TWITTER- GOOD OR BAD EXPERIENCE ?

Here’s the argument – the only argument, really – for paying more than $40 for Twitter. The global advertising market in 2013 is worth a bit over $500bn, according to ZenithOptimedia and various other industry observers, and it is growing at a mid-single digit rate annually. Advertising at the biggest western social networking companies – Facebook, Twitter, and LinkedIn – total a bit under $7bn during the past 12 months. So these companies, which have a billion-and-a-half active users between them, collect about $1 out of every $100 spent on advertising. That’s nothing.

So let’s try and imagine the world in, say, five years. If these three companies by then are collecting just $5 out of every hundred dollars, they will have captured a revenue pool of $29bn. If you suppose that Twitter gets just a fifth of that (supposing, that is to say, that it takes some share from Facebook) it will have annual revenues of $6bn. Now, Twitter’s variable costs are very low. So at that size, half the money that comes in the door could turn into cash profits. In that kind of a future, the company could be worth $60bn. So valuing it today at $30bn or so – what a $40+ price implies – makes sense. Right?

Maybe. Consider three objections:

How much advertising inventory can a social network – however large – carry? Facebook has said that it does no plan to increase the volume of ads in its users “news feeds,” or running ticker of updates from friends, from where it is now.

Advertising takes many forms, but all of them (whatever ad sellers might say) create friction for users. When imagining $7bn turning into $29bn, think on this.

Second, will advertisers decide the best way to deploy social networks is by buying ads from them? Coca-Cola has 2m followers on Twitter. The company pays nothing for this.

Finally, do ads on social networks work? Facebook’s astonishing results in the past few quarters show that advertisers are piling in – especially on mobile devices. But advertisers are, in essence, in the midst of an experiment that has been running for only a year or two. At some point they, and investors, will pause to assess whether it is working.