By WSJ Staff
From Deal Journal’s Michael Corkery:
Another day, another Twitter valuation. The latest one being bandied about for the popular site is $1 billion.
Of course, there is a long history of famously overvalued Internet start-up businesses. The $15 billion value once applied to Facebook and the $2.6 billion valuation of Skype four years ago come quickly to mind.
The problems are legion. First, it is often difficult to come up with comparables (there has never been anything quite like Twitter) and the valuations often come before such important standards as, say, profits, so investors are left valuing a business based on such metrics as future revenue.
Still, a $1 billion value for Twitter is not “outlandish,’’ says Anant Sundaram, a finance professor and valuation guru at Dartmouth’s Tuck School of Business, who agreed to provide a framework for valuing the company for Deal Journal.
“Who knows how it will pan out, but you can get a sense of the assumptions that would be required to justify a $1 billion valuation,’’ he says.
Deal Journal shared with Sundaram Twitter’s revenue and user projections that were reportedlyleaked out of the company a few months back–Twitter officially maintains that it hasn’t yet decided how it’s going to turn a profit.
Those projections estimate that Twitter will have one billion users by the end of 2013. To reach the $1 billion value, Mr. Sundaram instead used a projection of 250 million users. That would be about 10 times more users than Twitter is expected to have by 2009, according to some estimates. The $1 billion valuation also may assume that Twitter could throw off about $2 in annual revenue, for a total of $500 million revenue in 2013.
He then applied a set of Google’s multiples to Twitter. Like Google, Twitter could prove to be a low-cost, high-margin business with a huge user base.
Extrapolating from Google’s 27% profit margin would give Twitter about $135 million of profit four years from now. Applying Google’s forward price-to-earnings multiple of about 20, that reaches a value of about $2.7 billion.
Of course, that figure has to be discounted to account for the time value of money. To do that, Mr. Sundaram applied an approximately 20% discount rate, which is toward the high end of the range for discounts often applied to small, risky, high-growth companies.
That produces a current value of about $1.3 billion.
Of course, there are multiple caveats. Twitter execs have said recently they are planning to generate revenue by offering a way for companies to monitor tweets about their products. And it is an open question as to whether Twitter could come close to matching the Google profit machine. And can Twitter keep adding users at the current, blistering pace, or whether it can prevent another social-networking site from starting up and stealing Twitter’s users
“That’s the critical question,” Sundaram says. “Are there barriers to entry that can prevent competitors from competing you away?”
–Jodi Xu contributed to this article.
