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Twitter a Hugely Interesting Company

Jeremy Glaser
Rick Summer, CFA, CPA

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.

Twitter's S1 was made public this week, and I'm here with Rick Summer--he is the senior equity analyst who will be covering Twitter for us--to get his first take.

Rick, thanks for joining us.

Rick Summer: Sure thing.

Glaser: So, let's talk a little bit about how Twitter is doing so far. Any surprises when you cracked open that filing as to what kind of progress they are making?

Summer: I think there is a few things that are interesting. Obviously, a few years ago, the rumors were, Twitter can't figure out how to make money, and I think that clearly they have. At a run rate of at least north of half a billion dollars in revenue this year, they are already larger on an advertising basis than LinkedIn from their advertising segment. So pretty meaningful. Certainly not reaching the levels of a Facebook yet, so I think that's an important thing to consider.

Secondly, they are still investing a ton of money. They have somewhat turned the corner--positive operating cash flow in the first six months of this year--but still not positive free cash flow once you back out capital expenditures as well.

Glaser: Where are on that revenue ramp? Does Twitter have a significant opportunity to keep growing that revenue?

Summer: I think that one of the big success factors about Twitter is the fact that they've evolved from this 140-character interaction to really start to incorporate new sorts of ad formats as well. But first, promoted tweets, promoted trends, ways to start to differentiate exactly how you show content, but more importantly ways to charge advertisers at the same time without changing how you and I look at our Twitter feed--I think, that's really important. We are at 218 million users right now. We've seen just year-over-year 48% growth in their ability to generate ad revenues on each of those monthly active users at the same time. That's pretty tremendous. Good progress.

Glaser: Do you think that there is significant room to add a lot more users, or are we closer to an upper limit?

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Summer: It's the magic question I think: What is Twitter? Is it is a tool for the masses or is it a tool for a much smaller subset of that?

Certainly, they are a fraction, a fifth, of the size of Facebook today. The company has highlighted--I think it's obvious--but they've highlighted how challenging it can be to begin using that first Twitter experience. We would expect a great deal of investment by the company in how do you consume tweets to make it easier.

I would say the interesting thing--this is not a company that spends money on advertising. You can watch television and they are advertising for free for Twitter by showing hash tags, by incorporating Twitter content. So, unlike many companies, this is a company that has a symbiotic relationship with a whole host of other companies and celebrities trying to highlight hash tags and tweets, and I think that that actually helps pull in users. Everyone has a vested interest in making Twitter an easier platform to use.

Glaser: Let's talk a little bit about the economic moat, or the competitive advantage. I know we haven't actually started covering the company yet, so we don't have a rating. But how do you think about the advantage? Is it more like Facebook, where it's a real social network, with the network effect, or is it something that just isn't going to be as sticky?

Summer: It's a great, great point to make, which is when people lump in social networking, what does that really mean? You look at Facebook and LinkedIn. These are networks that you have with people you already know, primarily, or a way of growing your professional network at LinkedIn--but largely static. There are evolving relationships, but largely static.

You look at the relationships that you have, perhaps, in a Twitter community--calling them relationships is a bit strong. This is a little bit more of a promiscuous kind of relationship, where you're interacting with a celebrity. You're looking at pundits that follow your industry, whether it be pharmaceuticals or technology. You are following sports teams as a fan. There are a lots of different ways to be able to follow that, but we have no idea what you'll be doing 10 years from now versus today. It's much more difficult.

So what does that mean? It's a distribution platform, but highly unique and highly proprietary. As long as content producers keep coming out, sharing their jokes, trying to draw people into their offline properties, we think there is a great feedback loop to continue to have users come out and use Twitter.

Glaser: We don't have any pricing on the IPO yet, but when looking at valuations of other companies in this space, what would you expect? A pretty rich valuation for Twitter?

Summer: The way that we've talked about it already with clients is, look, we have LinkedIn, which we think is a pretty widely overstretched valuation. Facebook has actually traded reasonably far north now of what we think it's worth today. Given the environment, we would expect Twitter to probably trade ahead of what it's worth, but the devil will be in the details when it actually prices. Looking at the last round, where very few shares traded, you're close to $13 billion off of a half billion dollar run rate--already a pretty healthy multiple from that perspective as well.

So we'll see where we come out. Hugely interesting company. It's extremely importantly, we think, to understand from an investor standpoint, because if you don't get a crack now, you always might get a crack later as well.

Glaser: Rick, thanks for your first take today.

Summer: Sure thing. Thanks.

Glaser: For Morningstar, I'm Jeremy Glaser.