 2006, executives focused on adding new users and fixing the underlying technology to stop the frequent crashes.

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Only in the past few years has Twitter gotten serious about selling advertising, which appears above messages from users. Even then, it took the company a while to find the right formula and then entice marketers to give the service a try. Twitter’s revenue was $139 million in its most recent quarter, more than double from the same period in 2012. The company annual ad revenue is expected to reach $583 million this year, according to eMarketer.

Sizable? Yes, but hardly gargantuan. Other tech companies with a similar buzz had far bigger businesses along with actual profits when they filed for their IPOs. Facebook, for example, had $1.1 billion in revenue and $302 million in profits in the quarter prior to going public in 2011. Google had $652 million in revenue and $64 million in profits the quarter before its IPO in 2004.

Twitter plans to go public before reaching comparable maturity. The timing is no doubt influenced by early investors wanting to cash out, a desire to fill the company’s coffers for future spending on acquisitions as well as Wall Street’s renewed appetite for Internet IPOs.

Still, Twitter must overcome a pall cast by several poorly received IPOs in recent years like those of online gaming company Zynga and Groupon, the deals site. Facebook, despite its strong financials, also left many investors scared after its shares nose-dived in their public debut, only to recover in recent months. (That debut was also marred by technical trading glitches.)

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Twitter must show that its advertising business can continue its strong growth. There are a few signs of concern. For example, ad rates—what the company charges marketers per “ad engagement”—tumbled 46% in the last quarter. The drop continued a downward spiral that started a year ago.

Twitter must also add as many new users as possible to help lift ad revenue. But growth in recruits is slowing. Twitter’s monthly active users rose 7% in the most recent quarter. In the previous three quarters, the rate was 10% or 11%.

Another problem Twitter needs to address is its international ad business. People overseas, who make up three-quarters of the service’s users, generate just 25% of all revenue.

Steve Blank, a veteran Silicon Valley technology executive who is now a lecturer in entrepreneurship at University of California at Berkeley, voiced confidence that Twitter will build a strong business. Only a serious mistake can keep the company from thriving given its millions of users and smart leadership, he said. “This is not one of those fluffy, no revenue, no users and no trajectory kind of companies,” Blank said. “It’s not the bubble again. This company has a high intrinsic value.”

On the positive side, Twitter is well positioned—perhaps the best of any major Internet company—for the shift to mobile devices from desktop computers. Already, users on smartphones and tablets account for 65% of all ad revenue, a number that is expected to grow.

Dick Costolo, Twitter’s chief executive, tried to show it was business as usual amid the frenzy that followed the IPO filing being made public. Like on any other day, he tweeted whatever was on his mind—including a short video clip of Grover, the Sesame Street character.

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