Twitter Treading Warily on Road to IPO

Can the company tweet past Groupon’s graveyard and Facebook’s flop?

The White House plans to promote #My2K on Twitter and other social media.
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The tweets just keep coming for Twitter—thousands per second, by latest count. But the giant of social media one-liners needs to show a year of steady revenue growth if it hopes to avoid Facebook's disappointing stock market debut and the serious failure of others like Groupon and Zynga.

The pressure is on this year for Twitter as it enters the home stretch on its way to an IPO that many expect to launch a year or so from now. Before it happens, the company must complete the difficult transition from Web 1.0-style popularity to Web 2.0 profit.

"We have no doubt that the huge problems of the Facebook, Zynga, and Groupon IPOs—and high-profile LivingSocial's $950 million in venture capital raised burned through so quickly—reinforces Twitter's decision to take a go-slow approach on its IPO," says Sam Hamadeh, chief executive of PrivCo, a provider of financial data on private companies.

Creating an engaged audience is not a problem for Twitter—and it doesn't need any Super Bowl or Academy Award TV ads to do it. (There were nine million tweets about the awards during the event.) If anyone doubts Twitter's ability to create an audience, they are probably tweeting about it. Twitter is already so ingrained in the culture that it is an established media giant by itself with 500 million registered viewers. Tech-savvy people are too busy trying to build Twitter followings to stop and figure out if it's really worth the effort.

But for investors, the company's success will be measured not by who is tweeting but by Twitter's ability to find advertising sponsors to make money on those terabytes of tweets. The company is private and its true financial numbers are not known. Twitter investors are long-term investors who are betting the company will keep growing well into the future. But they are looking for some kind of payback in the next two years in the form of an initial public stock offering or a buyout by a larger firm at IPO-type valuations, says Hamadeh.

An IPO is far more likely than a sale to a larger company. There are a limited number of potential strategic acquirers who would pay $10 billion or more for an investment that might take years to become very profitable. Apple and other tech companies, with huge stashes of cash, have been mentioned as possible buyers who could enhance their market positions by adding Twitter to their offerings. A report last year said Twitter rejected a buyout offer from its archrival, Facebook.

[Read: Steve Jobs Obsessed Over Competition, Does Tim Cook?]

Twitter's chief executive officer Dick Costolo, in a recent interview with the Wall Street Journal, said an IPO is "not necessarily inevitable." He added that "There are lots of different choices companies can make now."

One of Twitter's options is to remain private for a prolonged period and build the company in a slower, more deliberate way than a public company can do, and preempt a sequel to the Facebook drama. An emerging marketplace for pre-IPO shares could satisfy any immediate demands by early shareholders and employees pushing to get money out of their holdings.

Still, there are also public buyers to worry about. Waiting too long to go public raises the concern that private investors will push the value so high that the shares will be overvalued by the time they are offered to the public, a factor in the $100 billion Facebook IPO. Facebook insiders sold heavily at the start of trading to capture the puffed-up shares, and the company's value began sinking, losing $40 billion in market value in the weeks after the offering. Zynga shares fell 70 percent from their IPO level and Groupon by 80 percent, leaving investors wary about buying any social media stock.

Twitter will do its best to avoid selling too late or too early, says Hamadeh. By waiting a year, it is likely to show a doubling of revenues and be in a stronger position to handle the kind of scrutiny and high expectations that met Facebook. By that time, Twitter is likely to be valued at about $9 billion to $11 billion, or about 10 times expected revenue, which is about half the amount per dollar of revenue that Facebook commanded when it went public.