Today Is a Major Test for Twitter

'What gets my mom to sign up for your service?' asks one Wall Street analyst

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Sam Gustin / TIME

Twitter's logo is seen at the New York Stock Exchange on Nov. 7, 2013, before the company's $1.8 billion initial stock offering.

Eight years ago this March, Jack Dorsey sent the first Twitter message. Although “just setting up my twttr” may not have been as ambitious as “What hath God wrought,” there is little doubt that Dorsey’s Tweet will go down as one of the most important text messages in modern communications history. Since then, Twitter’s short-character format has become a global craze, embraced by politicians, celebrities, corporate giants and millions of citizens around the world.

Twitter’s impact on society is evident, and like fellow transformative tech titans Google and Facebook, the company has a lofty mission: “To give everyone the power to create and share ideas and information instantly, without barriers. On Wednesday, Twitter will confront a somewhat more prosaic challenge when it tries to convince Wall Street bankers that it is worth $36 billion despite barely any profits. It’s the company’s first quarterly earnings report since going public last November.

As Twitter has exploded in popularity, the company has followed a now-familiar startup strategy: Build a massive user base first and worry about revenue later. Twitter has largely avoided plastering annoying ads into the service lest it alienate its fiercely loyal user base. Now, as a public company, the time has come for Twitter to explain its profit-making potential, according to Wall Street analysts.

Many on Wall Street are taking a wait-and-see approach, with several top analysts warning that the company is currently overvalued. Since going public, Twitter stock price has increased by nearly 50% — and that’s on top of the company’s 73% first day pop.

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Corporate America appears enthusiastic about Twitter’s commercial prospects — at least for them. Nearly half of all the ads aired during last weekend’s Super Bowl incorporated Twitter in one way or another, according to Scott Devitt, a tech analyst at Morgan Stanley. Still, Devitt says he’s “concerned that shares appear to price in a high likelihood of long-term success absent stronger evidence of mainstream adoption.” Twitter needs to keep adding millions of users in order to grow into its sky-high market valuation. “The question is: ‘What gets my mom to sign up for your service?’” Robert Peck, an analyst with Suntrust Robinson, told Reuters.

Twitter stock is trading at about 32 times expected 2014 sales, compared to 14 times for Facebook and 12 times for LinkedIn, according to Reuters data. By this metric, which is frequently used on Wall Street to assess the relative value of a company’s shares, Twitter’s stock price appears high, at least compared to other Internet companies that have gone public in recent years. Wall Street’s consensus expectation is for the company to report $218 million in fourth quarter revenue with a slight earnings per share loss.

Because Twitter has only been public for a few months, there’s a lack of data from which to extrapolate the company’s future performance. That helps explain why Wall Street analysts are so divided about Twitter’s valuation — and why they will be listening like hawks for any clues about the company’s prospects. Heading into the earnings report, seven analysts recommend or strongly recommend buying the stock, 13 rate it as “hold,” and 11 have it as “underperform” or “sell,” according to Wall Street firms surveyed Reuters.

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John Blackledge, a tech analyst a Cowen and Co., is also concerned that Twitter’s market value may be outpacing its business performance. “Twitter is a popular social platform, but shares are too rich in our view,” Blackledge says, adding that Twitter’s revenue growth appears to be decelerating. The company posted revenue of $317 million in 2012, and Blackledge expects that figure will double to $631 million for 2013. By 2014, Blackledge predicts Twitter revenues of $997 million, which would represent a substantial deceleration in revenue growth.

Mark Mahaney, a tech analyst at RBC Capital Markets, is more bullish than some of his Wall Street colleagues about Twitter’s prospects. “We think that current valuation does not fully reflect Twitter’s enormous opportunity,” Mahaney wrote in a note to clients this week. According to a recent study conducted by Ad Age in conjunction with RBC, 80% of ad executives surveyed say they plan to use Twitter in the next 12 months, but only 46% say they’ve ever bought an ad on the platform, suggesting significant potential for growth.

It’s worth noting that Facebook showed a similar dynamic just a few years ago. Now, the social media titan has become a staple of major corporate advertising budgets. Last week, Facebook reported an eight-fold increase in earnings, sending the company’s stock soaring.

Facebook’s performance has at least some Wall Street analysts optimistic about Twitter’s prospects. “We remain positive on Twitter’s ability to become one of the Web’s leading utilities (alongside Google, Amazon, Facebook),” Mahaney wrote. “Twitter has displayed very robust growth in key metrics, and we have confidence that this momentum can continue as the company develops its advertising platform.”